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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
[X] For the fiscal year ended December 31, 2003
or
[ ] Transition Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the Transition period from _______________ to ______________
Commission File Number: 1-8351
ROTO-ROOTER, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 31-0791746
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
2600 Chemed Center, 255 East Fifth Street, Cincinnati, Ohio 45202-4726
(Address of principal executive offices) (Zip Code)
(513) 762-6900
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Name of each exchange
Title of each class on which registered
------------------- -----------------------
Capital Stock - Par Value $1 Per Share New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ].
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. Yes [ ] No [X]
Indicate by check mark whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Act). Yes [X] No [ ]
The aggregate market value of the voting stock held by non-affiliates
of the registrant, based upon the average bid and asked price of said stock on
the New York Stock Exchange - Composite Transaction Listing on June 30, 2003
($38.03 per share), was $375,315,385.
DOCUMENTS INCORPORATED BY REFERENCE
DOCUMENT WHERE INCORPORATED
-------- ------------------
Proxy Statement for Annual Meeting to be held May 17, 2004 Part III
Form 8K-A filed February 23, 2004 Part II
ROTO-ROOTER, INC.
2003 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
PAGE
PART I
Item 1. Business.............................................................................................. 1
Item 2. Properties............................................................................................ 21
Item 3. Legal Proceedings..................................................................................... 21
Item 4. Submission of Matters to a Vote of Security Holders................................................... 22
-- Executive Officers of the Registrant.................................................................. 22
PART II
Item 5. Market for the Registrant's Common Equity, Related
Stockholder Matters and Issuer Purchases of Equity Securities......................................... 23
Item 6. Selected Financial Data............................................................................... 24
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations................................................................... 25
Item 7A. Quantitative and Qualitative Disclosures About Market Risk............................................ 39
Item 8. Financial Statements and Supplementary Data........................................................... 40
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure................................................................... 40
Item 9A. Controls & Procedures................................................................................. 40
PART III
Item 10. Directors and Executive Officers of the Registrant.................................................... 41
Item 11. Executive Compensation................................................................................ 41
Item 12. Security Ownership of Certain Beneficial Owners and
Management and Related Stockholder Matters............................................................ 41
Item 13. Certain Relationships and Related Transactions........................................................ 41
Item 14. Principal Accountant Fees and Services................................................................ 41
PART IV
Item 15. Exhibits, Financial Statement Schedules and Reports
on Form 8-K........................................................................................... 43
ITEM 1. BUSINESS
GENERAL
Pursuant to a stockholder vote at the Company's Annual Meeting of
Stockholders held on May 19, 2003, the Company amended its Amended Certificate
of Incorporation and changed its name from Chemed Corporation to Roto-Rooter,
Inc. The Company was incorporated in Delaware in 1970 as a subsidiary of W. R.
Grace & Co. and succeeded to the business of W. R. Grace & Co.'s Specialty
Products Group as of April 30, 1971 and remained a subsidiary of W. R. Grace &
Co. until March 10, 1982. As used herein, "Company" refers to Roto-Rooter, Inc.,
and its subsidiaries and "Grace" refers to W. R. Grace & Co. and its
subsidiaries.
On March 10, 1982, the Company transferred to Dearborn Chemical
Company, a wholly owned subsidiary of the Company, the business and assets of
the Company's Dearborn Group, including the stock of certain subsidiaries within
the Dearborn Group, plus $185 million in cash, and Dearborn Chemical Company
assumed the Dearborn Group's liabilities. Thereafter, on March 10, 1982 the
Company transferred all of the stock of Dearborn Chemical Company to Grace in
exchange for 16,740,802 shares of the capital stock of the Company owned by
Grace with the result that Grace no longer has any ownership interest in the
Company.
On December 31, 1986, the Company completed the sale of substantially
all of the business and assets of Vestal Laboratories, Inc., a wholly owned
subsidiary. The Company received cash payments aggregating approximately $67.4
million over the four-year period following the closing, the substantial portion
of which was received on December 31, 1986.
On April 2, 1991, the Company completed the sale of DuBois Chemicals,
Inc. ("DuBois"), a wholly owned subsidiary, to the Diversey Corporation
("Diversey"), then a subsidiary of The Molson Companies Ltd. Under the terms of
the sale, Diversey agreed to pay the Company net cash payments aggregating
$223,386,000, including deferred payments aggregating $32,432,000.
On December 21, 1992, the Company acquired The Veratex Corporation and
related businesses ("Veratex Group") from Omnicare, Inc. The purchase price was
$62,120,000 in cash paid at closing, plus a post-closing payment of $1,514,000
(paid in April 1993) based on the net assets of Veratex.
Effective January 1, 1994, the Company acquired all the capital stock
of Patient Care, Inc. ("Patient Care"), for cash payments aggregating
$20,582,000, plus 17,500 shares of the Company's Capital Stock. An additional
cash payment of $1,000,000 was made on March 31, 1996 and another payment of
$1,000,000 was made on March 31, 1997.
In July 1995, the Company's Omnia Group (formerly Veratex Group)
completed the sale of the business and assets of its Veratex Retail division to
Henry Schein, Inc. ("HSI") for $10 million in cash plus a $4.1 million note for
which payment was received in December 1995.
Effective September 17, 1996, the Company completed a merger of a
subsidiary of the Company, Chemed Acquisition Corp., and Roto-Rooter, Inc.
pursuant to a Tender Offer commenced on August 8, 1996 to acquire any and all of
the outstanding shares of Common Stock of Roto-Rooter, Inc. for $41.00 per share
in cash.
1
On September 24, 1997, the Company completed the sale of its wholly
owned businesses comprising the Omnia Group to Banta Corporation for $50 million
in cash and $2.3 million in deferred payments.
Effective September 30, 1997, the Company completed a merger between
its 81-percent-owned subsidiary, National Sanitary Supply Company, and a wholly
owned subsidiary of Unisource Worldwide, Inc. for $21.00 per share, with total
payments of $138.3 million.
Effective October 11, 2002, the Company sold its Patient Care, Inc.
subsidiary ("Patient Care") to an investor group that included Schroder Ventures
Life Sciences Group, Oak Investment Partners, Prospect Partners and Salix
Ventures. Patient Care provides home-healthcare services primarily in the New
York-New Jersey-Connecticut area. The cash proceeds to the Company totaled
$57,500,000, of which $5,000,000 was placed in escrow pending settlement of
Patient Care's receivables with third-party payers. Of this amount, $2,500,000
was distributed as of October 2003 and $2,500,000 is expected to be distributed
as of October 2004. Based on the collection history of Patient Care, the Company
expects to collect the funds held in escrow in full. The Company may also be
entitled to additional funds based on the final value of the estimated balance
sheet valuation which is expected to be determined in 2004. In addition, the
Company received a senior subordinated note receivable ("Note") for $12,500,000
and a common stock purchase warrant ("Warrant") for 2% of the outstanding stock
of the purchasing company. The Note is due October 11, 2007, and bears interest
at the annual rate of 7.5% through September 30, 2004, 8.5% from October 1,
2004, through September 30, 2005, and 9.5% thereafter. The Warrant has an
estimated fair value of $1,445,000.
During 2003 the Company conducted its business operations in two
segments: Plumbing and Drain Cleaning Group ("Plumbing and Drain Cleaning")
and Service America Systems, Inc. ("Service America").
Effective February 24, 2004, The Company completed a merger of its
wholly owned indirect subsidiary, Marlin Merger Corp., and Vitas Healthcare
Corporation ("Vitas"). Under the terms of the merger agreement, Vitas
stockholders received cash of $30.00 per share. The transaction, including the
refinancing of existing Vitas debt and other payments made in connection with
the merger, totaled approximately $406 million in cash. In order to complete the
merger the Company sold two million shares of its Capital Stock in a private
placement at a price of $50.00 per share, issued $110 million principal amount
of floating rate senior secured notes due 2010 ("Floating Rate Notes"), issued
$150 million principal amount of 8.75% Senior Notes due 2011 ("Fixed Rate
Notes"), and entered into new $135 million senior secured credit facilities.
More information with respect to the Company's merger with Vitas is set forth in
Item 7 of this Report on page 25 and within Note 23 of the Notes to the
Financial Statements appearing on pages F-31 - F-33 of this Report on Form 10-K.
FORWARD LOOKING STATEMENTS
This Annual Report contains or incorporates by reference certain
forward looking statements within the meaning of the Private Securities
Litigation Reform Act of 1995. The Company intends such statements to be subject
to the safe harbors created by that legislation. Such statements involve risks
and uncertainties that could cause actual results of operations to differ
materially from these forward looking statements.
2
FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS
The required segment and geographic data for the Company's continuing
operations (as described below) for the three years ended December 31, 2001,
2002 and 2003 are shown in Note 2 of the Notes to the Financial Statements on
pages F-11 to F-13 of this Report on Form 10-K.
DESCRIPTION OF BUSINESS BY SEGMENT
The information called for by this item with respect to the Plumbing
and Drain Cleaning segment and Service America segment is included within Note 2
of the Notes to Financial Statements appearing on pages F-11 - F-13 of this
Report on Form 10-K.
VITAS
General. Vitas is the nation's largest provider of hospice services for patients
with severe, life-limiting illnesses. This type of care is aimed at making the
terminally ill patient's final days as comfortable and pain free as possible.
Hospice care is typically available to patients who have been initially
certified as terminally ill (i.e. a prognosis of six months or less) by their
attending physician, if any, and the hospice physician.
Vitas' hospice operations began in South Florida in 1978 and were
incorporated as a for-profit corporation in 1983. Today, Vitas provides a
comprehensive range of hospice services through 25 operating programs covering
many of the large population areas in the U.S. including Florida, California,
Texas and Illinois. Vitas has over 6,000 employees, including approximately
2,400 nurses and 1,500 home health aides.
In general, Vitas offers all levels of hospice care in a given market.
In each of its markets, Vitas employs an active community relations effort that
involves relationship building and hospice education activities, the extensive
education of referral sources, and print and radio media initiatives. This
broad-based approach has helped Vitas increase market share and achieve
consistent historical revenue growth. As the largest provider of hospice care in
a highly fragmented industry, Vitas currently believes it has approximately 7%
of the market share in the U.S. hospice market.
Hospice Services Industry Overview
Hospice care is primarily provided under the government's Medicare and
Medicaid programs. In 1982, Congress established the Medicare Hospice Benefit,
which is available to patients who have been certified as terminally ill, with a
prognosis of six months or less, by the patient's attending physician, if any,
and the hospice physician.
Effective in 1997, the Medicare Hospice Benefit was amended to reflect
the following benefit periods: an initial 90-day period; a second 90-day period;
and an unlimited number of subsequent 60-day benefit periods, as long as the
patient is recertified as terminally ill by a physician at the beginning of each
benefit period. The Medicare Hospice Benefit covers care associated with a
patient's terminal illness, which would include prescription drugs for pain and
symptom relief, medical supplies and equipment, inpatient care and bereavement
services for the family for up to one year after death.
3
The variety of services provided by hospice programs include:
Nursing Care: Nurses coordinate care, provide direct patient care, and
check symptoms and medication. Because patient and family education is such an
important part of every care program, the nurse often becomes the link between
the patient and the family and the hospice services.
Social Services: Social workers provide advice and counseling to the
patient and family members and may also act as an advocate for the patient and
the family in utilizing community resources.
Physician Services: A hospice medical director and physician oversee
the plan of care as members of an interdisciplinary team.
Spiritual Support and Counseling: Chaplains are available to visit and
provide spiritual support to the patient.
Home and Health Aide Services: Home care includes personal care for the
patient, such as assistance with bathing, eating and general hygiene. Homemaking
services may also be available for the patient's living area.
Continuous Care: If the patient's condition requires, hospice staff may
provide around the clock care.
Volunteers: Volunteers are intended to be an integral part of any
hospice program. Hospice volunteers may provide compassionate support and
companionship, help with certain everyday tasks such as shopping or babysitting,
and deliver other helpful services.
24-hour On-call Availability: A hospice team member is on-call 24-hours
a day, seven days a week, either for phone consultation or visitation.
Hospice Inpatient Care: Although hospice care may be centered around
the home, it sometimes becomes necessary to move the patient to a hospice
inpatient bed. The hospice team will arrange this care as well as the return to
in-home care when appropriate.
Respite Care: To provide relief for the family members, the hospice may
be able to arrange for a brief period of inpatient care for the patient at a
hospice inpatient bed, depending upon the circumstances of the patient and the
family.
Bereavement Support: The hospice care team works with surviving family
members to help them through the grieving process for up to one year after the
patient's death. The hospice care provider may also suggest medical or
professional care for surviving family members as appropriate.
Vitas' Services
Vitas classifies its services based on the location and type of care
provided. The major classifications are Home Care, Continuous Care and Inpatient
Care.
Home Care: Routine care provided to patients and their families
residing at home or in a nursing facility. The hospice is typically paid the
routine home care rate for each day the patient is under the care of the
hospice. In the year ended December 31,
4
2003, Home Care accounted for 68.3% of Vitas' net revenues and 90.5% of its days
of care. Vitas' average daily reimbursement rate for Home Care in such period
was $122.70.
Inpatient Care: Short term care provided in a participating hospice
inpatient unit, hospital or skilled nursing facility that meets the special
hospice standards. Inpatient care may be required for procedures necessary for
pain control or acute symptom management which cannot be provided in other
settings. Medicare distinguishes two different levels of Inpatient Care: (i)
inpatient respite care and (ii) general inpatient care. The reimbursement rate
for inpatient respite care is paid for each day the patient is in an approved
inpatient facility and is receiving respite care. Payment for respite care may
be made for a maximum of five days. General inpatient care is reimbursed at a
different, higher rate. In the year ended December 31, 2003, Inpatient Care
accounted for 15.5% of Vitas' net revenues and 4.6% of its days of care. Vitas'
average daily reimbursement rate for Inpatient Care in such period was $544.98.
Continuous Care: Care provided to patients while at home, during
periods of crisis when intensive monitoring and care, primarily nursing care, is
required in order to achieve palliation or management of acute medical symptoms.
Reimbursement is calculated by multiplying the applicable continuous care hourly
rate by the number of hours of care provided. A minimum of 8 hours of continuous
care in a 24 hour period is to be provided to receive the continuous home care
rate. In the year ended December 31, 2003, Continuous Care accounted for 16.2%
of Vitas' net revenues and 4.9% of its days of care. Vitas' average daily
reimbursement rate for Continuous Care was $541.88.
Service Delivery and Systems
Vitas delivers its service through local hospice programs that operate
under a standardized organizational structure consisting of a senior management
team and multiple teams of caregivers assisted by volunteers. A senior
management team is typically comprised of a general manager, a patient care
administrator, a medical director and a director of admissions. Patient care
teams typically include a team manager, nurses, home health aides, a chaplain,
team physicians, a patient care secretary and a social worker.
Vitas' standardized model for patient care is complemented by its
internal systems and controls. Vitas has developed an information technology
platform that is designed to enable management to monitor and evaluate various
operating, clinical and employee performance measures in a timely manner.
Vitas' information systems infrastructure supports all its operations,
including clinical operations, billing and collections, accounts payable and
claims processing, financial reporting, human resources and compliance. The
system is built upon a proprietary business enterprise application. At the
corporate level, management uses this application to monitor and evaluate the
various operating, clinical and employee performance measures. At the program
level, it provides detailed information on referral sources, patients and
staffing for patient management, as well as staff scheduling and management.
Compliance and Training
Vitas' compliance and training structure is designed to monitor
conformity to company standards as well as standards mandated by Medicare, state
agencies and private insurance providers. The Compliance Committee, consisting
of members of senior
5
management, oversees Vitas' compliance program, reviews patient surveys and
analyzes the company's performance measurements. Vitas' Department of Clinical
Research, Analysis and Audit performs periodic reviews of each local program,
which are similar to Medicare certification and state licensing surveys. Any
finding documented in the survey report prepared as a part of the periodic
reviews requires a formal written response and corrective action plan. Vitas'
Department of Hospice Education and Training administers compliance training to
each employee on an annual basis. In addition, every patient and family is asked
to complete a satisfaction survey regarding the quality of care delivered to the
patient and the family.
Hospice Programs
Vitas currently operates 25 hospice programs in the following markets:
- California - Inland Empire, Orange County, Coastal
Cities, San Gabriel, San Diego, San Francisco Bay
Area and San Fernando
- Florida - Dade, Broward, Central Florida, Brevard and
Palm Beach
- Texas - Dallas, Ft. Worth, Houston and San Antonio
- Illinois - Chicago Northwest, Chicago Central and
Chicago South
- New Jersey - North, West and Shore
- Ohio - Cincinnati
- Pennsylvania - Philadelphia
- Wisconsin - Milwaukee
Historically, Vitas has expanded its hospice operations through the
acquisition of hospice programs and the opening of new hospice programs in new
geographic locations. In the fiscal year ended September 30, 2003, Vitas
acquired a hospice program in Palm Beach, Florida. Vitas intends to continue to
expand its business by actively pursuing strategic acquisitions of hospices in
new and existing markets throughout the United States. Since 1978, Vitas has
opened 16 new hospice programs throughout the country. In the fiscal year ended
September 30, 2003, Vitas opened three new hospice programs in New Jersey and
Brevard County, Florida. In opening a new program, Vitas assesses, among other
things, the potential Average Daily Census for the area by evaluating factors
such as the region's demographic profile, current hospice providers, mortality
rates by type of disease, and the availability of health care workers. A key
part of Vitas' growth strategy is to open new hospice programs.
Reimbursement Environment
Medicare rates of reimbursement for hospice care, as stipulated in
Section 1814(i)(1)(C)(ii) of the Social Security Act, continue to be adjusted
based on a market basket percentage increase, which for fiscal year 2004 has
already been established at an increase of 3.4%.
6
As with most government programs, the Medicare and Medicaid programs
are subject to statutory and regulatory changes, possible retroactive and
prospective rate adjustments, administrative rulings, freezes and funding
reductions, all of which may adversely affect the level of program payments to
Vitas for its services. Reductions or changes in Medicare or Medicaid funding
could significantly affect Vitas' results of operations. It is not possible to
predict at this time whether any additional health care reform initiatives will
be implemented or whether there will be other changes in the administration of
governmental health care programs or interpretations of governmental policies or
other changes affecting the health care system.
PRODUCT AND MARKET DEVELOPMENT
Each segment of the Company's business engages in a continuing program
for the development and marketing of new services and products. While new
products and services and new market development are important factors for the
growth of each active segment of the Company's business, the Company does not
expect that any new products and services or marketing effort, including those
in the development stage, will require the investment of a material amount of
the Company's assets.
RAW MATERIALS
The principal raw materials needed for the Company's manufacturing
operations are purchased from United States sources. No segment of the Company
experienced any material raw material shortages during 2003, although such
shortages may occur in the future. Products manufactured and sold by the
Company's active business segments generally may be reformulated to avoid the
adverse impact of a specific raw material shortage.
PATENTS, SERVICE MARKS AND LICENSES
The Roto-Rooter trademarks and service marks have been used and
advertised since 1935 by Roto-Rooter Corporation, an indirectly wholly owned
subsidiary of the Company. The Roto-Rooter marks are among the most highly
recognized trademarks and service marks in the United States. The Company
considers the Roto-Rooter marks to be a valuable asset and a significant factor
in the marketing of Roto-Rooter's franchises, products and services and the
products and services provided by its franchisees. "Vitas" is a trademark of
Vitas Healthcare Corporation. The Company and its subsidiaries also own certain
trade secrets including training manuals, pricing information, customer
information, and software source codes.
COMPETITION
ROTO-ROOTER
All aspects of the sewer, drain, and pipe cleaning, HVAC services and
plumbing repair businesses are highly competitive. Competition is, however,
fragmented in most markets with local and regional firms providing the primary
competition. The principal methods of competition are advertising, range of
services provided, name recognition, speed and quality of customer service,
service guarantees, and pricing.
7
No individual customer or market group is critical to the total sales
of this segment.
SERVICE AMERICA
All aspects of the HVAC and appliance repair and maintenance service
industry are highly competitive. Competition is, however, fragmented in most
markets with local and regional firms providing the primary competition. The
principal methods of competition are advertising, range of services provided,
speed and quality of customer service, service guarantees, and pricing.
No individual customer or market group is critical to the total sales
of this segment.
VITAS
Hospice care in the United States is competitive. Because payments for
hospice services are generally fixed, Vitas competes primarily on the basis of
its ability to deliver quality, responsive services. Vitas is the nation's
largest provider of hospice services in a market dominated by small, non-profit,
community-based hospices. More than 72% of all hospices are not-for-profit.
Because the hospice care market is highly fragmented, Vitas competes with a
large number of organizations.
Vitas also competes with a number of national and regional hospice
providers, including Odyssey Healthcare, Inc. and VistaCare, Inc., hospitals,
nursing homes, home health agencies and other health care providers. Many
providers offer home care to patients who are terminally ill, and some actively
market palliative care and hospice-like programs. In addition, various health
care companies have diversified into the hospice market. Some of these health
care companies may have greater financial resources than Vitas.
Relatively few barriers to entry exist in the markets served by Vitas.
Accordingly, other companies that are not currently providing hospice care may
enter these markets and expand the variety of services offered.
RESEARCH AND DEVELOPMENT
The Company engages in a continuous program directed toward the
development of new products and processes, the improvement of existing products
and processes, and the development of new and different uses of existing
products. The research and development expenditures from continuing operations
have not been nor are they expected to be material.
GOVERNMENT REGULATIONS
ROTO-ROOTER
Roto-Rooter's franchising activities are subject to various federal and
state franchising laws and regulations, including the rules and regulations of
the Federal Trade Commission (the "FTC") regarding the offering or sale of
franchises. The rules and regulations of the FTC require that Roto-Rooter
provide all prospective franchisees with specific information regarding the
franchise program and Roto-Rooter in the form of a detailed franchise offering
circular. In addition, a number of states require Roto-Rooter to register its
franchise offering prior to offering or selling franchises in the state. Various
state laws also provide for certain rights in favor of franchisees, including
(i)
8
limitations on the franchisor's ability to terminate a franchise except for good
cause, (ii) restrictions on the franchisor's ability to deny renewal of a
franchise, (iii) circumstances under which the franchisor may be required to
purchase certain inventory of franchisees when a franchise is terminated or not
renewed in violation of such laws, and (iv) provisions relating to arbitration.
Roto-Rooter's ability to engage in the plumbing repair business is also subject
to certain limitations and restrictions imposed by state and local licensing
laws and regulations.
SERVICE AMERICA
Service America's home and service warranty operations are regulated by
the Florida and Arizona Departments of Insurance. In accordance with certain
Florida regulatory requirements, Service America maintains cash with the
Department of Insurance and is also required to maintain additional unencumbered
reserves. In addition, Service America's air conditioning and appliance repair
and maintenance business is also subject to certain limitations imposed by state
and local licensing laws and regulations.
VITAS
General. The health care industry and Vitas' hospice programs are
subject to extensive federal and state regulation. Vitas' hospices are licensed
as required under state law as either hospices or home health agencies, or both,
depending on the regulatory requirements of each particular state. In addition,
Vitas' hospices are required to meet certain conditions of participation to be
eligible to receive payments as hospices under the Medicare and Medicaid
programs. All of Vitas' hospices, other than those currently in development, are
certified for participation as hospices in the Medicare program, and are also
eligible to receive payments as hospices from the Medicaid program in each of
the states in which Vitas operates. Vitas' hospices are subject to periodic
survey by governmental authorities or private accrediting entities to assure
compliance with state licensing, certification and accreditation requirements,
as the case may be.
Medicare Conditions of Participation. Federal regulations require that
a hospice program satisfy certain conditions of participation to be certified
and receive Medicare payment for the services it provides. Failure to comply
with the conditions of participation may result in sanctions, up to and
including decertification from the Medicare program. See "Surveys and Audits"
below.
The Medicare conditions of participation for hospice programs include
the following:
Governing Body. Each hospice must have a governing body that
assumes full responsibility for the policies and the overall operation
of the hospice and for ensuring that all services are provided in a
manner consistent with accepted standards of practice. The governing
body must designate one individual who is responsible for the
day-to-day management of the hospice.
