Chemed - 10-Q quarterly report FY2018 Q3

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

☒    Quarterly Report Under Section 13 or 15 (d) of the Securities Exchange Act of 1934 For the Quarterly Period Ended September 30, 2018

☐    Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

Commission File Number: 1-8351

CHEMED CORPORATION

(Exact name of registrant as specified in its charter)

CHEMED CORPORATION AND

SUBSIDIARY COMPANIES

Index

 

Notes to Unaudited Consolidated Financial Statements

1.   Basis of Presentation

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

We have prepared the accompanying unaudited consolidated financial statements of Chemed in accordance with Rule 10-01 of SEC Regulation S-X.  Consequently, we have omitted certain disclosures required under generally accepted accounting principles in the United States (“GAAP”) for complete financial statements. The December 31, 2017 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 state 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 audited Consolidated Financial Statements and related notes included in our Annual Report on Form 10-K for the year ended December 31, 2017.

In August 2016, the FASB issued Accounting Standards Update “ASU No. 2016-15 – Cash Flow Classification” which amends guidance on the classification of certain cash receipts and payments in the statement of cash flows.  The primary purpose of ASU 2016-15 was to reduce diversity in practice related to eight specific cash flow issues.  The guidance in this ASU was effective for fiscal years beginning after December 15, 2017.    We adopted this ASU as of January 1, 2018.  There was no material effect to our statements of cash flow.

The enactment of the Tax Cuts and Jobs Act (“the Act”) and subsequent issue of SAB 118 provides for a measurement period not to exceed one year in order to complete implementation of the Act. We have recognized and disclosed provisional amounts for material items in the prior period. We expect to complete our implementation within one year consistent with SAB 118.  We have not recognized a provisional amount for GILTI tax as we do not expect this to materially impact the financial statements. We have not adjusted or recognized any other provisional amounts related to the Act during the quarter and year ended September 30, 2018.

Our effective income tax rate was 18.6% in the third quarter of 2018 compared to 34.7% during the third quarter of 2017.   Excess tax benefit on stock options reduced our income tax expenses by $3.1 million and $1.8 million, respectively for the quarters ended September 30, 2018 and 2017.

Our effective income tax rate was 14.5% for the first nine months ended September 30, 2018 compared to 25.8% during the first nine months ended of 2017.   Excess tax benefit on stock options reduced our income tax expenses by $18.6 million and $8.1 million, respectively for the nine months ended September 30, 2018 and 2017.

Included in the accompanying Consolidated Balance Sheets are $2.5 million and $2.7 million of capitalized property and equipment which were not paid for as of September 30, 2018 and December 31, 2017, respectively.  These amounts have been excluded from capital expenditures in the accompanying Consolidated Statements of Cash Flow.  There are no material non-cash amounts included in interest expense for any period presented.

2.   Revenue Recognition

In May 2014, the FASB issued Accounting Standards Update “ASU No. 2014-09 – Revenue from Contracts with Customers.”  The standard and subsequent amendments are theoretically intended to develop a common revenue standard for removing inconsistencies and weaknesses, improve comparability, provide for more useful information to users through improved disclosure requirements and simplify the preparation of financial statements.  The standard is also referred to as Accounting Standards Codification No. 606 (“ASC606”).  We adopted ASC 606 effective January 1, 2018.  The required disclosures of ASC 606 and impact of adoption are discussed below for each of our operating subsidiaries.

Service revenue for VITAS is reported at the amount that reflects the ultimate consideration we expect to receive in exchange for providing patient care.  These amounts are due from third-party payors, primarily commercial health insurers and government programs (Medicare and Medicaid), and includes variable consideration for revenue adjustments due to settlements of audits and reviews, as well as certain hospice-specific revenue capitations.  Amounts are generally billed monthly or subsequent to patient discharge.  Subsequent changes in the transaction price initially recognized are not significant.

Hospice services are provided on a daily basis and the type of service provided is determined based on a physician’s determination of each patient’s specific needs on that given day.  Reimbursement rates for hospice services are on a per diem basis regardless of the type of service provided or the payor.  Reimbursement rates from government programs are established by the appropriate governmental agency and are standard across all hospice providers.  Reimbursement rates from health insurers are negotiated with each payor and generally structured to closely mirror the Medicare reimbursement model.  The types of hospice services provided and associated reimbursement model for each are as follows:

Routine Home Care occurs when a patient receives hospice care in their home, including a nursing home setting.  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.  For Medicare patients, the routine home care rate reflects a two-tiered rate, with a higher rate for the first 60 days of a hospice patient’s care and a lower rate for days 61 and after.  In addition, there is a Service Intensity Add-on payment which covers direct home care visits conducted by a registered nurse or social worker in the last seven days of a hospice patient’s life, reimbursed up to four hours per day in fifteen minute increments at the continuous home care rate.

General Inpatient Care occurs when a patient requires services in a controlled setting for a short period of time 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 is provided to patients while at home, including a nursing home setting, 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 at midnight.  The care must be predominantly nursing care provided by either a registered nurse or licensed nurse practitioner.  While the published Medicare continuous home care rates are daily rates, Medicare pays for continuous home care in fifteen minute increments.  This fifteen minute rate is calculated by dividing the daily rate by 96.

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.

Each level of care represents a separate promise under the contract of care and is provided independently for each patient contingent upon the patient’s specific medical needs as determined by a physician.  However, the clinical criteria used to determine a patient’s level of care is consistent across all patients, given that, each patient is subject to the same payor rules and regulations.  As a result, we have concluded that each level of care is capable of being distinct and is distinct in the context of the contract.  Furthermore, we have determined that each level of care represents a stand ready service provided as a series of either days or hours of patient care.  We believe that the performance obligations for each level of care meet criteria to be satisfied over time.  VITAS recognizes revenue based on the service output.  VITAS believes this to be the most faithful depiction of the transfer of control of services as the patient simultaneously receives and consumes the benefits provided by our performance. Revenue is recognized on a daily or hourly basis for each patient in accordance with the reimbursement model for each type of service.  VITAS’ performance obligations relate to contracts with an expected duration of less than one year.  Therefore, VITAS has elected to apply the optional exception provided in ASC 606 and is not required to disclose the aggregate amount of the transaction price allocated to performance obligations that are unsatisfied or partially unsatisfied at the end of the reporting period.  The unsatisfied or partially satisfied performance obligations referred to above relate to bereavement services provided to patients’ families for at least 12 months after discharge.

Care is provided to patients regardless of their ability to pay.  Patients who meet our criteria for charity care are provided care without charge.  There is no revenue or associated accounts receivable in the accompanying consolidated financial statements related to charity care.  The cost of providing charity care during the quarters ended September 30, 2018 and 2017 was $2.0 million and $1.9 million, respectively.  The cost of providing charity care during the nine months ended September 30, 2018 and 2017 was $6.2 million and $5.6 million, respectively. The cost of charity care is included in cost of services provided and goods sold and is calculated by taking the ratio of charity care days to total days of care and multiplying by the total cost of care.

Generally, patients who are covered by third-party payors are responsible for related deductibles and coinsurance which vary in amount.  VITAS also provides service to patients without a reimbursement source and may offer those patients discounts from standard charges.  VITAS estimates the transaction price for patients with deductibles and coinsurance, along with those uninsured patients, based on historical experience and current conditions.  The estimate of any contractual adjustments, discounts or implicit price concessions reduces the amount of revenue initially recognized.  Subsequent changes to the estimate of the transaction price are recorded as adjustments to patient service revenue in the period of change.  Subsequent changes that are determined to be the result of an adverse change in the patients’ ability to pay (i.e. change in credit risk) are recorded as bad debt expense.  VITAS has no material adjustments related to subsequent changes in the estimate of the transaction price or subsequent changes as the result of an adverse change in the patient’s ability to pay for any period reported.

Laws and regulations concerning government programs, including Medicare and Medicaid, are complex and subject to varying interpretation.  Compliance with such laws and regulations may be subject to future government review and interpretation.  Additionally, the contracts we have with commercial health insurance payors provide for retroactive audit and review of claims.  Settlement with third party payors for retroactive adjustments due to audits, reviews or investigations are considered variable consideration and are included in the determination of the estimated transaction price for providing patient care.  The variable consideration is estimated based on the terms of the payment agreement, existing correspondence from the payor and our historical settlement activity.  These estimates are adjusted in future periods, as new information becomes available.