Medical Director. Each hospice must have a medical director
who is a physician and who assumes responsibility for overseeing the
medical component of the hospice's patient care program.
Direct Provision of Core Services. Medicare limits those
services for which the hospice may use individual independent
contractors or contract agencies to provide care to patients.
Specifically, substantially all nursing, social work, and
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counseling services must be provided directly by hospice employees
meeting specific educational and professional standards. During periods
of peak patient loads or under extraordinary circumstances, the hospice
may be permitted to use contract workers, but the hospice must agree in
writing to maintain professional, financial and administrative
responsibility for the services provided by those individuals or
entities.
Professional Management of Non-Core Services. A hospice may
arrange to have non-core services such as therapy services, home health
aide services, medical supplies or drugs provided by a non-employee or
outside entity. If the hospice elects to use an independent contractor
to provide non-core services, however, the hospice must retain
professional management responsibility for the arranged services and
ensure that the services are furnished in a safe and effective manner
by qualified personnel, and in accordance with the patient's plan of
care.
Plan of Care. The patient's attending physician, the medical
director or designated hospice physician, and the interdisciplinary
team must establish an individualized written plan of care prior to
providing care to any hospice patient. The plan must assess the
patient's needs and identify services to be provided to meet those
needs and must be reviewed and updated at specified intervals.
Continuation of Care. A hospice may not discontinue or reduce
care provided to a Medicare beneficiary if the individual becomes
unable to pay for that care.
Informed Consent. The hospice must obtain the informed consent
of the hospice patient, or the patient's representative, that specifies
the type of care services that may be provided as hospice care.
Training. A hospice must provide ongoing training for its
employees.
Quality Assurance. A hospice must conduct ongoing and
comprehensive self-assessments of the quality and appropriateness of
care it provides and that its contractors provide under arrangements to
hospice patients.
Interdisciplinary Team. A hospice must designate an
interdisciplinary team to provide or supervise hospice care services.
The interdisciplinary team develops and updates plans of care, and
establishes policies governing the day-to-day provision of hospice
services. The team must include at least a physician, registered nurse,
social worker and spiritual or other counselor. A registered nurse must
be designated to coordinate the plan of care.
Volunteers. Hospice programs are required to recruit and train
volunteers to provide patient care services or administrative services.
Volunteer services must be provided in an amount equal to at least five
percent of the total patient care hours provided by all paid hospice
employees and contract staff.
Licensure. Each hospice and all hospice personnel must be
licensed, certified or registered in accordance with applicable
federal, state and local laws and regulations.
Central Clinical Records. Hospice programs must maintain
clinical records for each hospice patient that are organized in such a
way that they may be easily
10
retrieved. The clinical records must be complete and accurate and
protected against loss, destruction, and unauthorized use.
Surveys and Audits. Hospice programs are subject to periodic survey by
federal and state regulatory authorities and private accrediting entities to
ensure compliance with applicable licensing and certification requirements and
accreditation standards. Regulators conduct periodic surveys of hospice programs
and provide reports containing statements of deficiencies for alleged failure to
comply with various regulatory requirements. Survey reports and statements of
deficiencies are common in the healthcare industry. In most cases, the hospice
program and regulatory authorities will agree upon any steps to be taken to
bring the hospice into compliance with applicable regulatory requirements. In
some cases, however, a state or federal regulatory authority may take a number
of adverse actions against a hospice program, including the imposition of fines,
temporary suspension of admission of new patients to the hospice's service or,
in extreme circumstances, de-certification from participation in the Medicare or
Medicaid programs or revocation of the hospice's license.
From time to time Vitas receives survey reports containing statements
of deficiencies. Vitas reviews such reports and takes appropriate corrective
action. Vitas believes that its hospices are in material compliance with
applicable licensure and certification requirements. If a Vitas hospice were
found to be out of compliance and actions were taken against a Vitas hospice,
they could materially adversely affect the hospice's ability to continue to
operate, to provide certain services and to participate in the Medicare and
Medicaid programs, which could materially adversely affect Vitas.
Billing Audits/ Claims Reviews. The Medicare program and its fiscal
intermediaries and other payors periodically conduct pre-payment or post-payment
reviews and other reviews and audits of health care claims, including hospice
claims. There is pressure from state and federal governments and other payors to
scrutinize health care claims to determine their validity and appropriateness.
In order to conduct these reviews, the payor requests documentation from Vitas
and then reviews that documentation to determine compliance with applicable
rules and regulations, including the eligibility of patients to receive hospice
benefits, the appropriateness of the care provided to those patients and the
documentation of that care. During the past several years, Vitas' claims have
been subject to review and audit.
Certificate of Need Laws and Other Restrictions. Some states, including
Florida, have certificate of need or similar health planning laws that apply to
hospice care providers. These states may require some form of state agency
review or approval prior to opening a new hospice program, to adding or
expanding hospice services, to undertaking significant capital expenditures or
under other specified circumstances. Approval under these certificate of need
laws is generally conditioned on the showing of a demonstrable need for services
in the community. Vitas may seek to develop, acquire or expand hospice programs
in states having certificate of need laws. To the extent that state agencies
require Vitas to obtain a certificate of need or other similar approvals to
expand services at existing hospice programs or to make acquisitions or develop
hospice programs in new or existing geographic markets, Vitas' plans could be
adversely affected by a failure to obtain such certificate or approval. In
addition, competitors may seek administratively or judicially to challenge such
an approval or proposed approval by the state agency, and Vitas has been
defending against such a challenge in connection with the development of its
Palm Beach County, Florida hospice program. Such a challenge, whether or not
ultimately successful, could adversely affect Vitas.
11
Limitations on For-Profit Ownership. A few states have laws that
restrict the development and expansion of for-profit hospice programs. For
example, Florida law does not permit the operation of a hospice by a for-profit
corporation unless it was operated in that capacity on or before July 1, 1978,
although under certain circumstances a for-profit corporation may be permitted
to purchase a grandfathered hospice program and continue to operate it. In New
York, a hospice generally cannot be owned by a corporation that has another
corporation as a stockholder. These types of restrictions could affect Vitas'
ability to expand in Florida or into New York, or in other jurisdictions with
similar restrictions.
Limits on the Acquisition or Conversion of Non-Profit Health Care
Organizations. An increasing number of states have enacted laws that restrict
the ability of for-profit entities to acquire or otherwise assume the operations
of a non-profit health care provider. Some states may require government review,
public hearings, and/or government approval of transactions in which a
for-profit entity proposes to purchase certain non-profit healthcare
organizations. Heightened scrutiny of these transactions may significantly
increase the costs associated with future acquisitions of non-profit hospice
programs in some states, otherwise increase the difficulty in completing those
acquisitions or prevent them entirely. Vitas cannot assure that it will not
encounter regulatory or governmental obstacles in connection with any proposed
acquisition of non-profit hospice programs in the future.
Professional Licensure and Participation Agreements. Many hospice
employees are subject to federal and state laws and regulations governing the
ethics and practice of their profession, including physicians, physical, speech
and occupational therapists, social workers, home health aides, pharmacists and
nurses. In addition, those professionals who are eligible to participate in the
Medicare, Medicaid or other federal health care programs as individuals must not
have been excluded from participation in those programs at any time.
State Licensure of Hospice. Each of Vitas' hospices must be licensed in
the state in which it operates. State licensure rules and regulations require
that Vitas' hospices maintain certain standards and meet certain requirements,
which may vary from state to state. Vitas believes that its hospices are in
material compliance with applicable licensure requirements. If a Vitas hospice
were found to be out of compliance and actions were taken against a Vitas
hospice, they could materially adversely affect the hospice's ability to
continue to operate, to provide certain services and to participate in the
Medicare and Medicaid programs, which could materially adversely affect Vitas.
Overview of Government Payments -- General. A substantial portion of
Vitas' revenues are derived from payments received from the Medicare and
Medicaid programs. 95.2%, 95.4% and 95.4% of Vitas' net patient service revenue
for the years ended September 30, 2001, 2002 and 2003, respectively, and 95.8%
of Vitas' net patient service revenue for the three months ended December 31,
2003, consisted of payments from the Medicare and Medicaid programs. Such
payments are made primarily on a "per diem" basis. Under the per diem
reimbursement methodology, Vitas is essentially at risk for the cost of eligible
services provided to hospice patients. Profitability is therefore largely
dependent upon Vitas' ability to manage the costs of providing hospice services
to patients. Increases in operating costs, such as labor and supply costs that
are subject to inflation and other increases, without a compensating increase in
Medicare and Medicaid rates, could have a material adverse effect on Vitas'
business in the future. The Medicare and Medicaid programs are increasing
pressure to control health care costs and to decrease or limit increases in
reimbursement rates for health care services. As with most government
12
programs, the Medicare and Medicaid programs are subject to statutory and
regulatory changes, possible retroactive and prospective rate and payment
adjustments, administrative rulings, freezes and funding reductions, all of
which may adversely affect the level of program payments and could have a
material adverse effect on Vitas' business. Vitas' levels of revenues and
profitability will be subject to the effect of legislative and regulatory
changes, including possible reductions in coverage or payment rates, or changes
in methods of payment, by the Medicare and Medicaid programs.
Overview of Government Payments -- Medicare
Medicare Eligibility Criteria. To receive Medicare payment for hospice
services, the hospice medical director and, if the patient has one, the
patient's attending physician, must certify that the patient has a life
expectancy of six months or less if the illness runs its normal course. This
determination is made based on the physician's clinical judgment. Due to the
uncertainty of such prognoses, however, it is likely and expected that some
percentage of hospice patients will not die within six months of entering a
hospice program. The Medicare program (among other third-party payors)
recognizes that terminal illnesses often do not follow an entirely predictable
course, and therefore the hospice benefit remains available to beneficiaries so
long as the hospice physician or the patient's attending physician continues to
certify that the patient's life expectancy remains six months or less.
Specifically, the Medicare hospice benefit provides for two initial 90-day
benefit periods followed by an unlimited number of 60-day periods. In order to
qualify for hospice care, a Medicare beneficiary also must elect hospice care
and waive any right to other Medicare benefits related to his or her terminal
illness. A Medicare beneficiary may revoke his or her election of the Medicare
hospice benefit at any time and resume receiving regular Medicare benefits. The
patient may elect the hospice benefit again at a later date so long as he or she
remains eligible. Increased regulatory scrutiny of compliance with the Medicare
six-month eligibility rule has impacted the hospice industry. The Medicare
program, however, has recently reaffirmed that Medicare hospice beneficiaries
are not limited to six months of coverage and that there is no limit on how long
a Medicare beneficiary can continue to receive hospice benefits and services,
provided that the beneficiary continues to meet the eligibility criteria under
the Medicare hospice program. In addition, the Medicare, Medicaid and SCHIP
Benefits Improvement and Protection Act of 2000 requires HHS to conduct a study
to examine the appropriateness of the current physician certification
requirement required before a Medicare beneficiary is eligible to receive the
Medicare hospice benefit.
Levels of Care. Medicare pays for hospice services on a prospective
payment system basis under which Vitas receives an established payment rate for
each day that it provides hospice services to a Medicare beneficiary. These
rates are subject to annual adjustments for inflation and may also be adjusted
based upon the geographic location where the services are provided. The rate
Vitas receives will vary depending on which of the following four levels of care
is being provided to the beneficiary:
Routine Home Care. The routine home care rate is paid for each day that
a patient is in a hospice program and is not receiving one of the other
categories of hospice care. This rate is also paid when a patient is
receiving hospital care for a condition that is not related to his or
her terminal illness. The routine home care rate does not vary based
upon the volume or intensity of services provided by the hospice
program.
General Inpatient Care. The general inpatient care rate is paid when a
patient requires inpatient services for a short period for pain control
or symptom management
13
which cannot be managed in other settings. General inpatient care
services must be provided in a Medicare or Medicaid certified hospital
or long-term care facility or at a freestanding inpatient hospice
facility with the required registered nurse staffing.
Continuous Home Care. Continuous home care is provided to patients
while at home, during periods of crisis when intensive monitoring and
care, primarily nursing care, is required in order to achieve
palliation or management of acute medical symptoms. Continuous home
care requires a minimum of 8 hours of care within a 24-hour day, which
begins and ends at midnight. The care must be predominantly nursing
care provided by either a registered nurse or licensed practical nurse.
While the published Medicare continuous home care rates are daily
rates, Medicare actually pays for continuous home care services on an
hourly basis. This hourly rate is calculated by dividing the daily rate
by 24.
Respite Care. Respite care permits a hospice patient to receive
services on an inpatient basis for a short period of time in order to
provide relief for the patient's family or other caregivers from the
demands of caring for the patient. A hospice can receive payment for
respite care for a given patient for up to five consecutive days at a
time, after which respite care is reimbursed at the routine home care
rate.
Medicare Payment for Physician Services. Payment for direct patient
care physician services delivered by hospice physicians is billed separately by
the hospice to the Medicare intermediary and paid at the lesser of the actual
charge or the Medicare allowable charge for these services. This payment is in
addition to the daily rates Vitas receives for hospice care. Payment for hospice
physicians' administrative and general supervisory activities is included in the
daily rates discussed above. Payments for attending physician professional
services (other than services furnished by hospice physicians) are not paid to
the hospice, but rather are paid directly to the attending physician by the
Medicare carrier. For fiscal 2003, 1.9% of Vitas' net revenue was attributable
to physician services.
Medicare Limits on Hospice Care Payments. Medicare payments for hospice
services are subject to two additional limits or "caps." Each of Vitas' hospice
programs is separately subject to both of these "caps." Both of these "caps" are
determined on an annual basis for the period running from November 1 through
October 31 of each year.
First, under a Medicare rule known as the "80-20" rule applicable to
Medicare inpatient services, if the number of inpatient care days furnished by a
hospice to Medicare beneficiaries exceeds 20% of the total days of hospice care
furnished by such hospice to Medicare beneficiaries, Medicare payments to the
hospice for inpatient care days exceeding the inpatient cap are reduced to the
routine home care rate. During its history, Vitas has never exceeded the
inpatient cap.
Second, overall Medicare payments to a hospice are also subject to a
separate cap based on overall average payments per admission. Any payments
exceeding this overall hospice cap must be refunded by the hospice. This cap was
set at $18,661.29 per admission through the twelve-month period ended on October
31, 2003, and is adjusted annually to account for inflation. While historically
Vitas' revenues per admission generally have not exceeded the applicable cap,
there can be no assurance that Vitas' hospices will not be subject to future
payment reductions or recoupments as the result of this cap.
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Medicare Managed Care Programs. The Medicare program has entered into
contracts with managed care companies to provide a managed care benefit to
Medicare beneficiaries who elect to participate in managed care programs. These
managed care programs are commonly referred to as Medicare HMOs, Medicare +
Choice or Medicare risk products. Vitas provides hospice care to Medicare
beneficiaries who participate in these managed care programs, and Vitas is paid
for services provided to these beneficiaries in the same way and at the same
rates as those of other Medicare beneficiaries who are not in a Medicare managed
care program. Under current Medicare policy, Medicare pays the hospice directly
for services provided to these managed care program participants and then
reduces the standard per-member, per-month payment that the managed care program
otherwise receives.
Overview of Government Payments -- Medicaid
Medicaid Coverage and Reimbursement. State Medicaid programs are
another source of Vitas' net patient revenue. Medicaid is a state-administered
program financed by state funds and matching federal funds to provide medical
assistance to the indigent and certain other eligible persons. In 1986, hospice
services became an optional state Medicaid benefit. For those states that elect
to provide a hospice benefit, the Medicaid program is required to pay the
hospice at rates at least equal to the rates provided under Medicare and
calculated using the same methodology. States maintain flexibility to establish
their own hospice election procedures and to limit the number and duration of
benefit periods for which they will pay for hospice services.
Nursing Home Residents. For Vitas' patients who receive nursing home
care under a state Medicaid program and who elect hospice care under Medicare or
Medicaid, Vitas generally contracts with nursing homes for the nursing homes'
provision to patients of room and board services. In addition to the applicable
Medicare or Medicaid hospice daily or hourly rate, the state generally must pay
Vitas an amount equal to at least 95% of the Medicaid daily nursing home rate
for room and board services furnished to the patient by the nursing home. Under
Vitas' standard nursing home contracts, Vitas pays the nursing home for these
room and board services at the Medicaid daily nursing home rate.
Adjustments to Medicare and Medicaid Payment Rates. Payment rates under
the Medicare and Medicaid programs are generally indexed for inflation annually;
however, the increases have historically been less than actual inflation. On
October 1, 2001, the base Medicare payment rates for hospice care increased by
approximately 3.2% over the base rates previously in effect. On October 1, 2002
and on October 1, 2003, the base Medicare payment rates for hospice care
increased by approximately 3.4% each year over the base rates in effect in the
prior year. These rates were further adjusted by the hospice wage index. It is
possible that there will be further modifications to the rate structure under
which the Medicare or Medicaid programs pay for hospice care services. Any
future reductions in the rate of increase in Medicare and Medicaid payments may
have an adverse impact on Vitas' net patient service revenue and profitability.
OTHER HEALTHCARE REGULATIONS
Federal and State Anti-Kickback Laws and Safe Harbor Provisions. The
federal Anti-Kickback Law makes it a felony to knowingly and willfully offer,
pay, solicit or receive any form of remuneration in exchange for referring,
recommending, arranging, purchasing, leasing or ordering items or services
covered by a federal health care program including Medicare or Medicaid. The
Anti-Kickback Law applies regardless of whether the remuneration is provided
directly or indirectly, in cash or in kind. Although the anti-kickback statute
does not prohibit all financial transactions or relationships that providers of
healthcare
15
items or services may have with each other, interpretations of the law have been
very broad. Under current law, courts and federal regulatory authorities have
stated that this law is violated if even one purpose (as opposed to the sole or
primary purpose) of the arrangement is to induce referrals.
Violations of the Anti-Kickback Law carry potentially severe penalties
including imprisonment of up to five years, criminal fines of up to $25,000 per
act, civil money penalties of up to $50,000 per act, and additional damages of
up to three times the amounts claimed or remuneration offered or paid. Federal
law also authorizes exclusion from the Medicare and Medicaid programs for
violations of the Anti-Kickback Law.
The Anti-Kickback Law contains several statutory exceptions to the
broad prohibition. In addition, Congress authorized the Office of Inspector
General ("OIG") to publish numerous "safe harbors" that exempt some practices
from enforcement action under the Anti-Kickback Law and related laws. These
statutory exceptions and regulatory safe harbors protect various bona fide
employment relationships, contracts for the rental of space or equipment,
personal service arrangements, and management contracts, among other things,
provided that certain conditions set forth in the statute or regulations are
satisfied. The safe harbor regulations, however, do not comprehensively describe
all lawful relationships between healthcare providers and referral sources, and
the failure of an arrangement to satisfy all of the requirements of a particular
safe harbor does not mean that the arrangement is unlawful. Failure to comply
with the safe harbor provisions, however, may mean that the arrangement will be
subject to scrutiny. It is possible for healthcare providers to request an
advisory opinion from the OIG regarding an existing or proposed business
arrangement and the possible anti-kickback concerns raised by that arrangement.
Many states, including states where Vitas does business, have adopted
similar prohibitions against payments that are intended to induce referrals of
patients, regardless of the source of payment. Some of these state laws lack
explicit "safe harbors" that may be available under federal law. Sanctions under
these state anti-kickback laws may include civil money penalties, license
suspension or revocation, exclusion from Medicare or Medicaid, and criminal
fines or imprisonment. Little precedent exists regarding the interpretation or
enforcement of these statutes.
Vitas is required under the Medicare conditions of participation and
some state licensing laws to contract with numerous healthcare providers and
practitioners, including physicians, hospitals and nursing homes, and to arrange
for these individuals or entities to provide services to Vitas' patients. In
addition, Vitas has contracts with other suppliers, including pharmacies,
ambulance services and medical equipment companies. Some of these individuals or
entities may refer, or be in a position to refer, patients to Vitas, and Vitas
may refer, or be in a position to refer, patients to these individuals or
entities. These arrangements may not qualify for a safe harbor. Vitas from time
to time seeks guidance from regulatory counsel as to the changing and evolving
interpretations and the potential applicability of these anti-kickback laws to
its programs, and in response thereto, takes such actions as it deems
appropriate. We generally believe that Vitas' contracts and arrangements with
providers, practitioners and suppliers do not violate applicable anti-kickback
laws. However, we cannot assure you that such laws will ultimately be
interpreted in a manner consistent with Vitas' practices.
HIPAA Anti-Fraud Provisions. HIPAA includes several revisions to
existing health care fraud laws by permitting the imposition of civil monetary
penalties in cases involving violations of the anti-kickback statute or
contracting with excluded providers. In
16
addition, HIPAA created new statutes making it a federal felony to engage in
fraud, theft, embezzlement, or the making of false statements with respect to
healthcare benefit programs, which include private, as well as government
programs. In addition, for the first time, federal enforcement officials have
the ability to exclude from the Medicare and Medicaid programs any investors,
officers and managing employees associated with business entities that have
committed healthcare fraud, even if the investor, officer or employee had no
actual knowledge of the fraud.
OIG Fraud Alerts, Advisory Opinions and Other Program Guidance. In
1976, Congress established the OIG to, among other things, identify and
eliminate fraud, abuse and waste in HHS programs. To identify and resolve such
problems, the OIG conducts audits, investigations and inspections across the
country and issues public pronouncements identifying practices that may be
subject to heightened scrutiny. In the last several years, there have been a
number of hospice related audits and reviews conducted. These reviews and
recommendations have included the following:
- better ensuring that Medicare hospice eligibility
determinations are made in accordance with the Medicare
regulations; and
- revising the annual cap on hospice benefits to better reflect
the cost of care provided.
From time to time, various federal and state agencies, such as HHS and
the OIG, issue a variety of pronouncements, including fraud alerts, the OIG's
Annual Work Plan and other reports, identifying practices that may be subject to
heightened governmental scrutiny. For example, the OIG in 2002 specifically
called for a review of hospice plans of care to examine the variance among
hospice plans of care and the extent to which services are provided in
accordance with plans of care, and to determine whether there should be uniform
standards or minimum requirements for their completion. In addition, the OIG
called for a review of payments for the care of hospice patients residing in
nursing homes and the level of services they receive. We cannot predict what, if
any changes may be implemented in coverage, reimbursement, or enforcement
policies as a result of these OIG reviews and recommendations.
Additionally, in March 1998, the OIG issued a special fraud alert
titled "Fraud and Abuse in Nursing Home Arrangements with Hospices." This
special fraud alert focused on payments received by nursing homes from hospices.
Federal False Claims Acts. The federal law includes several criminal
and civil false claims provisions, which provide that knowingly submitting
claims for items or services that were not provided as represented may result in
the imposition of multiple damages, administrative civil money penalties,
criminal fines, imprisonment, and/or exclusion from participation in federally
funded healthcare programs, including Medicare and Medicaid. In addition, the
OIG may impose extensive and costly corporate integrity requirements upon a
healthcare provider that is the subject of a false claims judgment or
settlement. These requirements may include the creation of a formal compliance
program, the appointment of a government monitor, and the imposition of annual
reporting requirements and audits conducted by an independent review
organization to monitor compliance with the terms of the agreement and relevant
laws and regulations.
The Civil False Claims Act prohibits the known filing of a false claim
or the known use of false statements to obtain payments. Penalties for
violations include fines ranging
17
from $5,500 to $11,000, plus treble damages, for each claim filed. Provisions in
the Civil False Claims Act also permit individuals to bring actions against
individuals or businesses in the name of the government as so called "qui tam"
relators. If a qui tam relator's claim is successful, he or she is entitled to
share in the government's recovery.
Both direct enforcement activity by the government and qui tam actions
have increased significantly in recent years and have increased the risk that a
healthcare company may have to defend a false claims action, pay fines or be
excluded from the Medicare and/or Medicaid programs as a result of an
investigation arising out of this type of an action. Because of the complexity
of the government regulations applicable to the healthcare industry, we cannot
assure you that Vitas will not be the subject of an action under the False
Claims Act.
State False Claims Laws. At least 10 states and the District of
Columbia, including states in which Vitas currently operates, have adopted state
false claims laws that mirror to some degree the federal false claims laws.
While these statutes vary in scope and effect, the penalties for violating these
false claims laws include administrative, civil and/or criminal fines and
penalties, imprisonment, and the imposition of multiple damages.
The Stark Law and State Physician Self-Referral Laws. Section 1877 of
the Social Security Act, commonly known as the "Stark Law," prohibits physicians
from referring Medicare or Medicaid patients for "designated health services" to
entities in which they hold an ownership or investment interest or with whom
they have a compensation arrangement, subject to a number of statutory and
regulatory exceptions. Penalties for violating the Stark Law are severe and
include:
- denial of payment;
- civil monetary penalties of $15,000 per referral or $1,000,000
for "circumvention schemes;"
- assessments equal to 200% of the dollar value of each such
service provided; and
- exclusion from the Medicare and Medicaid programs.
Hospice care itself is not specifically listed as a designated health
service; however, certain services that Vitas provides, or in the future may
provide, are among the services identified as designated health services for
purposes of the self-referral laws. We cannot assure you that future regulatory
changes will not result in hospice services becoming subject to the Stark Law's
ownership, investment or compensation prohibitions in the future.
Many states where Vitas operates have laws similar to the Stark Law,
but with broader effect because they apply regardless of the source of payment
for care. Penalties similar to those listed above as well the loss of state
licensure may be imposed in the event of a violation of these state
self-referral laws. Little precedent exists regarding the interpretation or
enforcement of these statutes.
Civil Monetary Penalties. The Civil Monetary Penalties Statute provides
that civil penalties ranging between $10,000 and $50,000 per claim or act may be
imposed on any person
18
or entity that knowingly submits improperly filed claims for federal health
benefits or that offers or makes payments to induce a beneficiary or provider to
reduce or limit the use of health care services or to use a particular provider
or supplier. Civil monetary penalties may be imposed for violations of the
anti-kickback statute and for the failure to return known overpayments, among
other things.
Prohibition on Employing or Contracting with Excluded Providers. The
Social Security Act and federal regulations state that individuals or entities
that have been convicted of a criminal offense related to the delivery of an
item or service under the Medicare or Medicaid programs or that have been
convicted, under state or federal law, of a criminal offense relating to neglect
or abuse of residents in connection with the delivery of a healthcare item or
service cannot participate in any federal health care programs, including
Medicare and Medicaid. Additionally, individuals and entities convicted of
fraud, that have had their licenses revoked or suspended, or that have failed to
provide services of adequate quality also may be excluded from the Medicare and
Medicaid programs. Federal regulations prohibit Medicare providers, including
hospice programs, from submitting claims for items or services or their related
costs if an excluded provider furnished those items or services. The OIG
maintains a list of excluded persons and entities. Nonetheless, it is possible
that Vitas might unknowingly bill for services provided by an excluded person or
entity with whom it contracts. The penalty for contracting with an excluded
provider may range from civil monetary penalties of $50,000 and damages of up to
three times the amount of payment that was inappropriately received.
Corporate Practice of Medicine and Fee Splitting. Most states have laws
that restrict or prohibit anyone other than a licensed physician, including
business entities such as corporations, from employing physicians and/or
prohibit payments or fee-splitting arrangements between physicians and
corporations or unlicensed individuals. Violations of corporate practice of
medicine and fee-splitting laws vary from state to state, but may include civil
or criminal penalties, the restructuring or termination of the business
arrangements between the physician and unlicensed individual or business entity,
or even the loss of the physician's license to practice medicine. These laws
vary widely from state to state both in scope and origin (e.g. statute,
regulation, Attorney General opinion, court ruling, agency policy) and in most
instances have been subject to only limited interpretation by the courts or
regulatory bodies.
Vitas employs or contracts with physicians to provide medical direction
and patient care services to its patients. Vitas has made efforts in those
states where certain contracting or fee arrangements are restricted or
prohibited to structure those arrangements in compliance with the applicable
laws and regulations. Despite these efforts, however, we cannot assure you that
agency officials charged with enforcing these laws will not interpret Vitas'
contracts with employed or independent contractor physicians as violating the
relevant laws or regulations. Future determinations or interpretations by
individual states with corporate practice of medicine or fee splitting
restrictions may force Vitas to restructure its arrangements with physicians in
those locations.
Health Information Practices. There currently are numerous legislative
and regulatory initiatives at both the state and federal levels that address
patient privacy concerns. In particular, federal regulations issued under the
HIPAA Act of 1996 ("HIPAA") require Vitas to protect the privacy and security of
patients' individual health information. HHS published final regulations
addressing patient privacy on December 28, 2000, which were modified on August
14, 2002 (the "Privacy Rule"). Vitas was required to comply with the Privacy
Rule by April 14, 2003, and Vitas believes that it is in material compliance.
Additionally, HIPAA does not automatically preempt applicable state laws and
regulations
19
concerning Vitas' use, disclosure and maintenance of patient health information,
which means that Vitas is subject to a complex regulatory scheme that, in many
instances, requires Vitas to comply both with federal and state laws and
regulations.
In August of 2000, HHS published final regulations establishing health
care transaction standards and code sets for the electronic transmission of
health care information in connection with certain transactions, such as billing
or health plan eligibility (the "Transactions Standard"). The official deadline
for compliance with the Transactions Standard for covered entities such as Vitas
was October 16, 2003. The Centers for Medicare and Medicaid Services ("CMS") is
the division of HHS that is responsible for interpreting and enforcing the
Transactions Standard. Failure to comply with the Transactions Standard may
subject covered entities, including Vitas, to civil monetary penalties and
possibly to criminal penalties. Vitas believes that it has made significant and
appropriate good faith efforts to comply with the Transactions Standard and to
develop an appropriate contingency plan as encouraged by CMS. It is unclear,
however, how CMS will regulate providers in general or Vitas in particular with
respect to compliance with the Transactions Standard. Consequently, it also is
unclear whether Vitas would be found to be in material compliance with the
Transactions Standard if CMS were to review Vitas' electronic claims submissions
and assess Vitas' electronic transactions, or whether Vitas would be required to
expend substantial sums on acquiring and implementing new information systems,
or would otherwise be affected in a manner that would negatively impact its
profitability.
On May 31, 2002, HHS published its final rule regarding the HIPAA
Unique Employer Identifier Standard, which establishes a standard for
identifying employers in healthcare transactions where information about the
employer is transmitted electronically, as well as requirements concerning its
use by HIPAA covered entities. The deadline for compliance with the Unique
Employer Identifier Standard rule is July 30, 2004. Additionally, HHS published
final regulations addressing the security of such health information on February
20, 2003 (the "Security Rule"), and Vitas will be required to comply with the
Security Rule by April 21, 2005. Also, HHS published its final rule adopting the
HIPAA Standard Unique Health Identifier for health care providers on January 23,
2004, and Vitas' compliance deadline for that rule is May 23, 2007. Because
compliance with the final rules regarding the HIPAA Unique Employer Identifier
Standard and the Standard Unique Health Identifier, and the Security Rule is not
yet required, we cannot predict the total financial or other impact of any of
these final regulations on Vitas' operations, including any need for Vitas to
expend financial resources on acquiring and implementing new information systems
or any other negative impact on Vitas' profitability.
Additional Federal and State Regulation. Federal and state governments
also regulate various aspects of the hospice industry. In particular, Vitas'
operations are subject to federal and state health regulatory laws covering
professional services, the dispensing of drugs and certain types of hospice
activities. Some of Vitas' employees are subject to state laws and regulations
governing the ethics and professional practice of medicine, respiratory therapy,
pharmacy and nursing.
Compliance with Health Regulatory Laws. Vitas maintains an internal
regulatory compliance review program and from time to time retains regulatory
counsel for guidance on compliance matters. We cannot assure you, however, that
Vitas' practices, if reviewed, would be found to be in compliance with
applicable health regulatory laws, as such laws ultimately may be interpreted,
or that any non-compliance with such laws would not have a material adverse
effect on Vitas.
20
ENVIRONMENTAL MATTERS
Roto-Rooter's operations are subject to various federal, state, and
local laws and regulations regarding environmental matters and other aspects of
the operation of a sewer and drain cleaning, HVAC and plumbing services
business. For certain other activities, such as septic tank and grease trap
pumping, Roto-Rooter is subject to state and local environmental health and
sanitation regulations. Service America's operations are also subject to various
federal, state and local laws and regulations regarding environmental matters
and other aspects of the operation of a HVAC and appliance repair and
maintenance service industry.
At December 31, 2003, the Company's accrual for its estimated liability
for potential environmental cleanup and related costs arising from the sale of
DuBois Chemcials Inc. ("Dubois") amounted to $2,070,000. Of this balance,
$870,000 is included in other liabilities and $1,200,000 is included in other
current liabilities. The Company is contingently liable for additional
DuBois-related environmental cleanup and related costs up to a maximum of
$18,036,000. On the basis of a continuing evaluation of the Company's potential
liability, management believes that it is not probable this additional liability
will be paid. Accordingly, no provision for this contingent liability has been
recorded. Although it is not presently possible to reliably project the timing
of payments related to the Company's potential liability for environmental
costs, management believes that any adjustments to its recorded liability will
not materially adversely affect its financial position or results of operations.
The Company, to the best of its knowledge, is currently in compliance
in all material respects with the environmental laws and regulations affecting
its operations. Such environmental laws, regulations and enforcement proceedings
have not required the Company to make material increases in or modifications to
its capital expenditures and they have not had a material adverse effect on
sales or net income. Capital expenditures for the purposes of complying with
environmental laws and regulations during 2004 and 2005 with respect to
continuing operations are not expected to be material in amount; there can be no
assurance, however, that presently unforeseen legislative or enforcement actions
will not require additional expenditures.
SEASONALITY
Advertising costs for Roto-Rooter inordinately impact the Company's
fourth-quarter results. Roto-Rooter recognizes telephone directory costs
immediately upon distribution of a directory by its publisher into the
community. Since a large number of directories are distributed in the fourth
quarter, this direct expense accounting policy results in fourth-quarter
earnings including a disproportionately large share of Roto-Rooter's full-year
telephone directory advertising expense. In the fourth quarter 2003, Roto-Rooter
expensed $7.1 million of total advertising costs that represented 42% of the
aggregate advertising costs for the full-year 2003.
EMPLOYEES
On December 31, 2003, Roto-Rooter, Inc. had a total of 3,357 employees.
21
AVAILABLE INFORMATION
The Company's internet address is www.rotorooterinc.com. The Company's
annual report on Form 10-K, quarterly reports on Form 10-Q, and current reports
on Form 8-K, and amendments to those reports filed or furnished pursuant to
Section 13(a) or 15(d) of the Exchange Act are electronically available through
the Company's website as soon as reasonably practicable after such reports are
filed with, or furnished to, the SEC.
Annual and quarterly reports, press releases, and other printed
materials may also be obtained from Roto-Rooter Investor Relations without
charge by writing or by calling 800-224-3633 or 513-762-6463.
ITEM 2. PROPERTIES
The Company's corporate offices and the headquarters for the
Roto-Rooter Group are located in Cincinnati, Ohio. Roto-Rooter has manufacturing
and distribution center facilities in West Des Moines, Iowa and has 61 office
and service facilities in 26 states. The headquarters for Service America is
located in Ft. Lauderdale, Florida and Service America has 8 office and service
facilities in Florida and Arizona. Vitas operates 25 programs from 41 leased
facilities in 8 states, including Florida, California, Texas and Illinois.
All "owned" property is held in fee and is subject to the security
interests of the Company's new senior secured credit facilities and of the
holders of the Floating Rate Notes issued in connection of the Company's merger
with Vitas. The leased property have lease terms ranging from one year to
fifteen years. Management does not foresee any difficulty in renewing or
replacing the remainder of its current leases. The Company considers all of its
major operating properties to be maintained in good operating condition and to
be generally adequate for present and anticipated needs.
ITEM 3. LEGAL PROCEEDINGS
The Company is party to a class action lawsuit filed in the Third
Judicial Circuit Court of Madison County, Illinois in June of 2000 by Robert
Harris, alleging certain Roto-Rooter plumbing was performed by unlicensed
employees. The Company contests these allegations and believes them without
merit. Plaintiff moved for certification of a class of customers in 32 states
who allegedly paid for plumbing work performed by unlicensed employees.
Plaintiff also moved for partial summary judgment on grounds the licensed
apprentice plumber who installed his faucet did not work under the direct
personal supervision of a licensed master plumber. On June 19, 2002, the trial
judge certified an Illinois-only plaintiffs class and granted summary judgment
for the named party Plaintiff on the issue of liability, finding violation of
the Illinois Plumbing License Act and the Illinois Consumer Fraud Act, through
Roto-Rooter's representation of the licensed apprentice as a plumber. The court
has not yet ruled on certification of a class in the remaining 31 states. Due to
the complex legal and other issues involved, it is not presently possible to
estimate the amount of liability, if any, related to this matter.
On April 5, 2002 Michael Linn, an attorney, filed a class action
complaint against the Company in the Court of Common Pleas, Cuyahoga County,
Ohio. He alleges Roto-Rooter Services Company's miscellaneous parts charge,
ranging from $4.95 to $12.95 per job, violates the Ohio Consumer Sales Practices
Act. The Company contends that the charge,
22
which is included within the estimate approved by its customers, is a fully
disclosed component of its pricing. On February 25, 2003 the trial court
certified a class of customers who paid the charge from October 1999 to July
2002. The Company is appealing this order and believes the ultimate disposition
of this lawsuit will not have a material effect on its financial position.
However, management cannot provide assurance the Company will ultimately prevail
in either of the above two cases. Regardless of outcome, such litigation can
adversely affect the Company through defense costs, diversion of management's
time, and related publicity.
The District Attorney of Suffolk County, New York is contemplating
legal proceedings against Roto-Rooter Services Company, an indirect subsidiary
of the Company, arising out of the disposal of restaurant grease trap waste,
originating in adjacent Nassau County, in Suffolk County disposal sites. The
Company believes the disposition of this matter will not have a material effect
on its financial position.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
EXECUTIVE OFFICERS OF THE COMPANY
Name Age Office First Elected
- ------------------ --- ------------------------------------ ---------------
Edward L. Hutton 84 Chairman November 3, 1993 (1)
Kevin J. McNamara 50 President and Chief Executive Officer August 2, 1994 (2)
Timothy S. O'Toole 48 Executive Vice President May 18, 1992 (3)
Spencer S. Lee 48 Executive Vice President May 15, 2000 (4)
David P. Williams 43 Vice President and Chief Financial March 5, 2004 (5)
Officer
Arthur V. Tucker, 54 Vice President and Controller May 20, 1991 (6)
Jr.
(1) Mr. E. L. Hutton is the Chairman of the Company and has held this
position since November 1993. Previously, from April 1970 to May 2001,
Mr. E. L. Hutton also served as Chief Executive Officer and from April
1970 to November 1993, he held the position of President of the
Company. Mr. E. L. Hutton is the father of Mr. T. C. Hutton, a director
and a Vice President of the Company.
(2) Mr. K. J. McNamara is President and Chief Executive Officer of the
Company and has held these positions since August 1994 and May 2001,
respectively. Previously, he served as an Executive Vice President,
Secretary and General Counsel of the Company, since November 1993,
August 1986 and August 1986, respectively. He previously held the
position of Vice President of the Company, from August 1986 to May
1992.
(3) Mr. T. S. O'Toole is an Executive Vice President of the Company and has
held this position since May 1992. He is also President and Chief
Executive Officer of Vitas, a wholly owned subsidiary of the Company,
and has held this position since February 24, 2004. Previously, from
May 1992 to February 24, 2004, he also served the Company as Treasurer.
23
(4) Mr. Lee is an Executive Vice President of the Company and has held this
position since May 15, 2000. Mr. Lee is also Chairman and Chief
Executive Officer of Roto-Rooter Management Company, a wholly owned
subsidiary of the Company, and has held this position since January
1999. Previously, he served as a Senior Vice President of Roto-Rooter
Services Company from May 1997 to January 1999.
(5) Mr. Williams is Vice President and Chief Financial Officer of the
Company and has held these positions since March 5, 2004. Mr. Williams
is also Senior Vice President and Chief Financial Officer of
Roto-Rooter Management Company and has held these positions since
January 1999.
(6) Mr. A. V. Tucker, Jr. is a Vice President and Controller of the Company
and has held these positions since February 1989. From May 1983 to
February 1989, he held the position of Assistant Controller of the
Company.
Each executive officer holds office until the annual election at the
next annual organizational meeting of the Board of Directors of the Company
which is scheduled to be held on May 17, 2004.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS
AND ISSUER PURCHASES OF EQUITY SECURITIES
The Company's Capital Stock (par value $1 per share) is traded on the
New York Stock Exchange under the symbol RRR. The range of the high and low sale
prices on the New York Stock Exchange and dividends paid per share for each
quarter of 2002 and 2003 are set forth below.
Closing
------------------------- Dividends Paid
High Low Per Share
- -------------------------------------------------------------------------------------
2003
First Quarter $36.51 $31.55 $.12
Second Quarter 40.20 32.98 .12
Third Quarter 40.35 34.42 .12
Fourth Quarter 51.78 33.69 .12
2002
First Quarter $38.30 $33.52 $.11
Second Quarter 39.35 33.60 .11
Third Quarter 37.04 29.85 .11
Fourth Quarter 37.84 29.65 .12
Future dividends are necessarily dependent upon the Company's earnings
and financial condition, compliance with certain debt covenants and other
factors not presently determinable.
24
As of March 5, 2004, there were approximately 3,382 stockholders of
record of the Company's Capital Stock. This number only includes stockholders of
record and does not include stockholders with shares beneficially held in
nominee name or within clearinghouse positions of brokers, banks or other
institutions.
Information with respect to securities authorized for issuance under
the Company's equity compensation plans is included within Note 18 of the Notes
to Financial Statements appearing on page F-29 of this Report on Form 10-K.
25
ITEM 6. SELECTED FINANCIAL DATA
Selected financial data for Roto-Rooter, Inc. and subsidiary companies
("Company") as of and for each of the five years ended December 31, 1999 through
December 31, 2003 are presented below (in thousands, except per share and
footnote data, ratios and employee data):
2003 2002 2001 2000 1999
-------- --------- --------- --------- ---------
SUMMARY OF OPERATIONS
Continuing operations (a)
Service revenues and sales $ 308,871 $ 314,176 $ 337,908 $ 355,307 $ 316,719
Gross profit (excluding depreciation) 126,061 127,891 132,292 146,329 127,042
Depreciation 12,054 13,587 14,395 13,374 11,285
Amortization of goodwill - - 4,102 4,090 3,770
Income/ (loss) from operations (b) (7,720) (2,678) (11,561) 28,548 21,227
Income/ (loss) from continuing operations (c) (3,499) (8,854) (10,738) 18,030 16,195
Net income/ (loss) (c) (3,435) (2,545) (12,185) 19,971 19,481
Earnings/ (loss) per share
Income/ (loss) from continuing operations $ (0.35) $ (0.90) $ (1.11) $ 1.83 $ 1.55
Net income/ (loss) (0.35) (0.26) (1.25) 2.03 1.86
Average number of shares outstanding 9,924 9,858 9,714 9,833 10,470
Diluted earnings/ (loss) per share
Income/ (loss) from continuing operations $ (0.35) $ (0.90) $ (1.11) $ 1.82 $ 1.54
Net income/ (loss) (0.35) (0.26) (1.25) 2.01 1.85
Average number of shares outstanding 9,924 9,858 9,714 9,927 10,514
Cash dividends per share $ 0.48 $ 0.45 $ 0.44 $ 0.40 $ 2.12
Net income/(loss) excluding goodwill amortization (e)
Net income/(loss) $ (3,435) $ (2,545) $ (7,564) $ 24,579 $ 23,789
Earnings/(loss) per share (0.35) (0.26) (0.78) 2.50 2.27
Diluted earnings/(loss) per share (0.35) (0.26) (0.78) 2.48 2.26
FINANCIAL POSITION--YEAR END
Cash and cash equivalents $ 50,587 $ 37,731 $ 8,725 $ 9,978 $ 17,043
Working capital 42,993 29,269 19,200 6,911 21,478
Current ratio 1.73 1.45 1.23 1.07 1.23
Properties and equipment, at cost less
accumulated depreciation $ 41,004 $ 48,361 $ 54,549 $ 60,343 $ 56,913
Total assets 329,069 338,144 401,457 419,932 422,674
Long-term debt 25,931 25,603 61,037 58,391 78,580
Mandatorily redeemable convertible preferred
securities of the Chemed Capital Trust $ 14,126 $ 14,186 $ 14,239 $ 14,641 $ -
Stockholders' equity 192,693 198,422 204,160 211,451 210,344
OTHER STATISTICS--CONTINUING OPERATIONS
Net cash provided by continuing operations $ 22,590 $ 26,894 $ 27,123 $ 45,981 $ 28,582
Capital expenditures 11,178 11,855 14,457 17,586 16,696
Number of employees (d) 3,357 3,335 3,764 3,784 3,949
Number of service and sales representatives 2,529 2,514 2,623 2,586 2,699
- ------------------
(a) Continuing operations exclude Patient Care, discontinued in 2002, and Cadre
Computer, discontinued in 2001.
(b) Income/(loss) from operations includes asset impairment charges of
$15,828,000 and severance charges of $3,627,000 in 2003, a goodwill
impairment charge of $20,342,000 in 2002 and restructuring and similar
expenses and other charges of $27,211,000 in 2001.
(c) Income/(loss) from continuing operations and net income/(loss) include
aftertax asset impairment charges of $14,363,000 in 2003, an aftertax
goodwill impairment charge of $20,342,000 in 2002 and aftertax
restructuring and similar expenses and other charges of $16,943,000 and an
aftertax loss on the early extinguishment of debt of $1,701,000 in 2001.
Aftertax capital gains on the sales and redemption of investments for the
years 2003 through 1999 amounted to $3,351,000, $775,000, $703,000,
$2,261,000 and $2,960,000, respectively. In accordance with FASB Statement
No. 142, amortization of goodwill ceased December 31, 2001. Aftertax
amortization of goodwill for continuing operations for the years 2001
through 1999 was $3,888,000, $3,875,000 and $3,580,000, respectively.
(d) Employee numbers reflect full-time-equivalent employees.
(e) In accordance with FASB Statement No. 142, amortization of goodwill ceased
December 31, 2001. Aftertax amortization of goodwill for for all operations
for the years 2001 through 1999 was $4,621,000, $4,608,000 and $4,308,000,
respectively.
26
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
LIQUIDITY AND CAPITAL RESOURCES
Significant factors affecting the Company's consolidated cash flows
during 2003 and financial position at December 31, 2003, include the following:
- Continuing operations generated cash of $22.6 million;
- Proceeds from the redemption of Vitas' redeemable preferred stock
totaled $27.3 million;
- The Company invested $18.0 million in Vitas' common stock (37%
ownership interest);
- Capital expenditures totaled $11.2 million; and,
- The Company placed $10.0 million in escrow to secure its offer to
purchase the shares of Vitas it did not own.
The ratio of total debt (excluding the Preferred Securities) to total
capital was 12.0% at December 31, 2003, as compared with 10.9% at December 31,
2002. The Company's current ratio at December 31, 2003, was 1.7 as compared with
1.5 at December 31, 2002.
The Company had $51.4 million of unused lines of credit with various
banks at December 31, 2003.