We are subject to certain limitations on Medicare payments for services which are considered variable consideration, as follows:

Inpatient Cap.  If the number of inpatient care days any hospice program provides to Medicare beneficiaries exceeds 20% of the total days of hospice care such program provided to all Medicare patients for an annual period beginning September 28, the days in excess of the 20% figure may be reimbursed only at the routine homecare rate. None of VITAS’ hospice programs exceeded the payment limits on inpatient services during the three and nine months ended September 30, 2018 and 2017.

Medicare Cap.  We are also subject to a Medicare annual per-beneficiary cap (“Medicare cap”). Compliance with the Medicare cap is measured in one of two ways based on a provider election. The “streamlined” method compares total Medicare payments received under a Medicare provider number with respect to services provided to all Medicare hospice care beneficiaries in the program or programs covered by that Medicare provider number between November 1 of each year and October 31 of the following year with the product of the per-beneficiary cap amount and the number of Medicare beneficiaries electing hospice care for the first time from that hospice program or programs from September 28 through September 27 of the following year.  At September 30, 2018 all our programs except one are using the “streamlined” method.

The “proportional” method compares the total Medicare payments received under a Medicare provider number with respect to services provided to all Medicare hospice care beneficiaries in the program or programs covered by the Medicare provider number between September 28 and September 27 of the following year with the product of the per beneficiary cap amount and a pro-rated number of Medicare beneficiaries receiving hospice services from that program during the same period. The pro-rated number of Medicare beneficiaries is calculated based on the ratio of days the beneficiary received hospice services during the measurement period to the total number of days the beneficiary received hospice services.

We actively monitor each of our hospice programs, by provider number, as to their specific admission, discharge rate and median length of stay data in an attempt to determine whether revenues are likely to exceed the annual per-beneficiary Medicare cap. Should we determine that revenues for a program are likely to exceed the Medicare cap based on projected trends, we attempt to institute corrective actions, which include changes to the patient mix and increased patient admissions. However, should we project our corrective action will not prevent that program from exceeding its Medicare cap, we estimate revenue recognized during the government fiscal year that will require repayment to the Federal government under the Medicare cap and record an adjustment to revenue of an amount equal to a ratable portion of our best estimate for the year.

Roto-Rooter provides plumbing, drain cleaning, water restoration and other related services to both residential and commercial customers primarily in the United States.  Services are provided through a network of company-owned branches, independent contractors and franchisees.  Service revenue for Roto-Rooter is reported at the amount that reflects the ultimate consideration we expect to receive in exchange for providing services.

Roto-Rooter owns and operates branches focusing mainly on large population centers in the United States.  Roto-Rooter’s primary lines of business in company-owned branches consist of plumbing, sewer and drain cleaning, excavation and water restoration.  For purposes of ASC 606 analysis, plumbing, sewer and drain cleaning, and excavation have been combined into one portfolio and are referred to as “short-term core services”.  Water restoration is analyzed as a separate portfolio.  The following describes the key characteristics of these portfolios:

Short-term Core Services are plumbing, drain and sewer cleaning and excavation services.  These services are provided to both commercial and residential customers.  The duration of services provided in this category range from a few hours to a few days.  There are no significant warranty costs or on-going obligations to the customer once a service has been completed.  For residential customers, payment is received at the time of job completion before the Roto-Rooter technician leaves the residence.  Commercial customers may be granted credit subject to internally designated authority limits and credit check guidelines.  If credit is granted, payment terms are 30 days or less.

Each job in this category is a distinct service with a distinct performance obligation to the customer.  Revenue is recognized at the completion of each job.  Variable consideration consists of pre-invoice discounts and post-invoice discounts.  Pre-invoice discounts are given in the form of coupons or price concessions. Post-invoice discounts consist of credit memos generally granted to resolve customer service issues.  Variable consideration is estimated based on historical activity and recorded at the time service is completed.

Water Restoration Services involve the remediation of water and humidity after a flood.   These services are provided to both commercial and residential customers.  The duration of services provided in this category generally ranges from 3 to 5 days.  There are no significant warranties or on-going obligations to the customer once service has been completed.  The majority of these services are paid by the customer’s insurance company.  Variable consideration relates primarily to allowances taken by insurance companies upon payment.  Variable consideration is estimated based on historical activity and recorded at the time service is completed.

For both short-term core services and water restoration services, Roto-Rooter satisfies its performance obligation at a point in time.  The services provided generally involve fixing plumbing, drainage or flood-related issues at the customer’s property.  At the time service is complete, the customer acknowledges its obligation to pay for service and its satisfaction with the service performed.  This provides evidence that the customer has accepted the service and Roto-Rooter is now entitled to payment.  As such, Roto-Rooter recognizes revenue for these services upon completion of the job and receipt of customer acknowledgement.  Roto-Rooter’s performance obligations for short-term core services and water restoration services relate to contracts with an expected duration of less than a year.  Therefore, Roto-Rooter has elected to apply the optional exception provided in ASC 606 and is not required to disclose the aggregate amount of the transaction price allocated to performance obligations that are unsatisfied or partially unsatisfied at the end of the reporting period.  Roto-Rooter does not have significant unsatisfied or partially unsatisfied performance obligations at the time of initial revenue recognition for short-term core or water restoration services.

Roto-Rooter owns the rights to certain territories and contracts with an independent third-party to operate the territory under Roto-Rooter’s registered trademarks.  The contract is for a specified term but cancellable by either party without penalty with 90 days advance notice.  Under the terms of these arrangements, Roto-Rooter provides certain back office support and advertising along with a limited license to use Roto-Rooter’s registered trademarks.  The independent contractor is responsible for all day-to-day management of the business including staffing decisions and pricing of services provided. All performance obligations of Roto-Rooter cease at the termination of the arrangement.

Independent contractors pay Roto-Rooter a standard fee calculated as a percentage of their weekly labor sales.  The primary value for the independent contractors under these arrangements is the right to use Roto-Rooter’s registered trademarks.  Roto-Rooter recognizes revenue from independent contractors over-time (weekly) as the independent contractor’s labor sales are completed.  Payment from independent contractors is also received on a weekly basis.  The use of Roto-Rooter’s registered trademarks and advertising provides immediate value to the independent contractor as a result of Roto-Rooter’s nationally recognized brand.  Therefore, over-time recognition provides the most faithful depiction of the transfer of services as the customer simultaneously receives and consumes the benefits provided. There is no significant variable consideration related to these arrangements.

Roto-Rooter has licensed the rights to operate under Roto-Rooter’s registered trademarks in other territories to franchisees.   The contract is for a 10 year term but cancellable by Roto-Rooter for cause with 60 day advance notice without penalty.  The franchisee may cancel the contract for any reason with 60 days advance notice without penalty.  Under the terms of the contract, Roto-Rooter provides national advertising and consultation on various aspects of operating a Roto-Rooter business along with the right to use Roto-Rooter’s registered trademarks.  The franchisee is responsible for all day- to-day management of the business including staffing decisions, pricing of services provided and local advertising spend and placement. All performance obligations of Roto-Rooter cease at the termination of the arrangement.

Franchisees pay Roto-Rooter a standard monthly fee based on the population within the franchise territory.  The standard fee is revised on a yearly basis based on changes in the Consumer Price Index for All Urban Consumers.  The primary value for the franchisees under this arrangement is the right to use Roto-Rooter’s registered trademarks.  Roto-Rooter recognizes revenue from franchisees over-time (monthly).  Payment from franchisees is also received on a monthly basis.  The use of Roto-Rooter’s registered trademarks and advertising provides immediate value to the franchisees as a result of Roto-Rooter’s nationally recognized brand.  Therefore, over-time recognition provides the most faithful depiction of the transfer of services as the customer simultaneously receives and consumes the benefits provided. There is no significant variable consideration related to these arrangements.