CASH FLOW
The Company's cash flows for 2003, 2002 and 2001 are summarized as
follows (in millions):
For the Years Ended December 31,
-----------------------------------
2003 2002 2001
------- ------- -------
Net cash provided by operating activities $ 22.6 $ 29.5 $ 34.4
Capital expenditures (11.2) (11.9) (14.5)
------- ------- -------
Operating cash excess after capital expenditures 11.4 17.6 19.9
Proceeds from redemption of Vitas' preferred stock 27.3 - -
Investment in Vitas' common stock (18.0) - -
Deposit to secure Vitas merger offer (10.0) - -
Dividends paid (4.8) (4.4) (4.4)
Proceeds from sales of available for sale securities 4.5 1.9 1.4
Net proceeds/(uses) from sale of
discontinued operations 1.1 50.7 (6.3)
Net decrease in long-term debt (0.4) (35.4) (11.4)
Other--net 1.8 (1.4) (0.5)
------- ------- -------
Increase/(decrease) in cash and cash equivalents $ 12.9 $ 29.0 $ (1.3)
======= ======= =======
For 2003, the operating cash excess after capital expenditures was
$11.4 million as compared with $17.6 million in 2002 and $19.9 million in 2001.
This excess, along with the proceeds from the redemption of Vitas' preferred
stock, was used to purchase 37% of Vitas common stock, to place a deposit of
$10.0 million to secure the Company's merger offer for Vitas' remaining common
stock, to pay cash dividends and to increase the Company's available cash and
cash equivalents. For 2002, the operating excess after capital expenditures and
the proceeds from the sale of Patient Care were used to retire funded debt, to
pay cash dividends and to increase the Company's available cash and cash
equivalents. For 2001, the operating cash excess after capital expenditures was
used to fund debt repayment, pay costs related to discontinued operations and to
pay cash dividends.
COMMITMENTS AND CONTINGENCIES
In connection with the sale of DuBois Chemicals, Inc. ("DuBois") in
1991, the Company provided allowances and accruals relating to several long-term
costs, including income tax matters, lease commitments and environmental costs.
Also, in conjunction with the sales of The Omnia Group ("Omnia") and National
Sanitary Supply Company in 1997 and the sale of Cadre Computer Resources, Inc.
("Cadre Computer") in 2001, the Company provided long-term allowances and
accruals relating to costs of severance arrangements,
27
lease commitments and income tax matters. In the aggregate, the Company believes
these allowances and accruals are adequate as of December 31, 2003.
Based on reviews of its environmental-related liabilities under the
DuBois sale agreement, the Company has estimated its remaining liability to be
$2.1 million. As of December 31, 2003, the Company is contingently liable for
additional cleanup and related costs up to a maximum of $18.0 million, for which
no provision has been recorded.
In connection with the sale of Patient Care in 2002, $5.0 million of
the cash purchase price was placed in escrow pending collection of third-party
payer receivables on Patient Care's balance sheet at the sale date. Of this
amount, $2.5 million was returned to the Company in October 2003. Based on
Patient Care's collection history, the Company believes that the specified
receivables will be collected and that the remaining balance of the escrow funds
will be paid to Roto-Rooter, Inc. The remaining $2.5 million of these escrow
funds will be evaluated and distributed as of October 2004.
The Company's various loan agreements and guarantees of indebtedness as
of December 31, 2003, contained certain restrictive covenants. The Company was
in compliance with all of the covenants at that time. Effective with the
acquisition of Vitas on February 24, 2004, the Company's revolving credit
agreement with Bank One, N.A. ("Bank One") was cancelled. In addition, the
Company retired its $25 million senior notes due 2005 - 2009, incurring a
prepayment penalty of $3.3 million.
LIQUIDITY AND COMMITMENTS AFTER THE VITAS ACQUISITION
In connection with the acquisition of Vitas on February 24, 2004, the
Company entered into a secured revolving credit/term loan facility ("New Credit
Facility") with Bank One. The revolving credit facility provides for borrowings
of up to $100 million, including up to $40 million in letters of credit.
Interest payments for the revolving line of credit are based on LIBOR plus
3.25%. The term loan facility provides for a $35 million term loan and requires
quarterly principal payments of $1,250,000 with interest based on LIBOR plus
3.50%. All unpaid borrowings under the New Credit Facility, along with accrued
interest, are due February 24, 2009. Initially, the Company drew down $40
million under the revolving credit portion of the New Credit Facility and $35
million under the term loan portion. The Company intends to draw down
approximately $26 million of letters of credit under the New Credit Facility in
March 2004.
The Company also issued $110 million principal amount of floating rate
senior secured notes due 2010 ("Floating Rate Notes") and $150 million of 8.75%
senior notes due 2011 ("Fixed Rate Notes") in a private placement with various
institutional investors on February 24, 2004. Interest on the Floating Rate
Notes is computed at LIBOR plus 3.75% and is payable quarterly beginning May 15,
2004. Interest payments on the Fixed Rate notes are due quarterly beginning May
15, 2004. No principal payments are due on either the Floating Rate Notes or the
Fixed Rate Notes until their dates of maturity (February 24, 2010, and February
24, 2011, respectively).
As of February 24, 2004, the Company had $60 million of available
borrowings under the New Credit Facility. After the anticipated draw down of
approximately $26 million of letters of credit in March 2004, the Company will
have $34 million in borrowings available under the New Credit Facility.
The table below summarizes the Company's debt and contractual
obligations, giving effect to the transactions described above (in thousands):
Long-Term Minimum
Debt Preferred Lease Severance
Payments Securities Payments Payments Total
--------- ---------- -------- --------- --------
2004 $ 4,198 $ - $ 12,395 $ 1,559 $ 18,152
2005 5,190 - 11,237 1,356 17,783
2006 5,200 - 7,552 1,356 14,108
2007 5,210 - 4,740 265 10,215
2008 5,162 - 5,771 - 10,933
After 2008 311,419 14,126 205 - 325,750
-------- -------- -------- -------- --------
Total $336,379 $ 14,126 $ 41,900 $ 4,536 $396,941
======== ======== ======== ======== ========
28
Collectively, the credit agreements provide that the Company will be
required to meet the following financial covenants, to be tested quarterly,
beginning with the quarter ending June 30, 2004:
- a minimum net worth requirement, which requires a net worth of at
least (i) $232 million plus (ii) 50% of consolidated net income (if
positive) beginning with the quarter ending June 30, 2004, plus (iii)
the net cash proceeds from issuance of the Company's capital stock or
the capital stock of the Company's subsidiaries;
- a maximum leverage ratio, calculated quarterly, based upon the ratio
of consolidated funded debt to consolidated EBITDA which will require
maintenance of a ratio of 5.5 to 1.00 through December 31, 2004, a
ratio of 4.75 to 1.00 from January 1 through December 31, 2005, and
4.25 to 1.00 thereafter;
- a maximum senior leverage ratio, calculated quarterly, based upon the
ratio of senior consolidated funded debt to consolidated EBITDA (which
ratio excludes indebtedness in respect of the Fixed Rate Notes), which
will require maintenance of a ratio of 3.375 to 1.00 through December
31, 2004, a ratio of 2.875 to 1.00 from January 1 through December 31,
2005, and 2.625 to 1.00 thereafter; and
- a minimum fixed charge coverage ratio, based upon the ratio of
consolidated EBITDA minus capital expenditures to consolidated
interest expense plus consolidated current maturities (including
capitalized lease obligations) plus cash dividends paid on equity
securities plus expenses for taxes, which will require maintenance of
a ratio of 1.15 to 1.00 through December 31, 2004, 1.375 to 1.00 from
January 1 through December 31, 2005, and 1.50 to 1.00 thereafter.
In addition, the New Credit Facility, the Floating Rate Notes and the
Fixed Rate Notes provide for affirmative and restrictive covenants including
without limitation, requirements or restrictions (subject to exceptions) related
to the following:
- use of proceeds of loans,
- restricted payments, including payments of dividends and retirement of
stock (permitting $.48 per share dividends so long as the aggregate
amount of dividends in any fiscal year does not exceed $7.0 million
and providing for additional principal prepayments to the extent
dividends exceed $5.0 million in any fiscal year), with exceptions for
existing employee benefit plans and stock option plans,
- mergers and dissolutions,
- sales of assets,
- investments and acquisitions,
- liens,
- transactions with affiliates,
- hedging and other financial contracts,
- restrictions on subsidiaries,
- contingent obligations,
- operating leases,
- guarantors,
- collateral,
- sale and leaseback transactions,
- prepayments of indebtedness, and
- maximum annual capital expenditures of $20 million subject to one-year
carry-forwards on amounts not used during the previous year.
It is management's opinion that the Company has no long-range
commitments that would have a significant impact on its liquidity, financial
condition or the results of its operations. Due to the nature of the
environmental liabilities, it is not possible to forecast the timing of the cash
payments for these potential liabilities. Based on the Company's available
credit lines, sources of borrowing and cash and cash equivalents, management
believes its sources of capital and liquidity are satisfactory for the Company's
needs for the foreseeable future.
INTENTION TO CALL CONVERTIBLE SECURITIES
On March 15, 2004, and thereafter, the outstanding mandatorily
redeemable convertible preferred securities ("Preferred Securities") of the
Chemed Capital Trust are callable without premium at a price of $27.00 per
Preferred Security. The Preferred Securities are convertible into the Company's
capital stock at the ratio of .73 share of capital stock per Preferred Security.
The Company intends to call all of the Preferred Securities as soon after March
15, 2004, as practicable. Management anticipates that most of the
29
securities will be redeemed for capital stock rather than cash. However, were
all the Preferred Securities redeemed for cash, the Company would be obligated
to pay approximately $14.1 million in cash.
RESULTS OF OPERATIONS
Set forth below are the year-to-year changes in the components of the
statement of operations relating to continuing operations:
Percent
Increase/(Decrease)
---------------------
2003 vs. 2002 vs.
2002 2001
-------- --------
Service revenues and sales
Plumbing and Drain Cleaning 3% (6)%
Service America (20) (12)
Total (2) (7)
Cost of services provided and goods
sold (excluding depreciation) (2) (9)
General and administrative expenses 18 (10)
Selling and marketing expenses - (5)
Depreciation (11) (6)
Impairment, restructuring and similar expenses (22) (18)
Loss from operations 188 (77)
Interest expense (27) (46)
Distributions on preferred securities (1) (3)
Loss on extinguishment of debt n.a. 100
Other income--net 163 (14)
Income/(loss) before income taxes n.a. (85)
Income taxes (26) (229)
Equity in earnings of affiliate n.a. n.a.
Loss from continuing operations 35 (18)
2003 VERSUS 2002 - CONSOLIDATED RESULTS
The Company's service revenues and sales for 2003 declined 2% versus
revenues for 2002. This $5.3 million decline was attributable to the $12.4
million, or 20%, decline in Service America's revenues, partially offset by a
$7.1 million, or 3%, increase in the Plumbing and Drain Cleaning segment's total
revenues. Within this segment, plumbing repair and maintenance revenues
increased $2.8 million, or 3%, drain cleaning revenues were even with the prior
year, contractor revenues increased $1.8 million, or 14%, and industrial and
municipal revenues increased $1.2 million, or 8%. Service America's revenues
from repair services under contracts declined $8.8 million, or 19%, and its
revenues from demand repair services declined $3.6 million, or 23%.
Of the increase in plumbing revenues, 2.4 percentage points are
attributable to an increase in the number of jobs completed during the year. The
remainder is attributable to an increase in the average price per job. The drain
cleaning business experienced a 2.8% decline in the number of jobs completed
during 2003 and a 3% increase in the average price per job. The decline in
Plumbing and Drain Cleaning's HVAC repair and maintenance business was
attributable to the Company's decision in 2001 to exit this line of business.
Units divested in 2002 contributed $403,000 in revenues during 2002, prior to
their divestment. Of the 14% increase in contractor revenues, 5 percentage
points are attributable to locations acquired in 2003. The gross margin of the
Plumbing and Drain Cleaning segment declined from 44.4% in 2002 to 43.7% in
2003, primarily as a result of higher training wages in 2003. The increase in
training wages was directly attributable to hiring more service technicians in
2003.
The decline in Service America's service contract revenues is
attributable to insufficient sales of new service contracts to replace service
contracts that were not renewed either by Service America or the customer.
During 2003, the average number of service contracts outstanding declined 23%
versus the average for 2002. The year-to-year decline in service contract
revenues is anticipated to continue during 2004 at approximately the same rate
as experienced in 2003.
Consolidated cost of services provided and goods sold (excluding
depreciation) for 2003 declined 2% versus such costs in 2002, primarily due to
the decline in service revenues and sales.
General and administrative ("G&A") expenses for 2003 increased $9.2
million, or 18%, versus 2002 within the following operations (in millions):
30
Plumbing and Drain Cleaning $ 9.0
Service America .2
------
Total $ 9.2
======
The increase in Plumbing and Drain Cleaning G&A is largely due to incurring
severance charges of $3.6 million in the first quarter of 2003 for a corporate
officer and to unfavorable market-value adjustments to the deferred compensation
liability in 2003 (a $1.6 million charge to G&A) versus a favorable adjustment
in 2002 (a $1.4 million reduction in G&A). These market adjustments are offset
entirely by equal, but opposite, gains and losses on trading assets used to fund
the liabilities and included in other income. Higher employee recruiting costs
in 2003 (an increase of $542,000), related largely to recruiting and hiring
service technicians and higher legal fees (an increase of $485,000), due
primarily to increased costs of defending against class actions, also
contributed to the higher G&A costs in 2003.
Depreciation expense for 2003 declined $1.5 million, or 11%, versus
2002. Of this decline, $905,000 was attributable to the decline in depreciation
expense in the Plumbing and Drain Cleaning segment, and the remaining $628,000
occurred at Service America. Both declines are attributable to reduced capital
expenditures over the past several years, largely related to service vans.
Impairment charges for both 2003 and 2002 relate entirely to the
Service America segment. As of December 31, 2003, all of Service America's
intangibles have been written down to nil. In addition, Service America recorded
an impairment charge of approximately $4.0 million to reduce the value of its
internally developed software to its estimated fair value.
The Company's loss from operations increased from $2.7 million in 2002
to $7.7 million in 2003. Operating expenses for 2003 included severance charges
of $3.6 million and asset impairment charges of $15.8 million for the write-down
of Service America's goodwill, identifiable intangible assets and computer
software. Operating expenses for 2002 included Service America's goodwill
impairment charges of $20.3 million. Also affecting this year-to-year comparison
was an unfavorable market-value adjustment to the deferred compensation
liability in 2003 (a $1.6 million charge to operating expenses) versus a
favorable adjustment in 2002 (a $1.4 million reduction in operating expenses).
Interest expense, substantially all of which is classified as
unallocated investing and financing -- net, declined from $2.9 million in 2002
to $2.1 million in 2003. This decline is attributable to lower debt levels and
lower interest rates in 2003.
Other income--net increased $6,977,000 from $4,282,000 in 2002 to
$11,259,000 in 2003, primarily as a result of the following (in thousands):
Higher gains on the sales and redemption of investments in 2003 $ 4,249
Gains on trading assets held in employee benefit trusts in 2003
versus losses recorded in 2002 3,001
All other--net (273)
-------
Total $ 6,977
=======
Other income--net by segment by reporting category is summarized below
(in thousands):
2003 2002
------- -------
Unallocated Investing and Financing--net $ 8,240 $ 4,602
Plumbing and Drain Cleaning 2,610 (655)
Service America 409 335
------- -------
Total $11,259 $ 4,282
======= =======
The increase in other income classified as unallocated investing and
financing--net is attributable to the previously mentioned increase in gains on
sales and redemption of investments. The increase in the Plumbing and Drain
Cleaning segment's net other income for 2003 versus 2002 is attributable to
gains on trading assets held in employee benefit trusts in 2003 versus losses in
2002. The increase in Service America's net other income for 2003 versus 2002 is
attributable to the gain on the sale of a building in 2003.
The Company's effective income tax rate for continuing operations was
1,447.9% in 2003 as compared with negative 268.5% in 2002. The unusually high
effective rate in 2003 and the negative effective rate in 2002 were caused by
the nondeductibility of Service America's intangibles impairment charges in both
years.
For 2003, the Company recorded $922,000 of equity in the earnings of
Vitas, representing the Company's share of Vitas' earnings since acquiring a 37%
interest in the common stock of Vitas in October 2003.
The loss from continuing operations was $3,499,000 ($.35 per share) in
2003 as compared with $8,854,000 ($.90 per share) for 2002. Significant items
affecting the loss from continuing operations for 2003 included Service
America's aftertax asset impairment charges of $14.4 million ($1.44 per share)
and aftertax capital gains on the sales and redemption of investments of $3.4
million ($.34 per share). Unusual items affecting the loss from continuing
operations for 2002 included Service America's aftertax goodwill impairment
31
charge of $20.3 million ($2.06 per share), an aftertax investment impairment
charge of $780,000 ($.08 per share) and aftertax capital gains on the sales of
investments of $775,000 ($.08 per share).
Discontinued operations of $64,000 for 2003 represented the adjustment
of the allowance for uncollectible notes receivable for Cadre Computer. For
2002, discontinued operations included $3.4 million from the operations of and
gain on the sale of Patient Care (sold in 2002), a $2.9 million federal income
tax refund related to Omnia (sold in 1997), $744,000 additional expense ($1.1
million before income taxes) for the sublease related to the 1991 sale of DuBois
and other adjustments aggregating $797,000. The $1.1 million adjustments to the
sublease accrual were made to cover rental charges for vacant space previously
occupied by the Company's former DuBois subsidiary. Prior to December 31, 2002,
the sublease accrual was calculated under the assumption that all of the vacant
space would be subleased at various dates and at market rental rates. Although
the Company was able to sublease varying amounts of space during the past two
years, it has been unable to sublease one of the floors covered under its lease.
The adjustments made in 2002 decreased the amount of sublease rentals that were
assumed to be received to include rentals only from current sublessees. As a
result, the sublease accrual now covers the cost of all unoccupied space, plus
the shortfall between current subleased rentals and contract rental rates and
operating costs. No further charges for this liability are anticipated.
The net loss increased from $2.5 million ($.26 per share) in 2002 to a
loss of $3.4 million ($.35 per share) in 2003. The net losses included income
from discontinued operations of $64,000 in 2003 and $6.3 million ($.64 per
share) in 2002. Significant items affecting the net loss for 2003 included
Service America's aftertax asset impairment charges of $14.4 million ($1.44 per
share) and aftertax capital gains on the sales and redemption of investments of
$3.4 million ($.34 per share). Significant items affecting the net loss for 2002
include Service America's aftertax goodwill impairment charge of $20.3 million
($2.06 per share), an aftertax investment impairment charge of $780,000 ($.08
per share) and aftertax capital gains on the sales of investments of $775,000
($.08 per share).
2003 VERSUS 2002 - SEGMENT RESULTS
The aftertax earnings of the Plumbing and Drain Cleaning segment
declined $3.3 million from $9.8 million in 2002 to $6.5 million in 2003.
Earnings for 2003 included an aftertax severance charge of $2.4 million.
The aftertax loss of the Service America segment declined $5.3 million
from $20.0 million in 2002 to $14.7 million, primarily due to lower impairment
charges in 2003 versus amounts for 2002. Aftertax asset impairment charges for
2003 comprised the following (in millions):
Goodwill $ 10.0
Property and equipment 2.7
Identifiable intangible assets $ 1.7
-------
Total 14.4
=======
The aftertax goodwill impairment charge for 2002 was $20.3 million. As a result
of these write-downs, the carrying values of all intangibles for the Service
America segment have been reduced to nil.
The goodwill impairment charges are based on an appraisal firm's
valuation of Service America's business as of December 31, 2003 and 2002. The
fair value of Service America was calculated using an average of the enterprise
value determined under a capital markets valuation and discounted cash flows
using updated income and cash flow projections for Service America's business.
The capital markets method calculates an enterprise value based on valuations at
which comparable businesses sold in the capital markets and based on certain
financial ratios and statistics. The income and cash flow projections are
updated each year as a part of the Company's annual business plan process and
take into consideration the changing marketplace and changing operating
conditions. The declines in the overall valuation of Service America in 2003 and
2002 were a direct result of lower revenue, earnings and cash flow projections
due to the continuing decline in the contract base of the business (23% decline
in 2003; 19% decline in 2002). These projections were adjusted to reflect that
Service America missed achieving its budgeted revenues by $6.0 million, or 11%,
in 2003 ($8.7 million, or 13%, for 2002) and missed achieving its budgeted gross
margin by $2.8 million, or 19%, for 2003 ($4.5 million, or 26%, for 2002).
The property and equipment and identifiable intangible asset impairment
charges for 2003 are based on an analysis of undiscounted cash flows that
indicated that the book value of the net assets of Service America exceeded the
projected cash flows of the business over the life of the noncurrent assets.
Accordingly, the carrying values of the noncurrent assets that exceeded their
fair values were written down to their fair values, based largely on a recent
appraisal of assets by a professional valuation firm. Substantially all of the
property and equipment impairment charge related to computer software costs. The
large majority of the identifiable intangible asset costs related to capitalized
customer contracts, acquired in 1991 and 1993, which, in the opinion of
management, have no future value.
32
Unallocated investing and financing--net, which includes unallocated
financing costs and investment income, increased $3.4 million from $1.3 million
aftertax in 2002 to $4.7 million aftertax in 2003. The increase is attributable
to the following (in millions):
Higher gains on the sales and redemption of investments in 2003 $ 2.6
Impairment charge on Medic One, Inc. investment in 2002 .8
-----
Total $ 3.4
=====
2002 VERSUS 2001 - CONSOLIDATED RESULTS
The Company's service revenues and sales for 2002 declined 7% versus
revenues for 2001. This $23.7 million decline was primarily attributable to
declines in the Plumbing and Drain Cleaning segment's plumbing revenues (7% or
$7.0 million), HVAC repair and maintenance revenues (62% or $6.1 million), and
drain cleaning revenues (3% or $3.1 million) and in Service America's revenues
from repair services under contracts (12% or $6.1 million).
The decline in plumbing revenues is almost entirely attributable to a
reduction in the number of jobs performed during the year, while the decline in
the drain cleaning revenues was attributable to a 7% decline in the number of
jobs offset partially by an average price-per-job increase of 4%. The decline in
Plumbing and Drain Cleaning's HVAC repair and maintenance revenues was
attributable to the Company's decision in 2001 to exit this line of business.
During 2002, the Company decided to retain the largest and most profitable of
the HVAC and non-branded plumbing businesses because the Company believes this
business will generate more cash than could be obtained by selling it and
reinvesting the cash in passive investments. Despite a 7% decline in total job
count for 2002 versus 2001, Plumbing and Drain Cleaning was able to slightly
increase its overall gross profit as a percent of revenues in 2002 compared with
2001.
The decline in Service America's service contract revenues is
attributable to insufficient sales of new service contracts to replace service
contracts that were not renewed either by Service America or the customer. The
year-to-year decline in service contract revenues is anticipated to continue
during 2003, as Service America in the fourth quarter of 2002 cancelled
approximately 5% of its outstanding service contracts that were too costly to
service, as measured by the number of service calls during the year. These
cancelled service contracts generated annual revenues of approximately $1.8
million.
Consolidated cost of services provided and goods sold (excluding
depreciation) for 2002 declined 9% versus such costs in 2001. The primary
components of cost of services provided and goods sold (excluding depreciation)
are salaries, wages and benefits of service technicians and field personnel,
material costs, insurance costs and service vehicle costs. Prior to 2002,
amortization of goodwill was also included in the cost of services provided and
goods sold. Effective December 31, 2001, the adoption of SFAS No. 142 eliminated
the amortization of goodwill. This accounting change accounted for 2 percentage
points of the 9% decline in cost of services provided and goods sold in 2002
versus 2001. The remaining 7% decline in the cost of services provided and goods
sold is consistent with the decline in revenues for 2002 versus 2001.
G&A expenses for 2002 declined $5.5 million, or 10%, versus 2001 within
the following operations (in millions):
Plumbing and Drain Cleaning $ 5.1
Service America .4
------
Total $ 5.5
======
The decline in Plumbing and Drain Cleaning G&A is largely attributable to
reductions in discretionary compensation and benefits, resulting from failure to
achieve profitability targets in 2002, as shown below (in millions):
Elimination of restricted stock awards $ 1.8
Reduction in wages and discretionary benefits 1.0
Reduction in discretionary thrift plan contribution 1.0
Reduction in incentive compensation .9
Reduction in deferred compensation expense component
of G&A as the result of adjusting deferred liability
accruals for market losses on invested assets held
in benefit trusts .6
All other (.2)
-----
Total $ 5.1
=====
The $400,000 reduction in G&A expenses at Service America is attributable to
that segment's reduction in the number of administrative employees, necessitated
by the decline in the number of service contracts sold and serviced during the
year.
Selling and marketing ("Selling") expenses for 2002 declined $2.6
million, or 5%, versus 2001. This decline is attributable to
33
Service America's $1.2 million reduction in Selling expenses in 2002 as a result
of decreases in the number of selling employees (primarily outbound
telemarketing) throughout 2002. Plumbing and Drain Cleaning Selling expenses for
2002 declined $1.4 million versus 2001. Approximately 30% of this reduction was
due to lower spending on non-yellow pages advertising and most of the remainder
to lower salaries and wages.
Depreciation expense for 2002 declined $808,000, or 6%, versus 2002. Of
this decline, $500,000 was attributable to the decreased depreciation expense at
Service America, largely related to fewer purchases of vans for service
technicians in recent years. Depreciation expense for Plumbing and Drain
Cleaning in 2002 declined slightly versus 2001.
Impairment, restructuring and similar expenses for 2002 included an
impairment charge of $20,342,000 for the write-down of Service America's
goodwill to its fair value at December 31, 2002. For 2001, these expenses
included the following charges (in thousands):
Plumbing
and Drain Service
Cleaning America Total
--------- -------- -------
Restructuring expenses:
Cost of exiting HVAC and non-Roto-
Rooter-branded plumbing businesses $11,205 $ - $11,205
Cost of closing Service America's
Tucson branch - 1,171 1,171
Expenses not expected to
recur (similar expenses):
Charges for accelerating the vesting of
restricted stock awards in connection
with the anticipated revision of the
Company's long-term incentive plans
in 2002 5,294 146 5,440
Severance charges for 10 individuals
incurred in connection with reducing
administrative expenses, largely at the
Plumbing and Drain Cleaning segment's
corporate office 2,909 757 3,666
Resolution of overtime pay issues with
the U.S. Department of Labor, relating
primarily to Plumbing and Drain Cleaning's
prior years' compensation expense 2,749 - 2,749
Property and equipment impairment charges 337 166 503
------- -------- -------
Total restructuring and similar expenses $22,494 $ 2,240 $24,734
======= ======== =======
34
The Company's loss from operations declined from $11.6 million in 2001
to $2.7 million in 2002. Operating expenses for 2002 included an impairment
charge of $20.3 million for the write-down of Service America's goodwill.
Operating expenses for 2001 included pretax restructuring and similar expenses
of $24.7 million and the following other unusual charges (in thousands):
Plumbing
and Drain Service
Cleaning America Total
--------- ------- ------
Amounts included in cost of services provided and goods sold:
Additional casualty insurance expense recorded to reflect increase in
valuation of insurance claims for prior years $1,411 $ - $1,411
Terminated lease obligations - 69 69
All other - 414 414
Amounts included in G&A expenses:
Terminated lease obligations 166 - 166
All other 417 - 417
------ ------ ------
Total other unusual charges $1,994 $ 483 $2,477
====== ====== ======
During 2002, the HVAC and non-Roto-Rooter-branded businesses that were disposed
of generated $403,000 in service revenues and sales and operating losses of
$106,000. During 2001, these businesses generated service revenues and sales of
$6.3 million and operating losses of $754,000. Also in 2001, Service America's
Tucson branch generated $1.7 million of service revenues and sales and recorded
an operating loss of $430,000.
The elimination of the restricted stock awards reduced G&A expenses by
approximately $1.9 million per year ($1.8 million in the Plumbing and Drain
Cleaning segment and $100,000 at Service America) beginning in 2002. The cost of
a replacement long-term incentive plan is not estimable at this time. The
employee severance charges for Plumbing and Drain Cleaning provided
approximately $600,000 in annual savings starting in 2002.
Interest expense, substantially all of which is classified as
unallocated investing and financing -- net, declined from $5.4 million in 2001
to $2.9 million in 2002. This decline is attributable to lower debt levels and
lower interest rates in 2002.
The pretax loss on extinguishment of debt of $2.6 million ($1.7 million
aftertax or $.18 per share) in 2001 arose from the Company's decision to retire
its higher interest rate debt in December 2001.
Other income--net declined from $5.0 million in 2001 to $4.3 million in
2002, primarily as a result of an impairment charge of $1.2 million, partially
offset by a $441,000 increase in interest income in 2002. The impairment charge
arose from the decline in value of the Company's investment in the redeemable
preferred stock of Medic One, Inc. ("Medic One"), a privately held provider of
ambulance and wheelchair transportation services. During 2002, Medic One
violated certain of its debt covenants. As of December 31, 2002, Medic One had
not cured the violations or obtained a waiver for such violations. Despite the
fact that Medic One reported positive income from operations in 2002 and 2001,
it would apparently be unable to continue operations without the continued
forbearance of debt covenant violations. If Medic One's lender called its debt,
it is likely that Medic One would be forced into bankruptcy or forced
liquidation. In such circumstances, the possibility that the Company could
recover any significant portion of its investment is considered small. As a
result, the Company concluded that the decline in the value of its investment in
Medic One was other than temporary at December 31, 2002, and wrote down its
investment to its estimated net realizable value (nil).
Other income--net by reporting category is summarized below (in
millions):
2002 2001
------- -------
Unallocated Investing and Financing--net $ 4.6 $ 6.0
Plumbing and Drain Cleaning (.7) (1.9)
Service America .4 .9
------- -------
Total $ 4.3 $ 5.0
======= =======
The decline in other income classified as unallocated investing and
financing--net is attributable to the previously mentioned investment impairment
charge. The decline in the Plumbing and Drain Cleaning segment's net other
expense for 2002 versus 2001 is attributable primarily to intercompany interest
income of $231,000 in 2002 versus expense of $414,000 in 2001. The decline in
Service America's net other income for 2002 versus 2001 is attributable to lower
interest income primarily as the result of lower interest rates in 2002.
The Company's effective income tax rate for continuing operations was
negative 268.5% in 2002 as compared with positive
35
31.7% in 2001. The negative effective rate in 2002 is caused by the
nondeductibility of Service America's goodwill impairment charge in 2002.
The loss from continuing operations was $8.9 million ($.90 per share)
in 2002 as compared with $10.8 million ($1.11 per share) for 2001. Significant
items affecting the loss from continuing operations for 2002 included Service
America's aftertax goodwill impairment charge of $20.3 million ($2.06 per
share), an aftertax investment impairment charge of $780,000 ($.08 per share)
and aftertax capital gains on the sales of investments of $775,000 ($.08 per
share). Significant items affecting the loss from continuing operations for 2001
included the aftertax loss from extinguishment of debt ($1.7 million or $.18 per
share) and aftertax restructuring and similar expenses and other unusual charges
totaling $16.9 million ($1.74 per share) as summarized below (in thousands):
Plumbing
and Drain Service
Cleaning America Total
--------- -------- --------
Restructuring expenses:
Cost of exiting HVAC and non-Roto-
Rooter-branded plumbing business $ 6,765 $ - $ 6,765
Cost of closing Service America's
Tucson branch - 707 707
Expenses not expected to
recur (similar expenses):
Charges for accelerating the vesting of
restricted stock awards in connection
with the anticipated revision of the
Company's long-term incentive plans
in 2002 3,417 87 3,504
Severance charges for 10 individuals
incurred in connection with reducing
administrative expenses 2,033 489 2,522
Resolution of overtime pay issues with
the U.S. Department of Labor, relating
primarily to prior years' compensation
expense 1,656 - 1,656
Property and equipment impairment 206 100 306
--------- -------- --------
Total restructuring and
similar expenses 14,077 1,383 15,460
Other unusual charges:
Additional casualty insurance expense
recorded to reflect increase in valuation
of insurance claims for prior years 839 - 839
Terminated lease obligations 101 41 142
Other 254 248 502
--------- -------- --------
Total restructuring and similar
expenses and other unusual
charges $ 15,271 $ 1,672 $ 16,943
========= ======== ========
Also affecting the results for 2001 are aftertax goodwill amortization of
$3,888,000 ($.40 per share) (amortization of goodwill ceased effective December
31, 2001) and aftertax gains on the sales of investments of $703,000 ($.07 per
share).
Discontinued operations for 2002 included $3.4 million from the
operations of and gain on the sale of Patient Care (sold in 2002), a $2.9
million federal income tax refund related to Omnia (sold in 1997), $744,000
additional expense ($1.1 million pretax) for the sublease related to the 1991
sale of DuBois and other adjustments aggregating $797,000. The adjustments to
the sublease accrual of $1.1 million in 2002 and $1.8 million in 2001 were made
to cover rental charges for vacant space previously occupied by the Company's
former subsidiary, DuBois. Prior to December 31, 2002, the sublease accrual was
calculated under the assumption that all of the vacant space would be subleased
at various dates and at market rental rates. Although the Company was able to
sublease varying amounts of space during the past two years, it has been unable
to sublease one of the floors covered under its lease. The adjustments made in
2002 decreased the amount of sublease rentals that were assumed to be received
to include rentals only from current sublessees. As a result,
36
the sublease accrual now covers the cost of all unoccupied space, plus the
shortfall between current sublease rentals and contract rental rates and
operating costs. No further charges for this liability are anticipated.
The net loss declined from $12.2 million ($1.25 per share) in 2001 to a
loss of $2.5 million ($.26 per share) in 2002. The net losses include income
from discontinued operations of $6.3 million ($.64 per share) in 2002 and a loss
from discontinued operations of $1.5 million ($.15 per share) in 2001. Unusual
items affecting the net loss for 2002 included Service America's aftertax
goodwill impairment charge of $20.3 million ($2.06 per share), an aftertax
investment impairment charge of $780,000 ($.08 per share) and aftertax capital
gains on the sales of investments of $775,000 ($.08 per share). Unusual items
affecting the net loss for 2001 included aftertax restructuring and similar
expenses and other unusual charges totaling $16.9 million ($1.74 per share) as
summarized above, aftertax goodwill amortization of $3.9 million ($.40 per share
- -- amortization of goodwill ceased effective December 31, 2001) and aftertax
gains on the sales of investments of $703,000 ($.07 per share).
2002 VERSUS 2001 - SEGMENT RESULTS
The aftertax earnings of the Plumbing and Drain Cleaning segment
increased $18.5 million from a loss of $8.8 million in 2001 to income of $9.8
million in 2002. The loss for 2001 included the following aftertax restructuring
and similar expenses and other unusual charges (in thousands):
Restructuring expenses:
Cost of exiting HVAC and non-Roto-Rooter-
branded plumbing businesses $ 6,765
Expenses not expected to recur (similar expenses):
Resolution of overtime pay issues with the U.S.
Department of Labor, relating primarily to
prior years' compensation expense 1,656
Charges for accelerating the vesting of restricted
awards in connection with the anticipated
revision of the Company's long-term
incentive plans 3,417
Property and equipment impairment charges 206
Severance charges for 9 individuals, incurred in
connection with reducing administrative
expenses 2,033
----------
Total restructuring and similar expenses 14,077
Other unusual charges:
Additional casualty insurance expense recorded
to reflect increase in valuation of insurance
claims for prior years 839
Terminated lease obligations 101
Other 254
----------
Total $ 15,271
==========
In addition, aftertax amortization of goodwill, which ceased effective December
31, 2001, totaled $3.1 million for 2001 versus nil for 2002.
The aftertax loss of the Service America segment increased from
$686,000 in 2001 to $20.0 million in 2002, primarily due to an aftertax
impairment charge of $20.3 million in 2002. The impairment charge is based on an
appraisal firm's valuation of Service America's business as of December 31,
2002. The fair value of Service America was calculated using an average of the
enterprise value determined under a capital markets valuation and discounted
cash flows using updated income and cash flow projections for Service America's
business. The capital markets method calculates an enterprise value based on
valuations at which comparable businesses sold in the capital markets and based
on certain financial ratios and statistics. The income and cash flow projections
are updated each year as part of the Company's annual business plan process and
take into consideration the changing marketplace and changing operating
conditions. The decline in the overall valuation of Service America was a direct
result of lower revenue, earnings and cash flow projections due to the continued
decline in the contract base of the business (19% decline in 2002). These
projections were adjusted to reflect that Service America missed achieving its
budgeted revenues for 2002 by $8.7 million, or 13%, and missed achieving its
budgeted gross margin by $4.5 million, or 26%.
37
Amounts for Service America for 2001 include the following
restructuring and similar expenses and other unusual charges (in thousands):
Restructuring expenses:
Cost of closing Service America's Tucson branch $ 707
Expenses not expected to recur (similar expenses):
Severance charges for one individual, incurred in
connection with reducing administrative
expenses 489
Property and equipment impairment charges 100
Charges for accelerating the vesting of restricted stock
awards in connection with the anticipated
revision of the Company's long-term
incentive plans in 2002 87
--------
Total restructuring and similar expenses 1,383
Other unusual charges:
Terminated lease obligations 41
Other 248
--------
Total $ 1,672
========
In addition, aftertax amortization of goodwill, which ceased effective December
31, 2001, totaled $807,000 for 2001 versus nil for 2002.
Unallocated investing and financing--net, which includes unallocated
financing costs and investment income, increased $897,000 from $414,000 aftertax
in 2001 to $1,311,000 aftertax in 2002. The increase is attributable to the
following (in thousands):
Lower interest expense in 2002 due to lower debt levels $ 1,742
Interest income on tax refund in 2002 530
Impairment charge on Medic One investment in 2002 (780)
Lower intercompany interest income in 2002 (primarily Plumbing
and Drain Cleaning segment) (657)
Other 62
-------
Total $ 897
=======
CRITICAL ACCOUNTING POLICIES
INSURANCE ACCRUALS
As the Company self insures for casualty insurance claims (workers'
compensation, auto liability and general liability), management closely monitors
and frequently evaluates its historical claims experience to estimate the
appropriate level of accrual for insured claims. The Company's third-party
administrator ("TPA") processes claims on behalf of the Company and reviews
claims on a monthly basis. Currently, the Company's exposure on any single claim
is capped at $250,000. For most of the years prior to 1999, the caps for general
liability and workers compensation were $500,000 per claim.
In developing its estimates, the Company accumulates historical claims
data for the previous 10 years to calculate loss development factors ("LDF") by
insurance coverage type. LDFs are applied to known claims to estimate the
ultimate potential liability for known and unknown claims for each open policy
year. Prior to 2003, the LDFs were updated every three years and reviewed by the
Company's outside professional actuaries for reasonableness in view of the
Company's claims experience and insurance industry trends. Beginning in 2004,
LDFs will be updated annually. The current LDFs were last updated as of March
2003 and will next be updated in March 2004. Because this methodology relies
heavily on historical claims data, the key risk is whether the historical claims
are an accurate predictor of future claims exposure. The risk also exists that
certain claims have been incurred and not reported on a timely basis. To
mitigate these risks, the Company, in conjunction with its TPA, closely monitors
claims to ensure timely accumulation of data and compares its claims trends with
the industry experience of its TPA. As an indication of the sensitivity of the
accrued liability to reported claims, the Company's analysis indicates that a 1%
across-the-board increase or decrease in the amount of reported claims would
increase or decrease the accrued insurance liability at December 31, 2003, by
4.4% or $697,000.
38
INVESTMENTS
Equity investments with readily determinable fair values are recorded
at their fair values. Other equity investments are recorded at cost, subject to
write-down for impairment. The Company regularly reviews its investments for
impairment. As a result of this review, in the fourth quarter of 2002, the
Company reduced the carrying value of its investment in the redeemable preferred
stock of Medic One from its original cost of $1,200,000 to nil. Medic One, a
privately held provider of ambulance and wheelchair transportation services, is
in violation of certain covenants under a line of credit that expired in
November 2002. The lender has not waived such violations and has the right to
call the debt. If the debt were called, Medic One could be forced into
bankruptcy.
The Company also has a Patient Care common stock purchase warrant ("PC
Warrant") for the purchase of up to 2% of privately held Patient Care. The PC
Warrant has a carrying value of $1,445,000, which was its estimated fair value
on the date of issuance in October 2002. Patient Care's operating results for
2003 have declined from 2002 levels, but Patient Care remains profitable and
paid down significant amounts of bank debt in 2003. The Company views this
investment as a long-term investment and believes any decline in the fair value
of the PC Warrant is not "other than temporary" as of December 31, 2003.
Nonetheless, market conditions could change in the coming year and cause the
Company to reassess its valuation of this investment.
EQUITY INVESTMENT (VITAS)
The Company's 37% investment in Vitas common stock exceeds its share of
Vitas' net book value by approximately $18.3 million. On a preliminary basis,
the Company estimated that $3.7 million of this excess is attributable to the
excess value o f computer software with a five-year life and the remainder to
goodwill with an indefinite life. Amortization of this excess reduced the
Company's equity in the earnings of Vitas by $97,000 in 2003. In 2004, as a
result of completing the acquisition of the 63% of Vitas it did not own in 2003,
the Company will conduct a thorough review to value all assets and liabilities
of Vitas at their fair values. This, it is possible that the Company will
identify other intangible assets with different useful lives.
GOODWILL
The Company annually tests the goodwill balances of its reporting units
for impairment using appraisals performed by a valuation firm. The valuation of
each reporting unit is dependent upon many factors, some of which are
market-driven and beyond the Company's control. The valuations of goodwill for
the Company's Roto-Rooter Services and Roto-Rooter Franchising and Products
reporting units indicate that the fair value of goodwill for each of these units
exceeds its respective book value by a significant amount. The valuations of
Service America in 2003 and 2002 reduced goodwill for this reporting unit to
nil.
CRITICAL ACCOUNTING POLICIES RELATED TO VITAS
ALLOWANCE FOR UNCOLLECTIBLE ACCOUNTS
Vitas' net revenue is reported at the estimated net realizable amounts
due from third-party payors, primarily Medicare and Medicaid. Payors may deny
payment for services in whole or in part on the basis that such services are not
eligible for coverage and do not qualify for reimbursement. Vitas' management
estimates denials each period and makes adequate provision for them in its
financial statements. Due to the complexity of the laws and regulations
affecting the Medicare and Medicaid programs, estimates can and do change by
material amounts in future periods.
Vitas receives biweekly payments for patient services from the Medicare
program under the Prospective Interim Payment ("PIP") System. These payments are
subsequently applied against specific Medicare accounts as claims are processed
by the fiscal intermediary. The unapplied portion of these biweekly PIP payments
is recorded as a reduction to patient accounts receivable.
Vitas maintains a policy of providing an allowance for uncollectible
accounts based on a formula tied to the aging of accounts receivable by payor
class and historical write-off rates. Vitas provides allowances for specific
accounts determined to be uncollectible when such determinations are made.
Accounts are written off when all collection efforts are exhausted.
PURCHASE ACCOUNTING
On a preliminary basis the Company has identified the following fair
value adjustments to the historical bases of Vitas' assets (in thousands):
Covenant Not to Compete with Former CEO $ 18,000
Computer Software 10,000
Consulting Agreement with Former CEO 7,000
---------------
Total $ 35,000
===============
39
These assets are assumed to have useful lives of 8 years, 5 years and 7 years,
respectively. The Company also anticipates that a significant portion of the
excess of the purchase price over the book value of Vitas' assets and
liabilities will be allocated to goodwill or other indefinite-lived intangible
assets. Upon completion of the Company's review to value all of the assets and
liabilities of Vitas at their fair values, it is possible that the Company will
identify other intangible assets with different lives, and that the amount of
indefinite-lived intangible assets will be significantly less than originally
estimated.
RECENT ACCOUNTING STATEMENTS
SFAS NO. 143
In June 2001, the Financial Accounting Standards Board ("FASB")
approved the issuance of Statement of Financial Accounting Standards ("SFAS")
No. 143, Accounting for Asset Retirement Obligations. It is effective for fiscal
years beginning after June 15, 2002, and requires recognizing legal obligations
associated with the retirement of tangible long-lived assets that result from
the acquisition, construction or development or normal operation of a long-lived
asset. Since the Company has no material asset retirement obligations, the
adoption of SFAS No.143 in 2003 did not have a material impact on the Company's
financial statements.
SFAS NO. 145
In April 2002, the FASB approved the issuance of SFAS No. 145,
Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No.
13 and Technical Corrections. It is generally effective for transactions
occurring after May 15, 2002. The Company's adoption of SFAS No.145 in 2003
resulted in reclassifying its 2001 loss on early extinguishment of debt from
extraordinary to a separate line within continuing operations, but did not
otherwise have a material impact on its financial statements.
SFAS NO. 146
In July 2002, the FASB approved the issuance of SFAS No. 146,
Accounting for Costs Associated with Exit or Disposal Activities. Generally,
SFAS No. 146 stipulates that defined exit costs (including restructuring and
employee termination costs) are to be recorded on an incurred basis rather than
on a commitment basis, as was previously required. This statement is effective
for exit or disposal activities initiated after December 31, 2002. The Company's
adoption of SFAS No. 146 in 2003 did not have a material impact on its financial
statements.
FIN NO. 45
In November 2002, the FASB approved the issuance of FASB Interpretation
("FIN") No. 45, Guarantor's Accounting and Disclosure for Guarantees, Including
Indirect Guarantees of Indebtedness of Others. The initial recognition and
initial measurement provisions of this interpretation are applicable to
guarantees issued or modified after December 31, 2002. The Company's adoption of
FIN No. 45 in 2003 did not have a material impact on its financial statements.
SFAS NO. 148
In December 2002, the FASB issued SFAS No. 148, Accounting for
Stock-Based Compensation--Transition and Disclosure. It is effective for annual
periods ending, and for interim periods beginning, after December 15, 2002.
Because the Company uses Accounting Principles Board Opinion No. 25, Accounting
for Stock Issued to Employees, to account for stock-based compensation, this
statement did not have a material impact on the Company's financial statements.
FIN NO. 46 AND FIN NO. 46R
In January 2003, the FASB issued FIN No. 46, Consolidation of Variable
Interest Entities - an interpretation of Accounting Research Bulletin No. 51.
This Interpretation is intended to clarify the application of the majority
voting interest requirement of ARB No. 51, Consolidated Financial Statements, to
certain entities in which equity investors do not have the characteristics of a
controlling financial interest or do not have sufficient equity at risk for the
entity to finance its activities without additional subordinated financial
support from other parties. The controlling financial interest may be achieved
through arrangements that do not involve voting interests. FIN No. 46 may be
applied prospectively with a cumulative-effect adjustment as of the date on
which it is first applied or by restating previously issued financial statements
for one or more years with a cumulative-effect adjustment as of the beginning of
the first year restated. FIN No. 46 is effective immediately to variable
interests in a variable interest equity ("VIE") created or obtained after
January 31, 2003. As amended by FASB Staff Position ("FSP") FIN 46-6, FIN No. 46
became effective for variable interests in a VIE created before February 1, 2003
at the end of the first interim or annual period ending after December 15, 2003.
Subsequent to issuing FIN No. 46 and FSP FIN 46-6, the FASB continued
to propose modifications and issue FSPs that changed and clarified FIN No. 46.
These modifications and FSPs were subsequently incorporated into FIN No. 46
(revised) ("FIN No. 46R"), which replaces FIN No. 46. Among other things,
relative to FIN No. 46, FIN No. 46R a) essentially excludes operating businesses
from its provisions subject to four conditions, b) states the provisions of FIN
No. 46R are not required to be applied if a company is unable,
40
subject to making an exhaustive effort, to obtain the necessary information, c)
includes new definitions and examples of what variable interests are, d)
clarifies and changes the definition of a variable interest entity, and e)
clarifies and changes the definition and treatment of de facto agents, as that
term is defined in FIN No. 46 and FIN No. 46R. FIN No. 46R was issued December
23, 2003. The Company, will apply FIN No. 46R to all variable interest entities
at the end of the first quarter of 2004.