The composition of disaggregated revenue for the quarter ended September 30, 2018 is as follows (in thousands):

        Initial Adoption of ASC 606

3.   Segments

We report corporate administrative expenses and unallocated investing and financing income and expense not directly related to either segment as “Corporate”.

4.  Earnings/(Loss) per Share

Earnings per share (“EPS”) are computed using the weighted average number of shares of capital stock outstanding.  Earnings and diluted earnings per share are computed as follows (in thousands, except per share data):

For the three and nine month periods ended September 30, 2018, there were no stock options excluded in the computation of dilutive earnings per share because they would have been anti-dilutive.

For the three months ended September 30, 2017, no stock options and nonvested stock awards have been excluded in the calculation of dilutive earnings per share as they would be anti-dilutive due to the net loss for the period.

For the nine month period ended September 30, 2017, there were 7,304 stock options excluded in the computation of dilutive earnings per share because they would have been anti-dilutive.

5.   Long-Term Debt and Lines of Credit

On June 20, 2018, we replaced our existing credit agreement with the Fourth Amended and Restated Credit Agreement (“2018 Credit Agreement”).  Terms of the 2018 Credit Agreement consist of a five-year, $450 million revolving credit facility and a $150 million expansion feature, which may consist of term loans or additional revolving commitments.  The interest rate at the inception of the agreement is LIBOR plus 100 basis points.  The 2018 Credit Agreement has a floating interest rate that is generally LIBOR plus a tiered additional rate which varies based on our current leverage ratio.  The amount outstanding as of September 30, 2018 is $130.0 million.

Debt issuance costs associated with the prior credit agreement were not written off as the lenders and their relative percentages participation in the facility did not change.  With respect to the 2018 Credit Agreement, deferred financing costs were $1.0 million.

The 2018 Credit Agreement contains the following quarterly financial covenants:

We are in compliance with all debt covenants as of September 30, 2018. We have issued $36.4 million in standby letters of credit as of September 30, 2018 mainly for insurance purposes.  Issued letters of credit reduce our available credit under the 2018 Credit Agreement.  As of September 30, 2018, we have approximately $283.6 million of unused lines of credit available and eligible to be drawn down under our revolving credit facility.

6.   Other Operating (Income)/Expenses

In June 2017, we recorded a $90.0 million charge for the settlement of a lawsuit at VITAS.  See Footnote 10 for a detailed description.

7.   Other Income – Net

 8.   Stock-Based Compensation Plans

On February 16, 2018, the Compensation/Incentive Committee of the Board of Directors (“CIC”) granted 7,523 Performance Stock Units (“PSUs”) contingent upon the achievement of certain total shareholders return (“TSR”) targets as compared to the TSR of a group of peer companies for the three-year period ending December 31, 2020, the date at which such awards vest.  The cumulative compensation cost of the TSR-based PSU award to be recorded over the three year service period is $2.6 million.

On February 16, 2018, the CIC also granted 7,523 PSUs contingent upon the achievement of certain earnings per share (“EPS”) targets for the three-year period ending December 31, 2020.  At the end of each reporting period, the Company estimates the number of shares that it believes will ultimately be earned and records the corresponding expense over the service period of the award.  We currently estimate the cumulative compensation cost of the EPS-based PSUs to be recorded over the three year service period is $1.9 million.

9.   Retirement Plans

10.  Legal and Regulatory Matters

The VITAS segment of the Company’s business operates in a heavily-regulated industry.  As a result, the Company is subjected to inquiries and investigations by various government agencies, as well as to lawsuits, including qui tam actions.  The following sections describe the various ongoing material lawsuits and investigations of which the Company is currently aware.  It is not possible at this time for us to estimate either the timing or outcome of any of those matters, or whether any potential loss, or range of potential losses, is probable or reasonably estimable.

Regulatory Matters and Litigation

The Company and certain current and former directors and officers are defendants in a case captioned In re Chemed Corp. Shareholder Derivative Litigation, No. 13 Civ. 1854 (LPS) (CJB) (D. Del.), which was consolidated on February 2, 2015.

On February 2, 2015, the Court appointed KBC Asset Management NV the sole lead plaintiff and its counsel, the sole lead and liaison counsel.  On March 3, 2015, Lead Plaintiff KBC designated its Complaint as the operative complaint in the consolidated proceedings and defendants renewed a previously filed motion to dismiss those claims and allegations.  The consolidated Complaint named fourteen individual defendants, together with the Company as nominal defendant.  The Complaint alleges a claim for breach of fiduciary duty against the individual defendants for allegedly permitting the Company to submit false claims to the U.S. government.  The Complaint seeks (a) a declaration that the individual defendants breached their fiduciary duties to the Company; (b) an order requiring those defendants to pay compensatory damages, restitution and exemplary damages, in unspecified amounts, to the Company; (c) an order directing the Company to implement new policies and procedures; and (d) costs and disbursements incurred in bringing the action, including attorneys’ fees.  On May 12, 2016, the Court issued a Memorandum Order granting Chemed’s motion to dismiss, and dismissing Lead Plaintiff KBC’s Complaint without prejudice to KBC’s opportunity to file within 30 days of the date of the Court’s Order (i.e., by June 13, 2016) an amended Complaint addressing the deficiencies in its duty of loyalty claim.  Lead Plaintiff KBC did not file an amended Complaint within the time specified by the Court.

However, on June 13, 2016, counsel for Chemed shareholder Michael Kvint filed a letter with the Court requesting a two-week extension to file a motion to substitute Mr. Kvint as lead plaintiff, in place of Lead Plaintiff KBC and to file an amended Complaint.  Alternatively, counsel for Mr. Kvint requested that any dismissal of the action be with prejudice to KBC only.  On June 14, 2016, Chemed filed a reply letter with the Court, reserving its rights to oppose any motion filed by Mr. Kvint and, if warranted, to oppose any other actions taken by Mr. Kvint to proceed with the action (including by filing an untimely amended Complaint).  On June 21, 2016, the Court entered an Oral Order providing Mr. Kvint until June 30, 2016 to file a Motion to Substitute and Motion for Leave to File an Amended Complaint.  On that date, Mr. Kvint filed, under seal, a Motion to Substitute Plaintiff and File Amended Complaint, and attached a Proposed Amended Complaint.  Mr. Kvint’s motion was fully briefed by the parties.  On April 25, 2017, Magistrate Judge Burke issued a Report and Recommendation recommending that the Court permit Mr. Kvint to intervene as Lead Plaintiff and grant leave to amend the complaint to replead the duty of loyalty claim only.  On May 16, 2017, Chief Judge Stark signed an Order adopting that Report and Recommendation.  Plaintiff Kvint filed a Corrected Amended Complaint on May 30, 2017.  On September 13, 2017, the Court entered an order dismissing with prejudice the claims against defendants Timothy S. O’Toole and Joel F. Gemunder and permitting Defendants to file a Motion to Dismiss the Corrected Amended Complaint. The matter has been fully briefed and argued.  As the Company has previously disclosed, the legal fees and costs associated with defending against this lawsuit are presently being paid by insurance.  For additional procedural history of this litigation, please refer to our prior quarterly and annual filings.

On October 30, 2017, the Company entered into a settlement agreement (the “Settlement Agreement”) to resolve civil litigation under the False Claims Act brought by the United States Department of Justice (“DOJ”) on behalf of the OIG and various relators concerning VITAS, filed in the U.S. District Court of the Western District of Missouri (the “2013 Action”).  The Company denied any violation of law and agreed to settlement without admission of wrongdoing.

In connection with the settlement VITAS and certain of its subsidiaries entered into a corporate integrity agreement (“CIA”) on October 30, 2017.  The CIA formalizes various aspects of VITAS’ already existing Compliance Program and contains requirements designed to document compliance with federal healthcare program requirements.  It has a term of five years during which it imposes monitoring, reporting, certification, oversight, screening and training obligations, certain of which had previously been implemented by VITAS.  It also requires VITAS to engage an Independent Review Organization to perform audit and review functions and to prepare reports regarding compliance with federal healthcare programs.  In the event of breach of the CIA, VITAS could become liable for payment of stipulated penalties or could be excluded from participation in federal healthcare programs.