The Company has evaluated its contractual relationships with its
Roto-Rooter franchisees and has concluded that its interests in the franchisees
are not variable interests as defined in FIN No. 46 and FIN No. 46R. The Company
maintains contractual relationships with certain independent contractors to
provide plumbing and drain cleaning services in specified territories primarily
using the Roto-Rooter name. The Company has no equity interest in any of the
independent contractors, but in many cases, loans money to the contractor to
assist in financing equipment and working capital needs. The loans are generally
partially secured by the contractors' equipment and are guaranteed by the
business owner. The Company's contractor agreements do not require its
contractors to provide all the financial information necessary to apply the
provisions of FIN No. 46R to its contractors. Furthermore, the contractors
generally have not provided all the financial data they are required to provide
under the contractor agreements.
The Company evaluated its contractual relationships with the four
independent contractors that commenced operations in 2003 ("2003 Contractors")
and determined they are potentially subject to consolidation under FIN No. 46 as
a result of loans made to the contractors. The Company has been unable to obtain
sufficient information necessary to determine whether the 2003 Contractors
should be consolidated. The Company is in the process of evaluating the new
provisions of FIN No. 46R relative to its 2003 Contractors and to its
pre-February 2003 contractor arrangements. At this time, the Company does not
believe that the consolidation of any of its contractors, if required under FIN
No. 46 or FIN No. 46R, would materially impact its operating results. Instead,
consolidation of some, if any, of these arrangements is more likely to result in
a "grossing up" of amounts, such as revenues and expenses, with little or no net
change to the Company's net income or cash flows. None of these entities has
been consolidated in the Company's financial statements.
Under FIN No. 46, the Company is permitted to consolidate the accounts
of the Chemed Capital Trust ("CCT") in its financial statements due to the
existence of a call feature of the Preferred Securities whereby the Company can
call the Preferred Securities for prepayment. As disclosed above, the Company
currently intends to call the Preferred Securities after March 15, 2004, at
which time the Preferred Securities may be prepaid without premium.
When FIN No. 46R becomes fully effective for the Company in the first
quarter of 2004, the Company will be required to de-consolidate the accounts of
the Chemed Capital Trust, because the call feature may no longer be considered
as a condition for consolidation. As a result, the current balance sheet caption
that reads "Mandatorily redeemable convertible preferred securities of the
Chemed Capital Trust" will be revised to read "Convertible junior subordinated
debentures" in the same dollar amount as the Preferred Securities. Within the
statement of operations, the "Distributions on preferred securities" will be
reclassified as interest expense.
SFAS NO. 150
In May 2003, the FASB approved the issuance of SFAS No. 150, Accounting
for Certain Financial Instruments with Characteristics of both Liabilities and
Equity. As a result of the issuance of this pronouncement, the Company now
reports the mandatorily redeemable convertible preferred securities of the
Chemed Capital Trust as a noncurrent liability rather than in the "mezzanine"
(i.e., between liabilities and equity) as reported prior to June 2003. This
reclassification does not affect the Company's compliance with its debt
covenants. The adoption of this statement did not impact the statement of
operations.
SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
REGARDING FORWARD-LOOKING INFORMATION
In addition to historical information, this report contains
forward-looking statements and performance trends that are based upon
assumptions subject to certain known and unknown risks, uncertainties,
contingencies and other factors. Such forward-looking statements and trends
include, but are not limited to, those relating to the ability of Service
America to increase its gross profit margin, the impact of laws and regulations
on Company operations and the recoverability of deferred tax assets. Variances
in any or all of the risks, uncertainties, contingencies and other factors from
the Company's assumptions could cause actual results to differ materially from
these forward-looking statements and trends. The Company's ability to deal with
the unknown outcomes of these events, many of which are beyond the control of
the Company, may affect the reliability of its projections and other financial
matters.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company has an insignificant number of financial instruments held
for trading purposes and does not hedge any of its market risks with derivative
instruments at December 31, 2003. In connection with the Company's Vitas merger
on February 24, 2004, it borrowed $185 million at variable interest rates based
on LIBOR. If LIBOR fluctuates by 1/8%, the Company's interest expense on the
variable rate debt will increase or decrease approximately $231,000 per annum.
41
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The consolidated financial statements, together with the report thereon
of PricewaterhouseCoopers LLP dated March 5, 2004, appearing on pages F-2
through F-33 of this Report on Form 10-K, along with the Supplementary Data
(Unaudited Summary of Quarterly Results) appearing on pages F-34 - F-35, are
incorporated herein by reference.
The financial statements of Vitas Healthcare Corporation, a significant
investee of the Company, as of September 30, 2002 and 2003 and for the years
ended September 30, 2001 through 2003, included on pages F-1 through F-32 of the
Company's Report on Form 8-K/A, dated October 14, 2003 and filed on February 23,
2004 are incorporated herein by reference.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
ITEM 9A. CONTROLS & PROCEDURES
The Company maintains disclosure controls and procedures that are
designed to ensure that information required to be disclosed in the Company's
Exchange Act reports is recorded, processed, summarized and reported within the
time periods specified in the SEC's rules and forms, and that such information
is accumulated and communicated to the Company's management to allow timely
decisions regarding required disclosure.
The Company recently carried out an evaluation, under the supervision
of the Company's President and Chief Executive Officer, with the participation
of its Vice President and Chief Financial Officer and its Vice President and
Controller, of the effectiveness of the design and operation of the Company's
disclosure controls and procedures pursuant to Exchange Act Rule 13a-14. Based
upon this evaluation, the Company's President and Chief Executive Officer,
Executive Vice President and Vice President and Controller concluded the
Company's disclosure controls and procedures are effective in timely alerting
them to material information relating to the Company and its consolidated
subsidiaries required to be included in the Company's Exchange Act reports.
There have been no significant changes in internal control over financial
reporting during the year ended December 31, 2003.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The directors of the Company are:
Edward L. Hutton Sandra E. Laney
Kevin J. McNamara Timothy S. O'Toole
Charles H. Erhart, Jr. Donald E. Saunders
Joel F. Gemunder George J. Walsh III
Patrick P. Grace Frank E. Wood
Thomas C. Hutton
42
The additional information required under this Item with respect to the
directors and executive officers is set forth in the Company's 2004 Proxy
Statement and in Part I hereof under the caption "Executive Officers of the
Registrant" and is incorporated herein by reference.
The Company has adopted a Code of Ethics that applies to the Company's
principal executive officer, principal financial officer, principal accounting
officer, directors and employees. A copy of this Code of Ethics is being filed
with this Report as Exhibit 14 and it is also posted on the Company's Web site,
www.rotorooterinc.com. Any amendment to, or waiver from, a provision of the
Company's Code of Ethics shall be posted on the Company's Web site.
ITEM 11. EXECUTIVE COMPENSATION
Information required under this Item is set forth in the Company's 2004
Proxy Statement, which is incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information required under this Item is set forth in the Company's 2004
Proxy Statement, which is incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information required under this Item is set forth in the Company's 2004
Proxy Statement, which is incorporated herein by reference.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
AUDIT FEES
PricewaterhouseCoopers LLP billed the Company $536,600 and
$613,500, respectively, in aggregate fees and expenses for professional services
rendered for the audit of the Company's annual financial statements for the
years 2002 and 2003 and the reviews of the financial statements included in the
Company's Forms 10-Q for those years.
AUDIT-RELATED FEES
PricewaterhouseCoopers LLP billed the Company $50,200 and
$122,400, respectively, in aggregate fees and expenses for audit-related
services rendered in 2002 and 2003 and for implementation assistance with
internal control provisions of the Sarbanes-Oxley Act of 2002.
TAX FEES
The Company paid PricewaterhouseCoopers LLP $17,950 in fees
and expenses for tax services rendered during 2002. No such services were
rendered in 2003.
ALL OTHER FEES
43
PricewaterhouseCoopers LLC billed the Company $2,152 and
$2,172, respectively, in aggregate fees for services rendered by
PricewaterhouseCoopers LLP, other than the services described above, for the
years 2002 and 2003.
The Audit Committee has adopted a policy which requires the Committee's
pre-approval of audit and non-audit services performed by the independent
auditor to assure that the provision of such services does not impair the
auditor's independence. The Audit Committee pre-approved all of the audit and
non-audit services rendered by PricewaterhouseCoopers LLP as listed above.
44
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULE AND REPORTS ON FORM 8-K
EXHIBITS
3.1 Certificate of Incorporation of Roto-Rooter, Inc. (formerly
named Chemed Corporation).*
3.2 Certificate of Amendment to Certificate of Incorporation.*
3.3 By-Laws of Roto-Rooter, Inc.*
4.1 Offer to Exchange Chemed Capital Trust Convertible Preferred
Securities for Shares of Capital Stock, dated as of December
23, 1999.*
4.2 Chemed Capital Trust, dated as of December 23, 1999.*
4.3 Amended and Restated Declaration of Trust of Chemed Capital
Trust, dated February 7, 2000.*
4.4 Indenture, dated as of February 24, 2004, between Roto-Rooter,
Inc. and LaSalle Bank National Association.
4.5 Indenture, dated as of February 24, 2004, among Roto-Rooter,
Inc., the subsidiary guarantors listed on Schedule I thereto
and Wells Fargo Bank, N.A.
10.1 Agreement and Plan of Merger among Diversey U.S. Holdings,
Inc., D. C. Acquisition Inc., Chemed Corporation and DuBois
Chemicals, Inc., dated as of February 25, 1991.*
10.2 Stock Purchase Agreement between Omnicare, Inc. and Chemed
Corporation, dated as of August 5, 1992.*
10.3 Agreement and Plan of Merger among National Sanitary Supply
Company, Unisource Worldwide, Inc. and TFBD, Inc. dated as of
August 11, 1997.*
10.4 Stock Purchase Agreement dated as of May 8, 2002 by and
between PCI Holding Corp. and Chemed Corporation. *
10.5 Amendment No. 1 to Stock Purchase Agreement dated as of
October 11, 2002 by and among PCI Holding Corp., PCI-A Holding
Corp. and Chemed Corporation. *
10.6 Senior Subordinated Promissory Note dated as of October 11,
2002 by and among PCI Holding Corp. and Chemed Corporation. *
10.7 Common Stock Purchase Warrant dated as of October 11, 2002 by
and between PCI Holding Corp. and Chemed Corporation. *
10.8 1986 Stock Incentive Plan, as amended through May 20,
1991.*,**
10.9 1988 Stock Incentive Plan, as amended through May 20,
1991.*,**
45
10.10 1993 Stock Incentive Plan.*,**
10.11 1995 Stock Incentive Plan.*,**
10.12 1997 Stock Incentive Plan.*,**
10.13 1999 Stock Incentive Plan.*,**
10.14 1999 Long-Term Employee Incentive Plan as amended through May
20, 2002.*,**
10.15 2002 Stock Incentive Plan.*,**
10.16 2002 Executive Long-Term Incentive Plan.*,**
10.17 Employment Contracts with Executives.*,**
10.18 Amendment to Employment Agreements with Kevin J. McNamara,
Thomas C. Hutton and Sandra E. Laney dated August 7, 2002.*,**
10.19 Amendment to Employment Agreements with Timothy S. O'Toole and
Arthur V. Tucker dated August 7, 2002.*,**
10.20 Amendment to Employment Agreement with Spencer S. Lee dated
May 19, 2003.**
10.21 Amendment to Employment Agreements with Executives dated
January 1, 2002.*, **
10.22 Consulting Agreement between Timothy S. O'Toole and PCI
Holding Corp. effective October 11, 2002.*,**
10.23 Amendment No. 16 to Employment Agreement with Sandra E. Laney
dated March 1, 2003.*,**
10.24 Excess Benefits Plan, as restated and amended, effective June
1, 2001.**
10.25 Amendment No. 1 to Excess Benefits Plan, effective July 1,
2002.**
10.26 Amendment No. 2 to Excess Benefits Plan, effective November 7,
2003.**
10.27 Non-Employee Directors' Deferred Compensation Plan.*,**
10.28 Chemed/Roto-Rooter Savings & Retirement Plan, effective
January 1, 1999.*,**
10.29 First Amendment to Chemed/Roto-Rooter Savings & Retirement
Plan, effective September 6, 2000.*, **
10.30 Second Amendment to Chemed/Roto-Rooter Savings & Retirement
Plan, effective January 1, 2001.*, **
10.31 Third Amendment to Chemed/Roto-Rooter Savings & Retirement
Plan, effective December 12, 2001.*, **
46
10.32 Stock Purchase Agreement by and Among Banta Corporation,
Chemed Corporation and OCR Holding Company as of September 24,
1997.*
10.33 Directors Emeriti Plan.*,**
10.34 Second Amendment to Split Dollar Agreement with
Executives.*,**
10.35 Split Dollar Agreement with Sandra E. Laney.*,**
10.36 Split Dollar Agreement with Executives.*,**
10.37 Split Dollar Agreement with Edward L. Hutton.*,**
10.38 Split Dollar Agreement with Spencer S. Lee.*,**
10.39 Promissory Note under the Executive Stock Purchase Plan with
Edward L. Hutton.*,**
10.40 Promissory Note under the Executive Stock Purchase Plan with
Kevin J. McNamara.*,**
10.41 Schedule to Promissory Note under the Executive Stock Purchase
Plan with Edward L. Hutton.**
10.42 Schedule to Promissory Note under the Executive Stock Purchase
Plan with Kevin J. McNamara.**
10.43 Roto-Rooter Deferred Compensation Plan No. 1, as amended
January 1,1998.*,**
10.44 Roto-Rooter Deferred Compensation Plan No. 2.*,**
10.45 Agreement and Plan of Merger, dated as of December 18, 2003,
among Roto- Rooter, Inc., Marlin Merger Corp. and Vitas
Healthcare Corporation.*
10.46 Credit Agreement, dated as of February 24, 2004, among
Roto-Rooter, Inc., the lenders from time to time parties
thereto and Bank One, NA, as Administrative Agent.
10.47 Pledge and Security Agreement, dated as of February 24, 2004,
among Roto-Rooter, Inc., the subsidiaries of Roto-Rooter, Inc.
listed on the signature pages thereto and Bank One, NA, as
Collateral Agent.
10.48 Guaranty Agreement, dated as of February 24, 2004, among the
subsidiaries of Roto-Rooter, Inc. listed on the signature
pages thereto and Bank One, NA, as Administrative Agent.
13. 2003 Annual Report to Stockholders.
14. Policies on Business Ethics of Roto-Rooter, Inc.
21. Subsidiaries of Roto-Rooter, Inc.
23 Consent of Independent Accountants.
47
24 Powers of Attorney.
31.1 Certification by Kevin J. McNamara pursuant to Rule
13a-14(a)/15d-14(a) of the Exchange Act of 1934.
31.2 Certification by David P. Williams pursuant to Rule
13a-14(a)/15d-14(a) of the Exchange Act of 1934.
31.3 Certification by Arthur V. Tucker, Jr. pursuant to Rule
13a-14(a)/15d-14(a) of the Exchange Act of 1934.
32.1 Certification by Kevin J. McNamara pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.
32.2 Certification by David P. Williams pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.
32.3 Certification by Arthur V. Tucker, Jr. pursuant to Section 906
of the Sarbanes-Oxley Act of 2002.
* This exhibit is being filed by means of incorporation by reference (see
Index to Exhibits on page E-1). Each other exhibit is being filed with
this Annual Report on Form 10-K.
** Management contract or compensatory plan or arrangement.
FINANCIAL STATEMENT SCHEDULE
See Index to Financial Statements and Financial Statement Schedule on
page F-1.
REPORTS ON FORM 8-K
- A Current Report on Form 8-K, dated October 16, 2003, was filed
October 21, 2003. The report includes the Company's earnings
announcement for the third quarter.
-
- A Current Report on Form 8-K, dated October 14, 2003, was filed
October 29, 2003. The report disclosed the Company's exercise of
Warrants A and B to purchase 4,158,000 shares of Vitas for $18.0
million in cash.
-
- A Current Report on Form 8-K, dated October 31, 2003, was filed
November 3, 2003. The report includes the Company's press release
announcing its intent to restate earnings for the period January 1,
1998 through September 30, 2003 to recognize Yellow Pages
advertising expense when the directories are first placed in
circulation.
-
- A Current Report on Form 8-K, dated December 18, 2003, was filed
December 19, 2003. The report disclosed that the Company had entered
into a definitive agreement to acquire Vitas Healthcare Corporation.
-
- A Current Report on Form 8-K/A, was filed on December 19, 2003 which
amended the Current Report on Form 8-K, dated October 14, 2003.
48
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
ROTO-ROOTER, INC.
March 10, 2004 By /s/ Kevin J. McNamara
---------------------------
Kevin J. McNamara
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
Signature Title Date
--------- ----- ----
/s/Kevin J. McNamara President and Chief Executive Officer
- ---------------------- and a Director (Principal Executive
Kevin J. McNamara Officer)
/s/David P. Williams Vice President and Chief
- ---------------------- Financial Officer
David P. Williams (Principal Financial Officer)
/s/Arthur V. Tucker, Jr. Vice President and Controller March 10, 2004
- ------------------------ (Principal Accounting
Arthur V. Tucker, Jr. Officer)
Edward L. Hutton* Sandra E. Laney*
Charles H. Erhart, Jr.* Timothy S. O'Toole*
Joel F. Gemunder* Donald E. Saunders* --Directors
Patrick P. Grace* George J. Walsh III*
Thomas C. Hutton* Frank E. Wood*
- ------------------
* Naomi C. Dallob by signing her name hereto signs this document on behalf
of each of the persons indicated above pursuant to powers of attorney
duly executed by such persons and filed with the Securities and Exchange
Commission.
March 10, 2004 /s/ Naomi C. Dallob
- ----------------------- ----------------------------
Date Naomi C. Dallob
(Attorney-in-Fact)
49
ROTO-ROOTER, INC. AND SUBSIDIARY COMPANIES
INDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE
2003, 2002 AND 2001
PAGE(S)
ROTO-ROOTER, INC. CONSOLIDATED FINANCIAL
STATEMENTS AND FINANCIAL STATEMENT SCHEDULE
Report of Independent Auditors F-2
Consolidated Statement of Operations F-3
Consolidated Balance Sheet F-4
Consolidated Statement of Cash Flows F-5
Consolidated Statement of Changes in Stockholders' Equity F-6
Consolidated Statement of Comprehensive Loss F-6
Notes to Financial Statements F-7 - F-33
Unaudited Summary of Quarterly Results F-34 - F-35
Schedule II -- Valuation and Qualifying Accounts S-1
The Financial Statement Schedule should be read in conjunction with the
consolidated financial statements listed above. Schedules not included have been
omitted because they are not applicable or because required information is shown
in the financial statements or notes thereto as listed above.
F-1
REPORT OF INDEPENDENT AUDITORS
To the Stockholders and Board of Directors of Roto-Rooter, Inc.:
In our opinion, the accompanying consolidated balance sheets and the
related consolidated statements of operations, cash flows, changes in
stockholders' equity and comprehensive loss present fairly, in all
material respects, the financial position of Roto-Rooter, Inc. ("Company") and
its subsidiaries at December 31, 2003 and 2002, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 2003 in conformity with accounting principles generally accepted in
the United States of America. In addition, in our opinion, the financial
statement Schedule II, Valuation and Qualifying Accounts, listed in the
accompanying index, presents fairly, in all material respects, the information
set forth therein when read in conjunction with the related consolidated
financial statements. These financial statements and financial statement
schedule are the responsibility of the Company's management; our responsibility
is to express an opinion on these financial statements and financial statement
schedule based on our audits. We conducted our audits of these statements in
accordance with auditing standards generally accepted in the United States of
America, which require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
As discussed in Notes 1 and 4, effective January 1, 2002, the Company
adopted the provisions of Statement of Financial Accounting Standards No. 142,
Goodwill and Other Intangible Assets.
/s/ PricewaterhouseCoopers LLP
Cincinnati, Ohio
March 5, 2004
F-2
ROTO-ROOTER, INC. AND SUBSIDIARY COMPANIES
CONSOLIDATED STATEMENT OF OPERATIONS
(in thousands, except per share data)
FOR THE YEARS ENDED DECEMBER 31,
----------------------------------------------
2003 2002 2001
------------- -------------- -------------
CONTINUING OPERATIONS
Service revenues and sales $ 308,871 $ 314,176 $ 337,908
------------- -------------- -------------
Cost of services provided and goods sold (excluding depreciation) 182,810 186,285 205,616
General and administrative expenses 60,309 51,096 56,546
Selling and marketing expenses 45,590 45,544 48,178
Depreciation 12,054 13,587 14,395
Impairment, restructuring and similar expenses (Notes 4 and 5) 15,828 20,342 24,734
------------- -------------- -------------
Total costs and expenses 316,591 316,854 349,469
------------- -------------- -------------
Loss from operations (7,720) (2,678) (11,561)
Interest expense (2,140) (2,928) (5,423)
Distributions on preferred securities (Note 20) (1,071) (1,079) (1,113)
Loss on extinguishment of debt (Note 12) - - (2,617)
Other income--net (Note 8) 11,259 4,282 4,987
------------- -------------- -------------
Income/(loss) before income taxes 328 (2,403) (15,727)
Income taxes (Note 9) (4,749) (6,451) 4,989
Equity in earnings of affiliate (Note 3) 922 - -
------------- -------------- -------------
Loss from continuing operations (3,499) (8,854) (10,738)
DISCONTINUED OPERATIONS (NOTE 6) 64 6,309 (1,447)
------------- -------------- -------------
NET LOSS $ (3,435) $ (2,545) $ (12,185)
============= ============== =============
LOSS PER SHARE
Loss from continuing operations $ (0.35) $ (0.90) $ (1.11)
============= ============== =============
Net loss $ (0.35) $ (0.26) $ (1.25)
============= ============== =============
DILUTED LOSS PER SHARE (NOTE 17)
Loss from continuing operations $ (0.35) $ (0.90) $ (1.11)
============= ============== =============
Net loss $ (0.35) $ (0.26) $ (1.25)
============= ============== =============
NET LOSS EXCLUDING GOODWILL AMORTIZATION
Net loss $ (3,435) $ (2,545) $ (7,564)
============= ============== =============
Loss per share $ (0.35) $ (0.26) $ (0.78)
============= ============== =============
Diluted loss per share (Note 17) $ (0.35) $ (0.26) $ (0.78)
============= ============== =============
AVERAGE NUMBER OF SHARES OUTSTANDING
Loss per share 9,924 9,858 9,714
============= ============== =============
Diluted loss per share (Note 17) 9,924 9,858 9,714
============= ============== =============
The Notes to Financial Statements are integral parts of this statement.
F-3
ROTO-ROOTER, INC. AND SUBSIDIARY COMPANIES
CONSOLIDATED BALANCE SHEET
(in thousands, except shares and par value)
DECEMBER 31,
------------------------
2003 2002
--------- ---------
ASSETS
Current assets
Cash and cash equivalents (Note 10) $ 50,587 $ 37,731
Accounts receivable less allowances of $2,919 (2002--$3,309) 13,592 14,643
Inventories 8,256 9,493
Statutory deposits 9,358 12,323
Current deferred income taxes (Note 9) 10,056 9,894
Prepaid expenses and other current assets 10,236 9,931
--------- ---------
Total current assets 102,085 94,015
Investments of deferred compensation plans held in trust (Note 14) 17,743 15,176
Other investments (Notes 3 and 16) 25,081 37,326
Note receivable (Note 6) 12,500 12,500
Properties and equipment, at cost, less accumulated depreciation (Note 11) 41,004 48,361
Identifiable intangible assets less accumulated amortization of $1,704 (2002--$7,167)
(Note 4) 592 2,889
Goodwill less accumulated amortization (Note 4) 105,335 110,843
Other assets 24,729 17,034
--------- ---------
Total Assets $ 329,069 $ 338,144
========= =========
LIABILITIES
Current liabilities
Accounts payable $ 7,120 $ 5,686
Current portion of long-term debt (Note 12) 448 409
Income taxes (Note 9) 26 369
Deferred contract revenue 14,362 17,321
Accrued insurance 16,013 17,448
Other current liabilities (Note 13) 21,123 23,513
--------- ---------
Total current liabilities 59,092 64,746
Long-term debt (Note 12) 25,931 25,603
Mandatorily Redeemable Convertible Preferred Securities
of the Chemed Capital Trust (Note 20) 14,126 -
Deferred compensation liabilities (Note 14) 17,733 15,196
Other liabilities (Note 13) 19,494 19,991
Commitments and Contingencies (Notes 13, 15, 19, 22 and 23)
--------- ---------
Total Liabilities 136,376 125,536
--------- ---------
MANDATORILY REDEEMABLE CONVERTIBLE PREFERRED SECURITIES
OF THE CHEMED CAPITAL TRUST (NOTE 20) - 14,186
--------- ---------
STOCKHOLDERS' EQUITY
Capital stock--authorized 15,000,000 shares $1 par; issued 13,452,907 shares
(2002--13,448,475 shares) 13,453 13,448
Paid-in capital 170,501 168,299
Retained earnings 119,746 127,938
Treasury stock--3,508,663 shares (2002--3,630,689 shares), at cost (109,427) (111,582)
Unearned compensation (Note 14) (2,954) (4,694)
Deferred compensation payable in Company stock (Note 14) 2,308 2,280
Notes receivable for shares sold (Note 18) (934) (952)
Accumulated other comprehensive income - 3,685
--------- ---------
Total Stockholders' Equity 192,693 198,422
--------- ---------
Total Liabilities and Stockholders' Equity $ 329,069 $ 338,144
========= =========
The Notes to Financial Statement are integral parts of this statement.
F-4
ROTO-ROOTER, INC. AND SUBSIDIARY COMPANIES
CONSOLIDATED STATEMENT OF CASH FLOWS
(in thousands)
FOR THE YEARS ENDED DECEMBER 31,
------------------------------------
2003 2002 2001
-------- -------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss $ (3,435) $ (2,545) $(12,185)
Adjustments to reconcile net loss to net cash provided by operations
Depreciation and amortization 12,809 14,356 21,273
Noncash restructuring and impairment charges 15,828 21,542 15,150
Gains on redemption and sales of available-for-sale investments (5,390) (1,141) (993)
Provision for uncollectible accounts receivable 2,019 1,808 2,866
Provision for deferred income taxes (501) 459 (6,173)
Discontinued operations (Note 6) (64) (6,309) 1,447
Changes in operating assets and liabilities, excluding
amounts acquired in business combinations
Increase in accounts receivable (968) (2,351) (411)
Decrease in statutory reserve requirements 2,965 1,008 715
Decrease in inventories 1,237 931 79
Decrease/(increase) in prepaid expenses and other
current assets (746) (666) 990
Increase/(decrease) in accounts payable, deferred
contract revenue and other current liabilities (5,253) (6,724) 7,059
Increase/(decrease) in income taxes 2,732 4,096 (5,535)
Decrease/(increase) in other assets (2,243) (1,253) 233
Increase/(decrease) in other liabilities 2,937 (621) (96)
Noncash expense of internally financed ESOPs 1,740 2,742 4,109
Equity in earnings of affiliate (922) - -
Other sources/(uses) (155) 1,562 (1,405)
-------- -------- --------
Net cash provided by continuing operations 22,590 26,894 27,123
Net cash provided by discontinued operations (Note 6) - 2,629 7,258
-------- -------- --------
Net cash provided by operating activities 22,590 29,523 34,381
-------- -------- --------
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from redemption of available-for-sale investments (Notes 3 and 16) 27,270 - -
Purchase of equity investment in affiliate (Notes 3 and 16) (17,999) - -
Capital expenditures (11,178) (11,855) (14,457)
Deposit to secure merger offer (Note 23) (10,000) - -
Proceeds from sales of available-for-sale investments (Note 16) 4,493 1,917 1,377
Business combinations, net of cash acquired (Note 7) (3,850) (1,236) (1,555)
Proceeds from sales of property and equipment 2,747 2,479 3,676
Net proceeds/(uses) from sale of discontinued operations (Note 6) 1,091 50,676 (6,332)
Investing activities of discontinued operations (Note 6) - (469) (900)
Purchase of Roto-Rooter minority interest - (83) (820)
Other uses (356) (413) (78)
-------- -------- --------
Net cash provided /(used) by investing activities (7,782) 41,016 (19,089)
-------- -------- --------
CASH FLOWS FROM FINANCING ACTIVITIES
Dividends paid (4,761) (4,438) (4,384)
Issuance of capital stock 3,287 1,547 735
Purchases of treasury stock (637) (3,214) (1,226)
Repayment of long-term debt (Note 12) (409) (40,378) (46,377)
Proceeds from issuance of long-term debt (Note 12) - 5,000 35,000
Other sources/(uses) 568 (50) (293)
-------- -------- --------
Net cash used by financing activities (1,952) (41,533) (16,545)
-------- -------- --------
INCREASE/(DECREASE) IN CASH AND CASH EQUIVALENTS 12,856 29,006 (1,253)
Cash and cash equivalents at beginning of year 37,731 8,725 9,978
-------- -------- --------
Cash and cash equivalents at end of year $ 50,587 $ 37,731 $ 8,725
======== ======== ========
The Notes to Financial Statements are integral parts of this statement.
F-5
ROTO-ROOTER, INC. AND SUBSIDIARY COMPANIES
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
(in thousands, except per share data)
TREASURY
CAPITAL PAID-IN RETAINED STOCK- UNEARNED
STOCK CAPITAL EARNINGS AT COST COMPENSATION
---------- ---------- ---------- ---------- ------------
Balance at December 31, 2000 $ 13,318 $ 162,618 $ 151,596 $(105,249) $ (16,683)
Net loss - - (12,185) - -
Dividends paid ($.44 per share) - - (4,384) - -
Stock awards and exercise of stock
options (Note 18) 119 5,055 - (3,654) 5,138
Decrease in unearned compensation ( Note 14) - - - - 4,109
Transfer of deferred compensation payable
to other liabilities - 14 - (14) -
Other comprehensive income - - - - -
Purchases of treasury stock - - - (219) -
Payments on notes receivable (Note 18) - - - (1,288) -
Other 1 (145) 13 - -
--------- --------- --------- --------- ---------
Balance at December 31, 2001 13,438 167,542 135,040 (110,424) (7,436)
Net loss - - (2,545) - -
Dividends paid ($.45 per share) - - (4,438) - -
Decrease in unearned compensation ( Note 14) - - - - 2,742
Stock awards and exercise of stock options
(Note 18) 23 974 - (2,114) -
Other comprehensive loss - - - - -
Payments on notes receivable (Note 18) - - - (338) -
Purchases of treasury stock - - - (51) -
Distribution of assets to settle deferred
compensation liabilities - - - 1,066 -
Other (13) (217) (119) 279 -
--------- --------- --------- --------- ---------
Balance at December 31, 2002 13,448 168,299 127,938 (111,582) (4,694)
NET LOSS - - (3,435) - -
DIVIDENDS PAID ($.48 PER SHARE) - - (4,761) - -
DECREASE IN UNEARNED COMPENSATION ( NOTE 14) - - - - 1,740
STOCK AWARDS AND EXERCISE OF STOCK OPTIONS
(NOTE 18) 3 1,620 - 2,216 -
OTHER COMPREHENSIVE LOSS - - - - -
PAYMENTS ON NOTES RECEIVABLE (NOTE 18) - - - (23) -
PURCHASES OF TREASURY STOCK - - - (69) -
DISTRIBUTION OF ASSETS TO SETTLE DEFERRED
COMPENSATION LIABILITIES - - - 31 -
OTHER 2 582 4 - -
--------- --------- --------- --------- ---------
BALANCE AT DECEMBER 31, 2003 $ 13,453 $ 170,501 $ 119,746 $(109,427) $ (2,954)
========= ========= ========= ========= =========
DEFERRED
COMPENSATION ACCUMULATED NOTES
PAYABLE IN OTHER RECEIVABLE
CAPITAL COMPREHENSIVE FOR
STOCK INCOME SHARES SOLD TOTAL
------------ ------------- ----------- ----------
Balance at December 31, 2000 $ 5,500 $ 3,237 $ (2,886) $ 211,451
Net loss - - - (12,185)
Dividends paid ($.44 per share) - - - (4,384)
Stock awards and exercise of stock
options (Note 18) - - - 6,658
Decrease in unearned compensation ( Note 14) - - - 4,109
Transfer of deferred compensation payable
to other liabilities (2,293) - - (2,293)
Other comprehensive income - 977 - 977
Purchases of treasury stock - - - (219)
Payments on notes receivable (Note 18) - - 1,484 196
Other 81 - (100) (150)
--------- --------- --------- ---------
Balance at December 31, 2001 3,288 4,214 (1,502) 204,160
Net loss - - - (2,545)
Dividends paid ($.45 per share) - - - (4,438)
Decrease in unearned compensation ( Note 14) - - - 2,742
Stock awards and exercise of stock options
(Note 18) - - - (1,117)
Other comprehensive loss - (529) - (529)
Payments on notes receivable (Note 18) - - 576 238
Purchases of treasury stock - - - (51)
Distribution of assets to settle deferred
compensation liabilities (1,066) - - -
Other 58 - (26) (38)
--------- --------- --------- ---------
Balance at December 31, 2002 2,280 3,685 (952) 198,422
NET LOSS - - - (3,435)
DIVIDENDS PAID ($.48 PER SHARE) - - - (4,761)
DECREASE IN UNEARNED COMPENSATION ( NOTE 14) - - - 1,740
STOCK AWARDS AND EXERCISE OF STOCK OPTIONS
(NOTE 18) - - - 3,839
OTHER COMPREHENSIVE LOSS - (3,685) - (3,685)
PAYMENTS ON NOTES RECEIVABLE (NOTE 18) - - 34 11
PURCHASES OF TREASURY STOCK - - - (69)
DISTRIBUTION OF ASSETS TO SETTLE DEFERRED
COMPENSATION LIABILITIES (31) - - -
OTHER 59 - (16) 631
--------- --------- --------- ---------
BALANCE AT DECEMBER 31, 2003 $ 2,308 $ - $ (934) $ 192,693
========= ========= ========= =========
CONSOLIDATED STATEMENT OF COMPREHENSIVE LOSS
(in thousands)
FOR THE YEARS ENDED DECEMBER 31,
------------------------------------
2003 2002 2001
-------- -------- --------
Net loss $ (3,435) $ (2,545) $(12,185)
-------- -------- --------
Other comprehensive income/(loss), net of income tax
Unrealized holding gains/(losses) on available-for-sale investments
arising during the period (334) 246 1,680
Less: Reclassification adjustment for gains on available-for-sale
investments arising during the period (3,351) (775) (703)
-------- -------- --------
Total (3,685) (529) 977
-------- -------- --------
Comprehensive loss $ (7,120) $ (3,074) $(11,208)
======== ======== ========
The Notes to Financial Statements are integral parts of these statements.
F-6
ROTO-ROOTER, INC. AND SUBSIDIARY COMPANIES
NOTES TO FINANCIAL STATEMENTS
1. SUMMARY OF ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of
Roto-Rooter, Inc., its wholly owned subsidiaries and the accounts of the Chemed
Capital Trust ("CCT"). All significant intercompany transactions have been
eliminated. Long-term investments in affiliated companies representing ownership
interests of 20% to 50% are accounted for using the equity method.
Under current accounting rules, the accounts of the CCT are
consolidated and the Mandatorily Redeemable Preferred Securities ("Preferred
Securities") of the CCT are classified as a noncurrent liability on the
Company's consolidated balance sheet. Distributions on the Preferred Securities
are classified on a separate line as a nonoperating expense on the consolidated
statement of operations. Under accounting rules that become effective for the
quarter ending March 31, 2004, the CCT will be deconsolidated and the Company's
Junior Subordinated Debentures due 2030 ("JSD"), all of which are held by the
CCT, will be shown as a liability on the Company's balance sheet in the face
amount equal to the value of the Preferred Securities outstanding. Interest
expense of the JSD will be classified as interest expense on the consolidated
statement of operations.
CASH EQUIVALENTS
Cash equivalents comprise short-term highly liquid investments that
have been purchased within three months of their dates of maturity.
ACCOUNTS AND LOANS RECEIVABLE
Trade accounts receivables and loans are recorded at the principal
balance outstanding less estimated allowance for uncollectible accounts.
Generally, allowances for trade accounts receivable are provided for accounts
more than 90 days past due, although collection efforts continue beyond that
time. Due to the small number of loans receivable outstanding, allowances for
loan losses are determined on a case-by-case basis. Final write-off of overdue
accounts or loans receivable is made when all reasonable collection efforts
have been made and payment is not forthcoming. Management closely monitors its
receivables and periodically reviews procedures for the granting of credit to
ensure losses are held to a minimum.
INVENTORIES
Inventories are stated at the lower of cost or market. For determining
the value of inventories, the first-in, first-out ("FIFO") method is used.
STATUTORY DEPOSITS
Statutory deposits are funds held in a segregated account in the
Company's name as security for revenue collected for prepaid home service
warranty contracts by Service America. A minimum of 10% of the required balance
must be deposited directly with the State of Florida. The amount of the deposits
is calculated quarterly and equals 25% of total service contract revenue
represented by service contracts in force at the end of the quarter. As the
amount of the required deposit increases or decreases, cash is transferred to or
from unrestricted cash to the segregated statutory deposit accounts on the
consolidated balance sheet.
OTHER INVESTMENTS
At December 31, 2003, other investments, all of which are classified as
available-for-sale, include a 37% equity ownership interest in the common stock
of privately held Vitas Healthcare Corporation ("Vitas"), one common stock
purchase warrant of Vitas, a common stock purchase warrant in privately held
Patient Care, Inc. ("Patient Care"), a former subsidiary of the Company, and the
redeemable preferred stock of privately held Medic One, Inc. ("Medic One").
At December 31, 2002, other investments, all of which are classified as
available-for-sale, include the redeemable preferred stock of Vitas, three
common stock purchase warrant of Vitas, a common stock purchase warrant in
Patient Care, the redeemable preferred stock of Medic One and several publicly
traded common stocks.
Equity investments that are publicly traded are recorded at their fair
value with unrealized gains and losses, net of taxes, included in other
comprehensive income on the balance sheet. The Company's equity investment in
the common stock of Vitas and other privately held investments are carried at
cost, subject to write-down for impairment. The Company's equity investment in
Vitas is accounted for using the equity method of accounting.
All investments are reviewed periodically for impairment based on
available market and financial data. For its investment in Vitas, the Company
reviews Vitas' unaudited monthly operating data and audited annual financial
statements on a timely basis. In addition, the Company's treasurer sits on the
Vitas Board of Directors. If the market value or net realizable value of the
investment is less than the Company's cost and this decline is determined to be
other than temporary, a write-down to fair value is made, and a realized loss is
recorded in the statement of operations.
In calculating realized gains and losses on the sales of investments,
the specific-identification method is used to determine the cost of investments
sold.
DEPRECIATION AND PROPERTIES AND EQUIPMENT
Depreciation of properties and equipment is computed using the
straight-line method over the estimated useful lives of the assets. Expenditures
for maintenance, repairs, renewals and betterments that do not materially
prolong the useful lives of the assets are expensed as incurred. The cost of
property retired or sold and the related accumulated depreciation are removed
from the accounts, and the resulting gain or loss is reflected currently in
income.
F-7
The weighted average lives of the Company's gross properties and
equipment at December 31, 2003, were:
LIFE
----
Computer equipment 2.3 yrs.
Machinery and equipment 6.3
Furniture and fixtures 8.0
Transportation equipment 5.9
Computer software 7.5
Buildings 23.4
INTANGIBLE ASSETS
Identifiable intangible assets arise from purchase business
combinations and are amortized using the straight-line method over the estimated
useful lives of the assets. In accordance with Financial Accounting Standards
Board ("FASB") Statement No. 142, Goodwill and Other Intangible Assets,
amortization of goodwill ceased effective December 31, 2001. Beginning January
1, 2002, goodwill is tested at least annually for impairment. For 2001 and
earlier years, goodwill acquired prior to July 1, 2001, was amortized using the
straight-line method over the estimated useful life, but not in excess of 40
years. The weighted average lives of the Company's gross identifiable intangible
assets at December 31, 2003, were:
LIFE
-----------
Covenants not to compete 5.0 yrs.
Customer lists 12.7
LONG-LIVED ASSETS
The Company periodically makes an estimation and valuation of the
future benefits of its long-lived assets (other than goodwill) based on key
financial indicators. If the projected undiscounted cash flows of a major
business unit indicate that property and equipment or identifiable intangible
assets have been impaired, a write-down to fair value is made.
REVENUE RECOGNITION
Revenues received under prepaid contractual service agreements are
recognized on a straight-line basis over the life of the contract. All other
service revenues and sales are recognized when the services are provided or the
products are delivered.
GUARANTEES
In the normal course of business the Company enters into various
guarantees and indemnifications in its relationships with customers and others.
Examples of these arrangements include guarantees of service and product
performance. The Company's experience indicates guarantees and indemnifications
do not materially impact the Company's financial condition or results of
operations.
OPERATING EXPENSES
Cost of services provided and goods sold (excluding depreciation)
includes salaries, wages and benefits of service technicians and field
personnel, material costs, insurance costs, service vehicle costs and other
expenses directly related to providing service revenues or generating sales.
General and administrative expenses include salaries, wages and benefits of
administrative employees, office rent and operating costs, legal, banking and
professional fees and other administrative costs. Selling and marketing expenses
include salaries, wages and benefits of selling and marketing employees,
advertising expenses, communications and branch telephone expenses and other
selling and customer-related expenses.
ADVERTISING
The Company expenses the production costs of advertising the first time
the advertising takes place. Costs of yellow pages listings are expensed when
the directories are placed in circulation. Other advertising costs are expensed
as incurred. Advertising expense for the year ended December 31, 2003, was
$17,087,000 (2002 -- $17,520,000; 2001 -- $18,362,000).
DIVIDEND INCOME
Dividends on redeemable preferred stock investments are cumulative and
are recorded during the quarter they are earned. All other dividends are
recognized when declared.
COMPUTATION OF EARNINGS PER SHARE
Earnings per share are computed using the weighted average number of
shares of capital stock outstanding. Diluted earnings per share reflect the
dilutive impact of the Company's outstanding stock options and nonvested stock
awards. Diluted earnings per share also assume the conversion of the Preferred
Securities into capital stock only when the impact is dilutive on earnings per
share from continuing operations.
F-8
EMPLOYEE STOCK OWNERSHIP PLANS
Contributions to the Company's Employee Stock Ownership Plans ("ESOP")
are based on established debt repayment schedules. Shares are allocated to
participants based on the principal and interest payments made during the
period. The Company's policy is to record its ESOP expense by applying the
transition rule under the level-principal amortization concept.
STOCK-BASED COMPENSATION PLANS
The Company uses Accounting Principles Board Opinion No. 25 ("APB 25"),
Accounting for Stock Issued to Employees, to account for stock-based
compensation. Since the Company's stock options qualify as fixed options under
APB 25 and since the option price equals the market price on the date of grant,
there is no compensation cost recorded for stock options. Restricted stock was
recorded as compensation cost over the requisite vesting periods on a pro rata
basis, based on the market value on the date of grant.
The following table illustrates the effect on net loss and loss per
share if the Company had applied the fair-value-recognition provisions of FASB
Statement No. 123, Accounting for Stock-Based Compensation (in thousands, except
per share data):
FOR THE YEARS ENDED DECEMBER 31,
------------------------------------------------
2003 2002 2001
---------- ---------- ----------
Net loss $ (3,435) $ (2,545) $ (12,185)
Add: stock-based compensation expense included
in net income as reported, net of income tax effects 95 120 4,113
Deduct: total stock-based employee compensation
determined under a fair-value-based method for all
stock options and awards, net of income tax effects (952) (767) (4,444)
--------- --------- ---------
Pro forma net loss $ (4,292) $ (3,192) $ (12,516)
========= ========= =========
Loss per share
As reported $ (0.35) $ (0.26) $ (1.25)
========= ========= =========
Pro forma $ (0.43) $ (0.32) $ (1.29)
========= ========= =========
Diluted loss per share
As reported $ (0.35) $ (0.26) $ (1.25)
========= ========= =========
Pro forma $ (0.43) $ (0.32) $ (1.29)
========= ========= =========
The above pro forma data were calculated using the Black-Scholes
option-valuation method to value the Company's stock options granted in 2003 and
prior years. Key assumptions include:
FOR THE YEARS ENDED
DECEMBER 31,
2003 2002
------ ------
Weighted average grant-date fair value of options granted $10.14 $11.18
Risk-free interest rate 3.2% 4.8%
Expected volatility 27.8 25.1
Expected life of options 6 YRS. 6 yrs.
No options were granted in 2001; however, for 2002 and 2003, it was
assumed that the annual dividend would be increased $.01 per share per quarter
biannually in the fourth quarter. This assumption was based on the facts and
circumstances that existed at the time options were granted and should not be
construed to be an indication of future dividend amounts to be paid.
INSURANCE ACCRUALS
The Company is self-insured for casualty insurance claims, subject to a
stop-loss policy with a maximum per-occurrence limit of $250,000. Management
consults with insurance professionals and closely monitors and evaluates its
historical claims experience to estimate the appropriate level of accrual for
incurred claims.
F-9
ESTIMATES
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to make
estimates and assumptions that affect amounts reported in the financial
statements and accompanying notes. Actual results could differ from those
estimates.
RECLASSIFICATIONS
In April 2002, the FASB approved the issuance of Statement of Financial
Accounting Standards ("SFAS") No. 145, Rescission of FASB Statements No. 4, 44
and 64, Amendment of FASB Statement No. 13 and Technical Corrections. It is
generally effective for transactions occurring after May 15, 2002. The Company's
adoption of SFAS No.145 in 2003 resulted in reclassifying its 2001 loss on early
extinguishment of debt from extraordinary to a separate line within continuing
operations, but did not otherwise have a material impact on its financial
statements.
In May 2003, the FASB approved the issuance of SFAS No. 150, Accounting
for Certain Financial Instruments with Characteristics of both Liabilities and
Equity. As a result of the issuance of this pronouncement, the Company now
reports the mandatorily redeemable convertible preferred securities of the
Chemed Capital Trust as a noncurrent liability rather than in the "mezzanine"
(i.e., between liabilities and equity) as reported prior to June 2003. This
reclassification does not affect the Company's compliance with its debt
covenants. The adoption of this statement did not impact the statement of
operations.
For 2003 and 2002, the Company reclassified its noncurrent income taxes
from income taxes payable (within current liabilities) to other liabilities
(within noncurrent liabilities). In addition, certain other amounts in prior
years' financial statements have been reclassified to conform to the 2003
presentation.
RECENT ACCOUNTING STATEMENTS
In January 2003, the FASB issued FASB Interpretation ("FIN") No. 46,
Consolidation of Variable Interest Entities - an interpretation of Accounting
Research Bulletin No. 51. This Interpretation is intended to clarify the
application of the majority voting interest requirement of ARB No. 51,
Consolidated Financial Statements, to certain entities in which equity
investors do not have the characteristics of a controlling financial interest or
do not have sufficient equity at risk for the entity to finance its activities
without additional subordinated financial support from other parties. The
controlling financial interest may be achieved through arrangements that do not
involve voting interests. FIN No. 46 may be applied prospectively with a
cumulative-effect adjustment as of the date on which it is first applied or by
restating previously issued financial statements for one or more years with a
cumulative-effect adjustment as of the beginning of the first year restated. FIN
No. 46 is effective immediately to variable interests in a variable interest
equity ("VIE") created or obtained after January 31, 2003. As amended by FASB
Staff Position ("FSP") FIN 46-6, FIN No. 46 became effective for variable
interests in a VIE created before February 1, 2003, at the end of the first
interim or annual period ending after December 15, 2003.
Subsequent to issuing FIN No. 46 and FSP FIN No. 46-6, the FASB
continued to propose modifications and issue FSPs that changed and clarified FIN
No. 46. These modifications and FSPs were subsequently incorporated into FIN No.