Under the Settlement Agreement, the United States agreed to release the Company, VITAS, and its hospice operation subsidiaries from any civil or administrative monetary liability relating to any patients’ disputed terminal medical prognosis of six months or less; a lack of medical necessity for billed Continuous Home Care, General Inpatient Care, or Respite Care levels of hospice care; or that the claims for those levels of hospice care were not eligible for payment for any other reason.  The OIG agreed, conditioned on the Company’s full payment and in consideration of VITAS’ obligations under the CIA, to release its permissive exclusion rights and refrain from instituting any administrative action seeking to exclude the Company, VITAS, and its affiliates from participating in Medicare, Medicaid, or other federal healthcare programs in this regard.

The costs incurred related to U.S. v. VITAS and related regulatory matters were $935,000 and $5.2 million for the quarter and year to date September 30, 2017, respectively.  No significant costs were incurred during the quarter and nine months ended September 30, 2018, respectively.

Jordan Seper (“Seper”), a Registered Nurse at VITAS’ Inland Empire program from May 12, 2014 to March 21, 2015, filed a lawsuit in San Francisco Superior Court on September 26, 2016.  She alleged VITAS Healthcare Corp of CA (“VITAS CA”) (1) failed to provide minimum wage for all hours worked; (2) failed to provide overtime for all hours worked; (3) failed to provide a second meal period; (4) failed to provide rest breaks; (5) failed to indemnify for necessary expenditures; (6) failed to timely pay wages due at time of separation; and (7) engaged in unfair business practices.  Seper seeks a state-wide class action of current and former non-exempt employees employed with VITAS in California within the four years preceding the filing of the lawsuit.  She seeks court determination that this action may be maintained as a class action for the entire California class and subclasses, designation as class representative, declaratory relief, injunctive relief, damages (including wages for regular or overtime hours allegedly worked but not paid, premium payments for missed meal or rest periods, and unreimbursed expenses), all applicable penalties associated with each claim, pre and post-judgment interest, and attorneys’ fees and costs.  Seper served VITAS CA with the lawsuit, Jordan A. Seper on behalf of herself and others similarly situated v. VITAS Healthcare Corporation of California, a Delaware corporation; VITAS Healthcare Corp of CA, a business entity unknown; and DOES 1 to 100, inclusive; Los Angeles Superior Court Case Number BC 642857 on October 13, 2016 (“Jordan Seper case”).

On November 14, 2016, the Parties filed a Stipulation to transfer the venue of the lawsuit from San Francisco to Los Angeles.  The Los Angeles Superior Court Complex Division accepted transfer of the case on December 6, 2016 and stayed the case.  On December 16, 2016, VITAS CA filed its Answer and served written discovery on Seper.

Jiwann Chhina (“Chhina”), hired by VITAS as a Home Health Aide on February 5, 2002, is currently a Licensed Vocational Nurse for VITAS’ San Diego program.  On September 27, 2016, Chhina filed a lawsuit in San Diego Superior Court, alleging (1) failure to pay minimum wage for all hours worked; (2) failure to provide overtime for all hours worked; (3) failure to pay wages for all hours at the regular rate; (4) failure to provide meal periods; (5) failure to provide rest breaks; (6) failure to provide complete and accurate wage statements; (7) failure to pay for all reimbursement expenses; (8) unfair business practices; and (9) violation of the California Private Attorneys General Act.  Chhina seeks to pursue these claims in the form of a state-wide class action of current and former non-exempt employees employed with VITAS in California within the four years preceding the filing of the lawsuit.  He seeks court determination that this action may be maintained as a class action for the entire California class and subclasses, designation as class representative, declaratory relief, injunctive relief, damages (including wages for regular or overtime hours allegedly worked but not paid, premium payments for missed meal or rest period, and unreimbursed expenses), all applicable penalties associated with each claim, pre-judgment interest, and attorneys’ fees and costs.  Chhina served VITAS CA with the lawsuit, Jiwan Chhina v. VITAS Health Services of California, Inc., a California corporation; VITAS Healthcare Corporation of California, a Delaware corporation; VITAS Healthcare Corporation of California, a Delaware corporation dba VITAS Healthcare Inc.; and DOES 1 to 100, inclusive; San Diego Superior Court Case Number 37-2015-00033978-CU-OE-CTL on November 3, 2016 (“Jiwann Chhina case”).  On December 1, 2016, VITAS CA filed its Answer and served written discovery on Chhina.

On May 19, 2017, Chere Phillips (a Home Health Aide in Sacramento) and Lady Moore (a former Social Worker in Sacramento) filed a lawsuit against VITAS CA in Sacramento County Superior Court, alleging claims for (1) failure to pay all wages due; (2) failure to authorize and permit rest periods; (3) failure to provide off-duty meal periods; (4) failure to furnish accurate wage statements; (5) unreimbursed business expenses; (6) waiting time penalties; (7) violations of unfair competition law; and (8) violation of the Private Attorneys General Act.  The case is captioned: Chere Phillips and Lady Moore v. VITAS Healthcare Corporation of California, Sacramento County Superior Court, Case No. 34-2017-0021-2755.  Plaintiffs sought to pursue these claims in the form of a state-wide class action of current and former non-exempt employees employed with VITAS CA in California within the four years preceding the filing of the lawsuit.  Plaintiffs served VITAS with the lawsuit on June 5, 2017.  VITAS CA timely answered the Complaint generally denying the Plaintiffs’ allegations.  The Court has stayed all class discovery in this case pending resolution of mediation in the Jordan Seper and Jiwann Chhina cases.

There are currently three other lawsuits against VITAS pending in the superior courts of other California counties that contain claims and class periods that substantially overlap with Phillips’ and Moore’s claims: the Jordan Seper and Jiwann Chhina cases, and Williams v. VITAS Healthcare Corporation of California, filed on May 22, 2017 in Alameda County Superior Court, RG 17853886.

Jazzina Williams’ (a Home Health Aide in Sacramento) lawsuit alleges claims for (1) failure to pay all wages due; (2) failure to authorize and permit rest periods; (3) failure to provide off-duty meal periods; (4) failure to furnish accurate wage statements; (5) unreimbursed business expenses; (6) waiting time penalties; and (7) violations of the Private Attorneys General Act.  Williams seeks to pursue these claims in the form of a state-wide class action of current and former non-exempt employees.  Plaintiff served VITAS with the lawsuit on May 31, 2017.  VITAS CA timely answered the Complaint generally denying Plaintiff’s allegations.  Williams is pursing discovery of her individual claim and has agreed to a stay of class discovery pending mediation in the Jordan Seper and Jiwann Chhina cases.  Defendant filed and served each of Plaintiffs Williams, Phillips, and Moore with a Notice of Related Cases on July 19, 2017.

The Jordan Seper and Jiwann Chhina cases have been consolidated in Los Angeles County Superior court; Chhina was dismissed as a separate action and joined with Seper through the filing of an amended complaint in Seper in which Chhina is also identified as a named plaintiff, on August 28, 2018.

The Company is not able to reasonably estimate the probability of loss or range of loss for any of these lawsuits at this time.

The Company intends to defend vigorously against the allegations in each of the above lawsuits.  Regardless of the outcome of any of the preceding matters, dealing with the various regulatory agencies and opposing parties can adversely affect us through defense costs, potential payments, diversion of management time, and related publicity.  Although the Company intends to defend them vigorously, there can be no assurance that those suits will not have a material adverse effect on the Company.

11.   Concentration of Risk

During the quarter VITAS had pharmacy services agreements with one service provider to provide specified pharmacy services for VITAS and its hospice patients.  VITAS made purchases from this provider of $8.0 and $7.4 million for the three months ended September 30, 2018 and 2017, respectively.  VITAS made purchases from this provider of $24.1 and $24.8 million for the nine months ended September 30, 2018 and 2017, respectively.  Purchases from this provider represent more than 90% of all pharmacy services used by VITAS during each period presented.

12.   Cash Overdrafts and Cash Equivalents

There were no cash overdrafts payable included in accounts payable at September 30, 2018 (December 31, 2017 - $15.3 million).

From time to time throughout the year, we invest excess cash in money market funds with major commercial banks. We closely monitor the creditworthiness of the institutions with which we invest our overnight funds.  The amount invested was not material for each balance sheet date presented.

13.   Financial Instruments

FASB’s authoritative guidance on fair value measurements 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.

The following shows the carrying value, fair value and the hierarchy for our financial instruments as of September 30, 2018 (in thousands):

The following shows the carrying value, fair value and the hierarchy for our financial instruments as of  December 31, 2017 (in thousands):

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.  As further described in Footnote 5, our outstanding long-term debt and current portion of long-term debt have floating interest rates that are reset at short-term intervals, generally 30 or 60 days.  The interest rate we pay also includes an additional amount based on our current leverage ratio.  As such, we believe our borrowings reflect significant nonperformance risks, mainly credit risk.  Based on these factors, we believe the fair value of our long-term debt and current portion of long-term debt approximate the carrying value.

14.   Capital Stock Repurchase Plan Transactions

We repurchased the following capital stock for the three and nine months ended September 30, 2018 and 2017:

In March 2018, the Board of Directors authorized an additional $150.0 million for stock repurchase under Chemed’s existing share repurchase program. We currently have $83.6 million of authorization remaining under this share repurchase plan.

15.   Recent Accounting Standards

In February 2016, the FASB issued Accounting Standards Update “ASU No. 2016-02 – Leases” which introduces a lessee model that brings most leases on to the balance sheets and updates lessor accounting to align with changes in the lessee model and the revenue recognition standard.   The guidance is effective for fiscal years beginning after December 15, 2018.  We anticipate a modified retrospective adoption of the ASU and we are in the process of evaluating practical expediency options for adoption.  We have identified and contracted with a software vendor for the technology to support compliance with the ASU.  We currently have all real estate and equipment leases identified and populated into the software. We are in the process of completing our testing our contracts for any potential imbedded leases.   We have implemented controls over the implementation and are also in the process of developing controls once the new standard takes effect.  Based on the provisions of the ASU, we anticipate a material increase in both assets and liabilities when our current operating lease contracts are recorded on the balance sheets.  We do not yet have a dollar estimate of the impact.  We do not anticipate a material impact to overall net income or cash flows.

In January 2017, the FASB issued Accounting Standards Update “ASU No. 2017-4 – Intangibles – Goodwill and Other”.  To simplify the subsequent measurement of goodwill, the FASB eliminated Step 2 from the goodwill impairment test.  The guidance in the ASU is effective for the Company in fiscal years beginning after December 15, 2019.  Early adoption is permitted.  We anticipate adoption of this standard will have no impact on our consolidated financial statements.

In June 2018, the FASB issued Accounting Standards Update “ASU No. 2018-07 – Compensation – Stock Compensation”.  The ASU expands the scope of current guidance to include all share-based payment arrangements related to the acquisition of goods and services from both non-employees and employees.  The guidance in the ASU is effective for the Company in all fiscal years beginning after December 15, 2018.  We are currently evaluating the impact of this standard on our consolidated financial statements, if any.

16.   Acquisitions

On September 26, 2018, VITAS completed the acquisition of Hospice of Citrus and the Nature Coast for $11.0 million in cash.  This acquisition expands VITAS’ services to an additional 12 counties within the state of Florida. A substantial portion of the aggregate purchase price was allocated to goodwill as shown below.  The purchase price allocation related to this acquisition is preliminary and is anticipated to be finalized in the fourth quarter.  The operating results of this business combination have been included in our results of operations since the acquisition date and are not material for the quarter or nine months ended September 30, 2018.  If this acquisition had been completed on January 1, 2017, the acquisition would have added revenue of $3.3 million and $4.2 million, respectively to the quarters ended September 30, 2018 and 2017.  For the nine months ended September 30, 2018 and 2017, respectively, the acquisition would have added revenue of $10.0 million and $12.6 million.

During the first nine months of 2018, we completed two business combination within our Roto-Rooter segment for $1.9 million in cash.  A substantial portion of the aggregate purchase price was allocated to goodwill as shown below.  The operating results of this business combination have been included in our results of operations since the acquisition date and are not material for the quarter or nine months ended September 30, 2018 or for the comparable prior year period.

Shown below is movement in Goodwill (in thousands):

17.   Subsequent Events

On October 1, 2018, Roto-Rooter acquired five formerly independent franchises covering several areas of Northern California for $38.4 million.  The territories covered by the franchises encompass all or parts of six counties, including Contra Costa, Santa Clara, Solano, Napa, Sonoma and San Benito, with a combined population of approximately four million people.  We are in the process of determining the purchase price allocation for this acquisition in the fourth quarter.

Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

We operate through our two wholly-owned subsidiaries, VITAS Healthcare Corporation and Roto-Rooter Group, Inc.  VITAS focuses on hospice care that helps make terminally ill patients’ final days as comfortable as possible.  Through its teams of doctors, nurses, home health aides, social workers, clergy and volunteers, VITAS provides direct medical services to patients, as well as spiritual and emotional counseling to both patients and their families.  Roto-Rooter’s services are focused on providing plumbing, drain cleaning, water restoration and other related services to both residential and commercial customers.  Through its network of company-owned branches, independent contractors and franchisees, Roto-Rooter offers plumbing and drain cleaning service to over 90% of the U.S. population.

The following is a summary of the key operating results (in thousands except per share amounts):

Adjusted net income, adjusted diluted EPS, earnings before interest, taxes and depreciation and amortization (“EBITDA”), Adjusted EBITDA and Adjusted EBITDA as a percent of revenue are not measures derived in accordance with US GAAP.  We provide non-GAAP measures to help readers evaluate our operating results and to compare our operating performance with that of similar companies that have different capital structures.  Our non-GAAP measures should not be considered in isolation or as a substitute for comparable measures presented in accordance with GAAP.  A reconciliation of our non-GAAP measures is presented on pages 30-36.

Effective January 1, 2018 the Company adopted ASU No. 2014-09 – Revenue from Contracts with Customers.  This resulted in the change in classification of net room and board expenses associated with certain patients residing in nursing homes classified from cost of services to revenue.  The amount of the change in classification was $2.6 million and $7.9 million for the three and nine months ended September 30, 2018.  Additionally, approximately $4.6 million and $13.9 million that was historically considered bad debt expenses previously classified in selling, general and administrative expenses were recorded in revenue for the three and nine months ended September 30, 2018.  The Company adopted the standard on a modified retrospective basis for all contracts.  Thus, 2017 has not been restated to conform with the 2018 presentation.  Footnote 2 to the Consolidated Financial Statements gives a complete description of the Company’s adoption.

For the three months ended September 30, 2018, the increase in consolidated service revenues and sales was driven by an 10.8% increase at Roto-Rooter and a 4.4% increase at VITAS.  The increase in service revenues at Roto-Rooter was driven by an increase in all major service lines offset by a $1.6 million decrease related to the adoption of the new revenue recognition standard.  The increase in service revenues at VITAS is comprised primarily of a 0.8% geographically weighted average Medicare reimbursement rate increase, a 7.8% increase in average daily census, offset by $1.9 million in Medicare cap revenue reduction, a 1.8% in acuity mix shift and a $5.5 million decrease related to the adoption of the new revenue recognition standard.  See page 37 for additional VITAS operating metrics.

For the nine months ended September 30, 2018, the increase in consolidated service revenues and sales was driven by a 13.6% increase at Roto-Rooter and a 4.0% increase at VITAS.  The increase in service revenues at Roto-Rooter was driven by an increase in all major service lines offset by a $5.2 million decrease related to the adoption of the new revenue recognition standard.  The increase in service revenues at VITAS is comprised primarily of a 0.8% geographically weighted average Medicare reimbursement rate increase and a 7.2% increase in average daily census, offset by $668,000 in Medicare cap revenue reduction (compared to $247,000 for the same period in 2017), acuity mix shift and a $16.6 million decrease related to the adoption of the new revenue recognition standard.  See page 37 for additional VITAS operating metrics.

Our effective income tax rate was 18.6% in the third quarter of 2018 compared to 34.7% during the third quarter of 2017.  Our effective income tax rate was 14.5% for the nine months ended September 30, 2018 compared to 25.8% during the nine months ended September 30, 2017.     Law H.R.1, “An Act to Provide for Reconciliation Pursant to Titles II and V of the Concurrent Resolution on the Budget for Fiscal Year 2018” ( the “Act”) reduced our overall effective tax rate.  The Act amends the Internal Revenue Code to reduce tax rates and modifies policies, credits, and deductions for individuals and businesses. Additionally, excess tax benefit on stock options reduced our income tax expense by $3.1 million and $1.8 million, respectively for the quarters ended September 30, 2018 and 2017.  Additionally, excess tax benefit on stock options reduced our income tax expense by $18.6 million and $8.1 million, respectively for the nine months ended September 30, 2018 and 2017.

While we have significant Roto-Rooter operations in Florida, North Carolina and Virginia, we had no significant casualty losses or business interruptions as a result of Hurricane Florence or Hurricane Michael.

On September 26, 2018, VITAS completed the acquisition of Hospice of Citrus and the Nature Coast for $11.0 million in cash.  This acquisition expands VITAS’ services to an additional 12 counties within the state of Florida. A substantial portion of the aggregate purchase price was allocated to goodwill.  The purchase price allocation related to this acquisition is preliminary and is anticipated to be finalized in the fourth quarter.  The operating results of this business combination have been included in our results of operations since the acquisition date and are not material for the quarter or nine months ended September 30, 2018.

VITAS expects its full-year 2018 revenue growth, prior to Medicare cap, to be in the range of 4.5% to 5.0%.  Admissions are estimated to expand approximately 3.5% to 4.0% and Average Daily Census in 2018 is estimated to expand approximately 6.7%.  Adjusted EBITDA margin, prior to Medicare cap, is estimated to be 15.9%.  We are currently estimating $1.3 million for Medicare Cap billing limitations in the fourth quarter of 2018.   Roto-Rooter expects to achieve full-year 2018 revenue growth of 13.0% to 14.0%.  The revenue estimate is based upon increased job pricing of approximately 2.0%, continued growth in core plumbing and drain cleaning services as well as revenue growth in water restoration services.  Adjusted EBITDA margin for 2018 is estimated in the range of 23.6%.  We anticipate that our operating income and cash flows will be sufficient to operate our businesses and meet any commitments for the foreseeable future.

Material changes in the balance sheet accounts from December 31, 2017 to September 30, 2018 include the following:

Net cash provided by operating activities increased $39.6 million from September 30, 2017 to September 30, 2018 mainly as a result of a $107.6 million increase in net income offset by the after-tax impact of the litigation settlement recorded in 2017.  Significant changes in our accounts receivable balances are typically driven mainly by the timing of payments received from the Federal government at our VITAS subsidiary.  We typically receive a payment in excess of $40.0 million from the Federal government from hospice services every other Friday.  The timing of period end will have a significant impact on the accounts receivable at VITAS.  These changes generally normalize over a two year period, as cash flow variations in one year are offset in the following year.

Management continually evaluates cash utilization alternatives, including share repurchase, debt repurchase, acquisitions and increased dividends to determine the most beneficial use of available capital resources.

On June 20, 2018, we replaced our existing credit agreement with the Fourth Amended and Restated Credit Agreement (“2018 Credit Agreement”).  Terms of the 2018 Credit Agreement consist of a five-year, $450 million revolving credit facility and a $150 million expansion feature, which may consist of term loans or additional revolving commitments. The revolving credit facility has a five-year maturity with principal payments due at maturity.  The interest rate at the inception of the agreement is LIBOR plus 100 basis points.  The 2018 Credit Agreement has a floating interest rate that is generally LIBOR plus a tiered additional rate which varies based on our current leverage ratio.

We have issued $36.4 million in standby letters of credit as of September 30, 2018, mainly for insurance purposes.  Issued letters of credit reduce our available credit under the revolving credit agreement.  As of September 30, 2018, we have approximately $283.6 million of unused lines of credit available and eligible to be drawn down under our revolving credit facility. 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.  We are in compliance with all financial and other debt covenants as of September 30, 2018 and anticipate remaining in compliance throughout the foreseeable future.

The VITAS segment of the Company’s business operates in a heavily-regulated industry.  As a result, the Company is subjected to inquiries and investigations by various government agencies, as well as to lawsuits, including qui tam actions.  The following sections describe the various ongoing material lawsuits and investigations of which the Company is currently aware.  Other than as described below with respect to U.S. v. VITAS, it is not possible at this time for us to estimate either the timing or outcome of any of those matters, or whether any potential loss, or range of potential losses, is probable or reasonably estimable.

The Company and certain current and former directors and officers are defendants in a case captioned In re Chemed Corp. Shareholder Derivative Litigation, No. 13 Civ. 1854 (LPS) (CJB) (D. Del.), which was consolidated on February 2, 2015.

On February 2, 2015, the Court appointed KBC Asset Management NV the sole lead plaintiff and its counsel, the sole lead and liaison counsel.  On March 3, 2015, Lead Plaintiff KBC designated its Complaint as the operative complaint in the consolidated proceedings and defendants renewed a previously filed motion to dismiss those claims and allegations.  The consolidated Complaint named fourteen individual defendants, together with the Company as nominal defendant.  The Complaint alleges a claim for breach of fiduciary duty against the individual defendants for allegedly permitting the Company to submit false claims to the U.S. government.  The Complaint seeks (a) a declaration that the individual defendants breached their fiduciary duties to the Company; (b) an order requiring those defendants to pay compensatory damages, restitution and exemplary damages, in unspecified amounts, to the Company; (c) an order directing the Company to implement new policies and procedures; and (d) costs and disbursements incurred in bringing the action, including attorneys’ fees.  On May 12, 2016, the Court issued a Memorandum Order granting Chemed’s motion to dismiss, and dismissing Lead Plaintiff KBC’s Complaint without prejudice to KBC’s opportunity to file within 30 days of the date of the Court’s Order (i.e., by June 13, 2016) an amended Complaint addressing the deficiencies in its duty of loyalty claim.  Lead Plaintiff KBC did not file an amended Complaint within the time specified by the Court.

However, on June 13, 2016, counsel for Chemed shareholder Michael Kvint filed a letter with the Court requesting a two-week extension to file a motion to substitute Mr. Kvint as lead plaintiff, in place of Lead Plaintiff KBC and to file an amended Complaint.  Alternatively, counsel for Mr. Kvint requested that any dismissal of the action be with prejudice to KBC only.  On June 14, 2016, Chemed filed a reply letter with the Court, reserving its rights to oppose any motion filed by Mr. Kvint and, if warranted, to oppose any other actions taken by Mr. Kvint to proceed with the action (including by filing an untimely amended Complaint).  On June 21, 2016, the Court entered an Oral Order providing Mr. Kvint until June 30, 2016 to file a Motion to Substitute and Motion for Leave to File an Amended Complaint.  On that date, Mr. Kvint filed, under seal, a Motion to Substitute Plaintiff and File Amended Complaint, and attached a Proposed Amended Complaint.  Mr. Kvint’s motion was fully briefed by the parties.  On April 25, 2017, Magistrate Judge Burke issued a Report and Recommendation recommending that the Court permit Mr. Kvint to intervene as Lead Plaintiff and grant leave to amend the complaint to replead the duty of loyalty claim only.  On May 16, 2017, Chief Judge Stark signed an Order adopting that Report and Recommendation.  Plaintiff Kvint filed a Corrected Amended Complaint on May 30, 2017.  On September 13, 2017, the Court entered an order dismissing with prejudice the claims against defendants Timothy S. O’Toole and Joel F. Gemunder and permitting Defendants to file a Motion to Dismiss the Corrected Amended Complaint. The matter has been fully briefed and argued.  As the Company has previously disclosed, the legal fees and costs associated with defending against this lawsuit are presently being paid by insurance.  For additional procedural history of this litigation, please refer to our prior quarterly and annual filings.

On October 30, 2017, the Company entered into a settlement agreement (the “Settlement Agreement”) to resolve civil litigation under the False Claims Act brought by the United States Department of Justice (“DOJ”) on behalf of the OIG and various relators concerning VITAS, filed in the U.S. District Court of the Western District of Missouri (the “2013 Action”).  The Company denied any violation of law and agreed to settlement without admission of wrongdoing.

In connection with the settlement VITAS and certain of its subsidiaries entered into a corporate integrity agreement (“CIA”) on October 30, 2017.  The CIA formalizes various aspects of VITAS’ already existing Compliance Program and contains requirements designed to document compliance with federal healthcare program requirements.  It has a term of five years during which it imposes monitoring, reporting, certification, oversight, screening and training obligations, certain of which had previously been implemented by VITAS.  It also requires VITAS to engage an Independent Review Organization to perform audit and review functions and to prepare reports regarding compliance with federal healthcare programs.  In the event of breach of the CIA, VITAS could become liable for payment of stipulated penalties or could be excluded from participation in federal healthcare programs.

Under the Settlement Agreement, the United States agreed to release the Company, VITAS, and its hospice operation subsidiaries from any civil or administrative monetary liability relating to any patients’ disputed terminal medical prognosis of six months or less; a lack of medical necessity for billed Continuous Home Care, General Inpatient Care, or Respite Care levels of hospice care; or that the claims for those levels of hospice care were not eligible for payment for any other reason.  The OIG agreed, conditioned on the Company’s full payment and in consideration of VITAS’ obligations under the CIA, to release its permissive exclusion rights and refrain from instituting any administrative action seeking to exclude the Company, VITAS, and its affiliates from participating in Medicare, Medicaid, or other federal healthcare programs in this regard.

The costs incurred related to U.S. v. VITAS and related regulatory matters were $935,000 million and $5.2 million for the quarter and year to date September 30, 2017, respectively.  No significant costs were incurred during the quarter and nine months ended September 30, 2018, respectively.

Jordan Seper (“Seper”), a Registered Nurse at VITAS’ Inland Empire program from May 12, 2014 to March 21, 2015, filed a lawsuit in San Francisco Superior Court on September 26, 2016.  She alleged VITAS Healthcare Corp of CA (“VITAS CA”) (1) failed to provide minimum wage for all hours worked; (2) failed to provide overtime for all hours worked; (3) failed to provide a second meal period; (4) failed to provide rest breaks; (5) failed to indemnify for necessary expenditures; (6) failed to timely pay wages due at time of separation; and (7) engaged in unfair business practices.  Seper seeks a state-wide class action of current and former non-exempt employees employed with VITAS in California within the four years preceding the filing of the lawsuit.  She seeks court determination that this action may be maintained as a class action for the entire California class and subclasses, designation as class representative, declaratory relief, injunctive relief, damages (including wages for regular or overtime hours allegedly worked but not paid, premium payments for missed meal or rest periods, and unreimbursed expenses), all applicable penalties associated with each claim, pre and post-judgment interest, and attorneys’ fees and costs.  Seper served VITAS CA with the lawsuit, Jordan A. Seper on behalf of herself and others similarly situated v. VITAS Healthcare Corporation of California, a Delaware corporation; VITAS Healthcare Corp of CA, a business entity unknown; and DOES 1 to 100, inclusive; Los Angeles Superior Court Case Number BC 642857 on October 13, 2016 (“Jordan Seper case”).

On November 14, 2016, the Parties filed a Stipulation to transfer the venue of the lawsuit from San Francisco to Los Angeles.  The Los Angeles Superior Court Complex Division accepted transfer of the case on December 6, 2016 and stayed the case.  On December 16, 2016, VITAS CA filed its Answer and served written discovery on Seper.

Jiwann Chhina (“Chhina”), hired by VITAS as a Home Health Aide on February 5, 2002, is currently a Licensed Vocational Nurse for VITAS’ San Diego program.  On September 27, 2016, Chhina filed a lawsuit in San Diego Superior Court, alleging (1) failure to pay minimum wage for all hours worked; (2) failure to provide overtime for all hours worked; (3) failure to pay wages for all hours at the regular rate; (4) failure to provide meal periods; (5) failure to provide rest breaks; (6) failure to provide complete and accurate wage statements; (7) failure to pay for all reimbursement expenses; (8) unfair business practices; and (9) violation of the California Private Attorneys General Act.  Chhina seeks to pursue these claims in the form of a state-wide class action of current and former non-exempt employees employed with VITAS in California within the four years preceding the filing of the lawsuit.  He seeks court determination that this action may be maintained as a class action for the entire California class and subclasses, designation as class representative, declaratory relief, injunctive relief, damages (including wages for regular or overtime hours allegedly worked but not paid, premium payments for missed meal or rest period, and unreimbursed expenses), all applicable penalties associated with each claim, pre-judgment interest, and attorneys’ fees and costs.  Chhina served VITAS CA with the lawsuit, Jiwan Chhina v. VITAS Health Services of California, Inc., a California corporation; VITAS Healthcare Corporation of California, a Delaware corporation; VITAS Healthcare Corporation of California, a Delaware corporation dba VITAS Healthcare Inc.; and DOES 1 to 100, inclusive; San Diego Superior Court Case Number 37-2015-00033978-CU-OE-CTL on November 3, 2016 (“Jiwann Chhina case”).  On December 1, 2016, VITAS CA filed its Answer and served written discovery on Chhina.

On May 19, 2017, Chere Phillips (a Home Health Aide in Sacramento) and Lady Moore (a former Social Worker in Sacramento) filed a lawsuit against VITAS CA in Sacramento County Superior Court, alleging claims for (1) failure to pay all wages due; (2) failure to authorize and permit rest periods; (3) failure to provide off-duty meal periods; (4) failure to furnish accurate wage statements; (5) unreimbursed business expenses; (6) waiting time penalties; (7) violations of unfair competition law; and (8) violation of the Private Attorneys General Act.  The case is captioned: Chere Phillips and Lady Moore v. VITAS Healthcare Corporation of California, Sacramento County Superior Court, Case No. 34-2017-0021-2755.  Plaintiffs sought to pursue these claims in the form of a state-wide class action of current and former non-exempt employees employed with VITAS CA in California within the four years preceding the filing of the lawsuit.  Plaintiffs served VITAS with the lawsuit on June 5, 2017.  VITAS CA timely answered the Complaint generally denying the Plaintiffs’ allegations.  The Court has stayed all class discovery in this case pending resolution of mediation in the Jordan Seper and Jiwann Chhina cases.

There are currently three other lawsuits against VITAS pending in the superior courts of other California counties that contain claims and class periods that substantially overlap with Phillips’ and Moore’s claims: the Jordan Seper and Jiwann Chhina cases, and Williams v. VITAS Healthcare Corporation of California, filed on May 22, 2017 in Alameda County Superior Court, RG 17853886.

Jazzina Williams’ (a Home Health Aide in Sacramento) lawsuit alleges claims for (1) failure to pay all wages due; (2) failure to authorize and permit rest periods; (3) failure to provide off-duty meal periods; (4) failure to furnish accurate wage statements; (5) unreimbursed business expenses; (6) waiting time penalties; and (7) violations of the Private Attorneys General Act.  Williams seeks to pursue these claims in the form of a state-wide class action of current and former non-exempt employees.  Plaintiff served VITAS with the lawsuit on May 31, 2017.  VITAS CA timely answered the Complaint generally denying Plaintiff’s allegations.  Williams is pursing discovery of her individual claim and has agreed to a stay of class discovery pending mediation in the Jordan Seper and Jiwann Chhina cases.  Defendant filed and served each of Plaintiffs Williams, Phillips, and Moore with a Notice of Related Cases on July 19, 2017.

 The Jordan Seper and Jiwann Chhina cases have been consolidated in Los Angeles County Superior court; Chhina was dismissed as a separate action and joined with Seper through the filing of an amended complaint in Seper in which Chhina is also identified as a named plaintiff, on August 28, 2018.

The Company is not able to reasonably estimate the probability of loss or range of loss for any of these lawsuits at this time.

The Company intends to defend vigorously against the allegations in each of the above lawsuits.  Regardless of the outcome of any of the preceding matters, dealing with the various regulatory agencies and opposing parties can adversely affect us through defense costs, potential payments, diversion of management time, and related publicity.  Although the Company intends to defend them vigorously, there can be no assurance that those suits will not have a material adverse effect on the Company.

Results of Operations

Our service revenues and sales for the third quarter of 2018 increased 6.4% versus services and sales revenues for the third quarter of 2017.  Of this increase, a $12.8 million increase was attributable to VITAS and $13.9 million increase was attributable to Roto-Rooter.  The following chart shows the components of revenue by operating segment (in thousands):

Days of care at VITAS during the quarter ended September 30 were as follows:

The remaining increase in VITAS’ revenues for the third quarter of 2018 versus the third quarter of 2017 was primarily comprised of a geographically weighted average Medicare reimbursement rate increase of approximately 0.8%, offset by $1.9 million in Medicare cap revenue reductions and by the $5.5 million change in classification related to the adoption of the new revenue recognition standard.

Over 90% of VITAS’ service revenues for the period were from Medicare and Medicaid.

The increase in plumbing revenues for the third quarter of 2018 versus 2017 is attributable to an 8.9% increase in price and service mix shift and a 1.6% increase in job count.  Drain cleaning revenues for the third quarter of 2018 versus 2017 reflect a 5.6% increase in price and service mix shift and a 6.0% increase in job count.  Water restoration for the third quarter of 2018 versus 2017 increased as a result of a 15.0% increase in job count and a 3.7% increase in price and service mix shift.   Contractor operations increased 16.9% mainly due to their expansion into water restoration. Revenue was negatively impacted by the change in the classification of $1.6 million due to the adoption of the new revenue recognition standard.

The consolidated gross margin was 31.3% in the third quarter of 2018 as compared with 31.0% in the third quarter of 2017.  On a segment basis, VITAS’ gross margin was 22.8% in the third quarter of 2018 as compared with 23.1%, in the third quarter of 2017.  The decrease in VITAS gross margin is the result of a $3.0 million change in classification of implicit price concessions from selling, general and administrative expenses to revenue for the third quarter of 2018 as a result of the new revenue recognition standard.  The Roto-Rooter segment’s gross margin was 49.2% for the third quarter of 2018 compared with 48.7% in the third quarter of 2017. The increase in Roto-Rooter gross margin is primarily related to improved health insurance experience during the quarter offset by the change in the classification of $1.6 million of implicit price concessions as a result of the new revenue recognition standard.

Selling, general and administrative expenses (“SG&A”) comprise (in thousands):

Other income/(expense) - net comprise (in thousands):

Our effective income tax rate was 18.6% in the third quarter of 2018 compared to 34.7% during the third quarter of 2017.   Law H.R.1, “An Act to Provide for Reconciliation Pursant to Titles II and V of the Concurrent Resolution on the Budget for Fiscal Year 2018” (the “Act”) reduced our overall effective tax rate.  The Act amends the Internal Revenue Code to reduce tax rates and modifies policies, credits, and deductions for individuals and businesses.  Additionally, excess tax benefit on stock options reduced our income tax expenses by $3.1 million and $1.8 million, respectively for the quarters ended September 30, 2018 and 2017

Net income for both periods included the following after-tax items/adjustments that (reduced) or increased after-tax earnings (in thousands):

Net income/(loss) for the third quarter of 2018 versus the third quarter of 2017 by segment (in thousands):

VITAS’ after-tax earnings were positively impacted in 2018 compared to 2017 due to higher revenue as well as a reduced effective tax rate.  After-tax earnings as a percent of revenue at VITAS in the third quarter of 2018 was 11.9% as compared to 9.2% in the third quarter of 2017.

Roto-Rooter’s net income was positively impacted in 2018 compared to 2017 primarily by higher revenue as well as a reduced effective tax rate.  After-tax earnings as a percent of revenue at Roto-Rooter in the third quarter of 2018 was 17.3% as compared to 12.5% in the third quarter of 2017.

After-tax Corporate expenses for 2018 increased 31.0% when compared to 2017 due to increased long-term incentive compensation expense and a lower effective tax rate, (results in lower tax benefit) offset by a $1.3 million increase in tax benefit related to the adoption of ASU 2016-09.

Results of Operations

Our service revenues and sales for the first nine months of 2018 increased 7.0% versus services and sales revenues for the first nine months of 2017.  Of this increase, a $34.6 million increase was attributable to VITAS and $52.2 million increase was attributable to Roto-Rooter.  The following chart shows the components of revenue by operating segment (in thousands):

Days of care at VITAS during the nine months ended were as follows:

The remaining increase in VITAS’ revenues for the first nine months of 2018 versus the first nine months of 2017 was primarily comprised of a geographically weighted average Medicare reimbursement rate increase of approximately 0.8%, offset by a $668,000 in Medicare cap liability compared to $247,000 contra-revenue in the same period of 2017 and $16.6 million change in classification related to the adoption of the new revenue recognition standard.

Over 90% of VITAS’ service revenues for the period were from Medicare and Medicaid.

The increase in plumbing revenues for the first nine months of 2018 versus 2017 is attributable to an 10.7% increase in price and service mix shift and a 3.9% increase in job count.  Drain cleaning revenues for the first nine months of 2018 versus 2017 reflect a 6.4% increase in price and service mix shift and a 5.0% increase in job count.  The increase in water restoration for the first nine months of 2018 versus 2017 is a result of a 19.1% increase in job count and a 9.5% increase in price a service mix shift.  Contractor operations increased 13.2% mainly due to their expansion into water restoration. Revenue was negatively impacted by the change in the classification of $5.2 million due to the adoption of the new revenue recognition standard.

The consolidated gross margin was 30.9% in the first nine months of 2018 as compared with 30.6% in the first nine months of 2017.  On a segment basis, VITAS’ gross margin was 22.1% in the first nine months of 2018 as compared with 22.5%, in the first nine months of 2017.  The decrease in VITAS gross margin is the result of an $8.7 million change in classification of implicit price concessions from selling, general and administrative expenses to revenue for the first nine months of 2018.  The Roto-Rooter segment’s gross margin was 48.9% for the first nine months of 2018 and 2017, respectively.

Selling, general and administrative expenses (“SG&A”) comprise (in thousands):

SG&A expenses before long-term incentive compensation, expenses related to OIG investigation and the impact of market value adjustments related to assets held in deferred compensation trusts for the first nine months of 2018 were up 2.6% when compared to the first nine months of 2017. This increase was mainly a result of the increase in variable selling expenses caused by increased revenue and increased advertising expense at Roto-Rooter offset by $13.9 million of implicit price concessions being classified in revenue versus selling, general and administrative expenses due to the new revenue recognition standard.

Other operating expense for the first nine months of 2017 was $91.1 million.  This was related to a $90.0 million litigation settlement as well as $1.1 million related to the closure of the programs in one state at VITAS.

Other income/(expense) - net comprise (in thousands):

Our effective income tax rate was 14.5% for the year ended September 30, 2018 compared to 25.8% during the year ended September 30, 2017.  Law H.R.1, “An Act to Provide for Reconciliation Pursant to Titles II and V of the Concurrent Resolution on the Budget for Fiscal Year 2018” (the “Act”) reduced our overall effective tax rate.  The Act amends the Internal Revenue Code to reduce tax rates and modifies policies, credits, and deductions for individuals and businesses.  Additionally, excess tax benefit on stock options reduced our income tax expenses by $18.6 million and $8.1 million, respectively for the years ended September 30, 2018 and 2017.

Net income for both periods included the following after-tax items/adjustments that (reduced) or increased after-tax earnings (in thousands):

Net income/(loss) for the first nine months of 2018 versus the first nine months of 2017 by (in thousands):

VITAS’ after-tax earnings were positively impacted in 2018 compared to 2017 due to higher revenue as well as a reduced effective tax rate.  VITAS’ lower net income in 2017 was the result of a $55.8 million (after-tax) litigation settlement.

Roto-Rooter’s net income was positively impacted in 2018 compared to 2017 primarily by an increase in revenue as well as a reduced effective tax rate.

After-tax Corporate expenses for 2018 increased 12.8% when compared to 2017 due to increased stock option expense, long-term incentive compensation expense, and a lower effective tax rate (results in a lower tax benefit) offset by a $10.5 million increase in tax benefit related to the adoption of ASU No. 2016-09 and the impact of tax reform.