46 (revised) ("FIN No. 46R"), which replaces FIN No. 46. Among other things,
relative to FIN No. 46, FIN No. 46R a) essentially excludes operating businesses
from its provisions subject to four conditions, b) states the provisions of FIN
No. 46R are not required to be applied if a company is unable, subject to making
an exhaustive effort, to obtain the necessary information, c) includes new
definitions and examples of what variable interests are, d) clarifies and
changes the definition of a variable interest entity, and e) clarifies and
changes the definition and treatment of de facto agents, as that term is defined
in FIN No. 46 and FIN No. 46R. FIN No. 46R was issued December 23, 2003. The
Company will apply FIN No. 46R to all variable interest entities at the end of
the first quarter of 2004.
The Company has evaluated its contractual relationships with its
Roto-Rooter franchisees and has concluded that its interests in the franchisees
are not variable interests as defined in FIN No. 46 and FIN No. 46R. The Company
maintains contractual relationships with certain independent contractors to
provide plumbing and drain cleaning services in specified territories primarily
using the Roto-Rooter name. The Company has no equity interest in any of the
independent contractors, but in many cases, loans money to the contractor to
assist in financing equipment and working capital needs. The loans are generally
partially secured by the contractors' equipment and are guaranteed by the
business owner. The Company's contractor agreements do not require its
contractors to provide all the financial information necessary to apply the
provisions of FIN No. 46R to its contractors. Furthermore, the contractors
generally have not provided all the financial data they are required to provide
under the contractor agreements.
The Company has evaluated its contractual relationships with the four
independent contractors that commenced operations in 2003 ("2003 Contractors")
and determined they are potentially subject to consolidation under FIN No. 46 as
a result of loans made to them. The Company has been unable to obtain sufficient
information necessary to determine whether the 2003 Contractors should be
consolidated. The Company is in the process of evaluating the new provisions of
FIN No. 46R relative to its 2003 Contractors and to its pre-February 2003
contractor arrangements. At this time, the Company does not believe that the
consolidation of any of its contractors, if required under FIN No. 46 or FIN No.
46R, would materially impact its operating results. Instead, consolidation of
some, if any, of these arrangements is more likely to result in a "grossing up"
of amounts such as revenues and expenses with little or no net change to the
Company's net income or cash flows. None of these entities has been consolidated
in the Company's financial statements.
F-10
Under FIN No. 46, the Company is permitted to consolidate the accounts
of the Chemed Capital Trust in its financial statements due to the existence of
a call feature of the Preferred Securities whereby the Company can call the
Preferred Securities for prepayment. As disclosed above, the Company currently
intends to call the Preferred Securities after March 15, 2004, at which time the
Preferred Securities may be prepaid without premium.
When FIN No. 46R becomes fully effective for the Company in the first
quarter of 2004, the Company will be required to de-consolidate the accounts of
the Chemed Capital Trust, because the call feature may no longer be considered
as a condition for consolidation. As a result, the current balance sheet caption
that reads "Mandatorily redeemable convertible preferred securities of the
Chemed Capital Trust" will be revised to read "Convertible junior subordinated
debentures" in the same dollar amount as the Preferred Securities. Within the
statement of operations, the "Distributions on preferred securities" will be
reclassified as interest expense.
2. SEGMENTS AND NATURE OF THE BUSINESS
During the second quarter of 2003, the corporate-office administrative
functions for employee benefits, retirement services, risk management, public
relations, cash management and taxation were combined with the Plumbing and
Drain Cleaning business to enable the Company to benefit from economies of
scale. In May 2003, the shareholders of the Company approved changing the
corporation's name from Chemed Corporation to Roto-Rooter, Inc. ("Roto-Rooter").
Due to these changes and the changing composition of businesses comprising the
Company over the past several years, management re-evaluated the Company's
segment reporting as it relates to corporate-office administrative expenses. The
discontinuance of businesses in 1997 [the Omnia Group ("Omnia") and National
Sanitary Supply Company ("National")], 2001 [Cadre Computer Resources, Inc.
("Cadre Computer")] and 2002 (Patient Care) results in more than 80% of the
Company's business being represented by Roto-Rooter's Plumbing and Drain
Cleaning business.
To better reflect how executive management evaluates its operations,
the costs of the administrative functions of the corporate office were combined
with the operating results of the Plumbing and Drain Cleaning business (formerly
the Roto-Rooter Group) to form the Plumbing and Drain Cleaning segment,
effective in the second quarter of 2003. The Service America segment remains
essentially unchanged.
The Plumbing and Drain Cleaning segment provides plumbing and draining
cleaning services, and Service America Network Inc. ("Service America") provides
major-appliance and heating/air-conditioning ("HVAC") repair, maintenance and
replacement services. Relative contributions of each segment to service revenues
and sales were 84% and 16%, respectively, in 2003.
The reportable segments have been defined along service lines,
consistent with the way the businesses are managed. In determining reportable
segments, the Roto-Rooter Services, Roto-Rooter Franchising and Products and
Roto-Rooter HVAC and non-Roto-Rooter brand operating segments of the Plumbing
and Drain Cleaning segment have been aggregated on the basis of possessing
similar operating and financial characteristics. The characteristics of these
operating segments and the basis for aggregation are reviewed annually.
Accordingly, the reportable segments are defined as follows:
- The Plumbing and Drain Cleaning segment provides repair and maintenance
services to residential and commercial accounts using the Roto-Rooter
service mark. Such services include plumbing and sewer, drain and pipe
cleaning. They are delivered through company-owned,
independent-contractor-operated and franchised locations. This segment
also manufactures and sells products and equipment used to provide such
services.
- The Service America segment provides HVAC repair, maintenance and
replacement services primarily to residential customers through service
contracts and retail sales (demand services). In addition, Service
America sells air conditioning equipment and duct cleaning services.
F-11
Substantially all of the Company's service revenues and sales from
continuing operations are generated from business within the United States.
Management closely monitors accounts receivable balances and has established
policies regarding the extension of credit and compliance therewith.
Segment data for the Company's continuing operations are set forth
below (in thousands, except footnote data):
FOR THE YEARS ENDED DECEMBER 31,
---------------------------------------
2003 2002 2001
--------- --------- ---------
REVENUES BY TYPE OF SERVICE
Plumbing and Drain Cleaning
Sewer and drain cleaning $ 106,127 $ 106,125 $ 109,250
Plumbing repair and maintenance 101,590 98,812 105,803
Industrial and municipal sewer and drain cleaning 15,876 14,660 14,526
Contractors 14,125 12,350 11,873
HVAC repair and maintenance 3,044 3,746 9,859
Other products and services 20,013 17,994 18,042
--------- --------- ---------
Total Plumbing and Drain Cleaning 260,775 253,687 269,353
--------- --------- ---------
Service America
Repair services under contracts 36,384 45,182 51,299
Demand repair services 11,712 15,307 17,256
--------- --------- ---------
Total Service America 48,096 60,489 68,555
--------- --------- ---------
Total service revenues and sales $ 308,871 $ 314,176 $ 337,908
========= ========= =========
AFTERTAX SEGMENT EARNINGS/(LOSS)
Plumbing and Drain Cleaning (a) $ 6,528 $ 9,796 $ (8,765)
Service America (b) (14,687) (19,961) (686)
--------- --------- ---------
Total segment loss (8,159) (10,165) (9,451)
Unallocated investing and financing--net (c) 4,660 1,311 414
Loss on extinguishment of debt - - (1,701)
Discontinued operations 64 6,309 (1,447)
--------- --------- ---------
Net loss $ (3,435) $ (2,545) $ (12,185)
========= ========= =========
F-12
FOR THE YEARS ENDED DECEMBER 31,
---------------------------------------
2003 2002 2001
---------- --------- ---------
INTEREST INCOME
Plumbing and Drain Cleaning $ 817 $ 549 $ 243
Service America 294 413 799
--------- --------- ---------
Subtotal 1,111 962 1,042
Unallocated investing and financing--net 2,187 2,644 2,010
Intercompany eliminations (581) (298) (180)
--------- --------- ---------
Total interest income $ 2,717 $ 3,308 $ 2,872
========= ========= =========
INTEREST EXPENSE
Plumbing and Drain Cleaning $ 210 $ 153 $ 223
Service America 34 59 -
--------- --------- ---------
Subtotal 244 212 223
Unallocated investing and financing--net 1,896 2,716 5,614
Intercompany eliminations - - (414)
--------- --------- ---------
Total interest expense $ 2,140 $ 2,928 $ 5,423
========= ========= =========
INCOME TAX PROVISION
Plumbing and Drain Cleaning $ 4,645 $ 6,535 $ (3,380)
Service America (1,431) 418 437
--------- --------- ---------
Subtotal 3,214 6,953 (2,943)
Unallocated investing and financing--net 1,535 (502) (2,046)
--------- --------- ---------
Total income tax provision $ 4,749 $ 6,451 $ (4,989)
========= ========= =========
IDENTIFIABLE ASSETS
Plumbing and Drain Cleaning $ 172,380 $ 166,308 $ 174,083
Service America 25,655 49,729 71,399
--------- --------- ---------
Total identifiable assets 198,035 216,037 245,482
Unallocated investing and financing--net(d) 131,034 122,107 74,665
Discontinued operations - - 81,310
--------- --------- ---------
Total assets $ 329,069 $ 338,144 $ 401,457
========= ========= =========
ADDITIONS TO LONG-LIVED ASSETS (e)
Plumbing and Drain Cleaning $ 12,610 $ 9,433 $ 10,892
Service America 797 3,414 4,696
--------- --------- ---------
Subtotal 13,407 12,847 15,588
Unallocated investing and financing--net(d) 1,621 184 424
--------- --------- ---------
Total additions $ 15,028 $ 13,031 $ 16,012
========= ========= =========
DEPRECIATION AND AMORTIZATION (f)
Plumbing and Drain Cleaning $ 9,388 $ 10,214 $ 14,128
Service America 2,965 3,633 4,951
--------- --------- ---------
Subtotal 12,353 13,847 19,079
Unallocated investing and financing--net(d) 456 509 2,194
--------- --------- ---------
Total depreciation and amortization $ 12,809 $ 14,356 $ 21,273
========= ========= =========
- ------------------------
(a) Amount for 2003 includes aftertax severance charges of $2,358,000.
Amount for 2001 includes aftertax restructuring and similar expenses
and other charges totaling $15,271,000.
(b) Amounts for 2003 and 2002 include aftertax impairment charges
aggregating $14,363,000 and $20,342,000, respectively. Amount for 2001
includes aftertax restructuring and similar expenses and other charges
of $1,672,000.
(c) Amount for 2002 includes a $780,000 aftertax investment impairment
charge. Amounts for 2003, 2002 and 2001 include aftertax capital gains
on the sales and redemption of investments of $3,351,000, $775,000 and
$703,000, respectively.
(d) Corporate assets consist primarily of cash and cash equivalents,
marketable securities, properties and equipment and other investments.
(e) Long-lived assets include goodwill, identifiable intangible assets and
property and equipment.
(f) Depreciation and amortization include amortization of goodwill,
identifiable intangible assets and other assets.
F-13
3. EQUITY INTEREST IN AFFILIATE (VITAS)
At December 31, 2003, the Company held a 37% interest in privately held
Vitas, which provides palliative and medical care and related services to
terminally ill patients. On August 18, 2003, Vitas retired the Company's
investment in the 9% Redeemable Preferred Stock of Vitas. Cash proceeds to the
Company totaled $27.3 million, and the Company realized a pretax gain of
$1,846,000 ($1,200,000 aftertax or $.12 per share) on the redemption of
preferred stock in the third quarter of 2003. During 2003, the dividends and
amortization of preferred stock discount on this investment contributed
$1,585,000 to the aftertax earnings of the Company. Dividends ceased to accrue
on August 17, 2003. On October 14, 2003, the Company exercised two of its three
warrants (Warrants A and B) to purchase 4,158,000 common shares of Vitas, or
37%, for $18.0 million in cash. At December 31, 2003, the Company's common stock
ownership in Vitas has a carrying value of $21.0 million, and the Company's
investment exceeded its share of Vitas' net book value by approximately $16.6
million. On a preliminary basis, the Company estimates that $3.7 million of this
excess is attributable to the excess value of computer software with a 5-year
life and the remainder to goodwill with an indefinite life. Amortization of this
excess reduced the Company's equity in the earnings of Vitas by $97,000 in 2003.
In 2004, as a result of completing the acquisition of the 63% of Vitas it did
not own in 2003, the Company will conduct a thorough review to value all assets
and liabilities of Vitas at their fair values. Thus, it is possible that the
Company may identify other intangible assets with different useful lives.
Summarized financial data for Vitas follow (in thousands):
AS OF AND
FOR THE THREE AS OF AND FOR THE
MONTHS ENDED YEARS ENDED SEPTEMBER 30,
DECEMBER 31, ---------------------------------------
2003 2003 2002 2001
--------- --------- --------- --------
Income Statement
Revenues $ 121,062 $ 420,074 $ 359,200 $319,517
Gross profit 27,515 88,254 77,841 69,973
Income from operations 10,727 32,022 28,019 23,814
Net income 5,396 13,689 13,789 12,311
Net income available for common stockholders 5,396 5,678 9,727 6,112
Financial Position
Current assets $ 79,619 $ 69,891 $ 51,780
Noncurrent assets 63,746 62,660 59,687
Current liabilities 62,963 54,046 46,881
Noncurrent liabilities 68,553 90,053 59,006
Redeemable preferred stock - - 22,006
Stockholders' equity/(deficit) 11,849 (11,548) (16,426)
4. INTANGIBLE ASSETS
Amortization of intangible assets from continuing operations was (in
thousands):
FOR THE YEARS ENDED
DECEMBER 31,
----------------------------
2003 2002 2001
------ ------ ------
Identifiable intangible assets $ 560 $ 621 $ 680
Goodwill - - 4,102
------ ------ ------
Total $ 560 $ 621 $4,782
====== ====== ======
The following is a schedule by year of projected amortization expense
for intangible assets (in thousands):
2004 $116
2005 88
2006 73
2007 54
2008 50
F-14
The changes in the carrying amount of goodwill for the years ended
December 31, 2002 and 2003, are as follows (in thousands):
PLUMBING
AND DRAIN SERVICE
CLEANING AMERICA TOTAL
-------- ---------- ----------
December 31, 2001 $ 100,023 $ 30,379 $ 130,402
Acquired in business combinations 1,110 - 1,110
Impairment losses - (20,342) (20,342)
Other adjustments (327) - (327)
--------- --------- ---------
DECEMBER 31, 2002 100,806 10,037 110,843
ACQUIRED IN BUSINESS COMBINATIONS 4,246 - 4,246
IMPAIRMENT LOSSES - (10,037) (10,037)
OTHER ADJUSTMENTS 283 - 283
--------- --------- ---------
DECEMBER 31, 2003 $ 105,335 $ - $ 105,335
========= ========= =========
During the fourth quarter of 2003, the Company recognized a $10,037,000
impairment loss on the goodwill (fourth quarter of 2002 -- $20,342,000) included
in the Service America segment. The goodwill impairment charges are based on an
appraisal firm's valuation of Service America's business as of December 31, 2003
and 2002. The fair value of Service America was calculated using an average of
the enterprise value determined under a capital markets valuation and discounted
cash flows using updated income and cash flow projections for Service America's
business. The capital markets method calculates an enterprise value based on
valuations at which comparable businesses sold in the capital markets and based
on certain financial ratios and statistics. The income and cash flow projections
are updated each year as a part of the Company's annual business plan process
and take into consideration the changing marketplace and changing operating
conditions. The decline in the overall valuations of Service America in 2003 and
2002 were a direct result of lower revenue, earnings and cash flow projections
due to the continued decline in the contract base of the business (23% decline
in 2003; 19% decline in 2002). These projections were adjusted to reflect that
Service America missed achieving its budgeted revenues by $6.0 million, or 11%,
in 2003 ($8.7 million, or 13%, for 2002) and missed achieving its budgeted gross
margin by $2.8 million, or 19%, for 2003 ($4.5 million or 26% for 2002).
As required by SFAS No. 142, the Company performed goodwill impairment
tests for all of its reporting units as of December 31, 2003 and 2002. These
tests indicated that none of the reporting units' goodwill, other than Service
America's, is impaired.
In conjunction with the adoption of SFAS No. 142, the Company performed
its transition evaluation of goodwill as of January 1, 2002. For the purpose of
impairment testing, the Company determined its reporting components to be
Service America, Roto-Rooter Services (plumbing and drain cleaning services),
Roto-Rooter Franchising and Products (franchising and manufacturing and sale of
plumbing and drain cleaning products) and Roto-Rooter HVAC/non-Roto-Rooter
brands (heating, ventilating, and air-conditioning repair services and
non-Roto-Rooter-branded plumbing and drain cleaning services). The Company's
transition impairment tests, based on valuations by a professional valuation
firm, indicated that none of the goodwill for any of its reporting components
was impaired at January 1, 2002.
During 2001, the Company recognized a $10,580,000 impairment loss under
FASB Statement No. 121, Accounting for the Impairment of Long-Lived Assets and
for Long-Lived Assets to Be Disposed Of. Most of this amount ($9,793,000)
relates to goodwill included on the books of Plumbing and Drain Cleaning's HVAC
and non-Roto-Rooter-branded plumbing operations. As the Company had committed to
exit these underperforming businesses in November 2001, the amount of the
impairment was based on the estimated selling price of the operations to be sold
or dissolved. The remaining $787,000 impairment loss relates to the closing of
Service America's Tucson branch. These charges are included in the
restructuring-and-similar-expenses account in the statement of operations.
The loss for 2001 excluding the amortization of goodwill is presented
below (in thousands):
Reported loss from continuing operations $(10,738)
Aftertax amortization of goodwill 4,621
--------
Adjusted loss $ (6,117)
========
Reported net loss $(12,185)
Aftertax amortization of goodwill 4,621
--------
Adjusted net loss $ (7,564)
========
5. IMPAIRMENT, RESTRUCTURING AND SIMILAR EXPENSES
In addition to the goodwill impairment charges discussed above, the
Service America segment recognized asset impairment charges in 2003 under FASB
Statement No. 144, Accounting for the Impairment or Disposal of Long-Lived
Assets, comprising $4,052,000 for property and equipment (primarily capitalized
software) and $1,739,000 for identifiable intangible assets (primarily customer
contracts).
F-15
The property and equipment and identifiable intangible asset impairment
charges for 2003 are based on an analysis of undiscounted cash flows that
indicated that the book value of the net assets of Service America exceeded the
projected cash flows of the business over the life of the noncurrent assets.
Accordingly, the carrying values of the noncurrent assets that exceeded their
fair values were written down to their fair values, based largely on a recent
appraisal of assets by a professional valuation firm. Substantially all of the
property and equipment impairment charge related to computer software costs. The
large majority of the identifiable intangible asset charge related to
capitalized customer contracts, acquired in 1991 and 1993, which, in the opinion
of management, have no future value.
Total impairment charges recognized by Service America in the fourth
quarters of 2003 and 2002 are (in thousands):
2003 2002
------- -------
Goodwill $10,037 $20,342
Identifiable intangible assets 1,739 -
Properties and equipment -
(primarily capitalized software) 4,052 -
------- -------
Total $15,828 $20,342
======= =======
The aftertax cost of these impairment charges was $14,363,000 in 2003 and
$20,342,000 in 2002.
In the third quarter of 2001, the Company decided to close Service
America's Tucson branch, which was acquired in 1999, due to its operating
performance. The branch failed to achieve the level of profitability that had
been anticipated upon acquisition.
In the fourth quarter of 2001, the Company decided to exit the HVAC and
non-Roto-Rooter-branded plumbing businesses by selling them or closing them or
transferring their operations to Roto-Rooter branches. The decision to dispose
of these operations was made because they failed to improve profitability in
recent years and were requiring the use of resources which management believed
could be better used elsewhere in the Plumbing and Drain Cleaning segment.
In the third quarter of 2002, management decided to retain the largest
of the HVAC and non-Roto-Rooter-branded plumbing businesses, as it remained
profitable throughout the period and the majority of its revenue was from
plumbing operations. Additionally, management determined there was sufficient
synergism between this non-Roto-Rooter-branded operation and the nearby
Roto-Rooter branch to justify retaining it. The decision to retain this business
did not have a material impact on the results of operations for 2002 and would
not have materially changed the restructuring charges recorded in 2001 for the
cost of exiting HVAC and non-Roto-Rooter-branded businesses.
The closing of Service America's Tucson branch was completed in 2001,
and the restructuring of Roto-Rooter's HVAC and non-branded plumbing businesses
was completed in the third quarter of 2002. Since most of the restructuring
expenses arose from noncash asset impairment charges, the restructuring plans
did not consume a significant amount of the Company's resources.
F-16
During 2001, the Company's continuing operations recorded pretax
restructuring and similar expenses and other nonrecurring and unusual charges as
follows (in thousands, except footnote):
Plumbing
and Drain Service
Cleaning America Total
--------- ------ -------
Restructuring expenses:
Cost of exiting HVAC and non-Roto-Rooter-
branded plumbing businesses (a) $11,205 $ - $11,205
Cost of closing Service America's Tucson branch (b) - 1,171 1,171
Expenses not expected to recur (similar expenses):
Charges for accelerating the vesting of
restricted stock awards in connection with the
anticipated revision of the Company's long-term
incentive plans in 2002 (c) 5,294 146 5,440
Severance charges for 10 individuals incurred in
connection with reducing administrative
expenses, largely at the corporate office (d) 2,909 757 3,666
Resolution of overtime pay issues with the U.S.
Department of Labor ("DOL") , relating
primarily to prior years' compensation expense (e) 2,749 - 2,749
Property and equipment impairment charges (f) 337 166 503
------- ------- -------
Total restructuring and similar expenses 22,494 2,240 24,734
Other unusual charges:
Additional casualty insurance expense recorded
to reflect increase in valuation of insurance
claims for prior years 1,411(g) - 1,411
Terminated lease obligations 166(h) 69(g) 235
All other 417(h) 414(g) 831
------- ------- -------
Total restructuring and similar expenses
and other unusual charges $24,488 $ 2,723 $27,211
======= ======= =======
- ---------------
(a) Amount includes a charge of $9,793,000 for the reduction in the carrying
value of goodwill and $477,000 for the reduction in the carrying value of
identifiable intangible assets.
(b) Amount includes a charge of $833,000 for the reduction in the carrying
value of goodwill and $50,000 for the reduction in the carrying value of
identifiable intangible assets.
(c) In the fourth quarter of 2001, the Board of Directors of the Company
approved accelerating the vesting of all outstanding restricted stock
awards as a result of its decision to terminate this long-term incentive
program. In May 2002, the shareholders of the Company approved the adoption
of the 2002 Executive Long-Term Incentive Plan to replace the restricted
stock award program (see Note 19). Stock award expense is typically
classified as general and administrative expense in the statement of
operations. This charge is included in the "restructuring and similar
expense" category because this type of expense is not expected to recur in
the foreseeable future. The accrual balance related to these charges was
nil at December 31, 2002 ($ 1,177,000 at December 31, 2001).
(d) These charges are included in the "restructuring and similar expense"
category as the charges relate primarily to personnel who are not expected
to be replaced. Severance expense is typically classified as general and
administrative expense in the statement of operations. The accrual balance
related to these charges totaled $3,489,000 at December 31, 2002
($3,666,000 at December 31, 2001).
(e) This charge represents the cost of the nationwide settlement between
Roto-Rooter and the DOL for wages and benefits of prior periods. The charge
is included in the "restructuring and similar expense" category as it is
not expected to recur in the foreseeable future. Wages and related benefits
are typically classified as cost of services provided and goods sold in the
statement of operations. The accrual balance related to this charge totaled
nil at December 31, 2002 ($250,000 at December 31, 2001).
(f) The fixed asset impairment charges are included in the "restructuring and
similar expense" category because they are not expected to recur in the
foreseeable future. The depreciation of property and equipment is typically
included in a separate line (depreciation) in the statement of operations.
(g) Amounts are included in cost of services provided and goods sold in the
consolidated statement of operations.
(h) Amounts are included in general and administrative expenses in the
consolidated statement of operations.
These costs were charged to the following accounts in the consolidated statement
of operations in 2001 (in thousands):
Cost of services provided and goods sold $ 2,027
General and administrative expenses 450
Impairment, restructuring and similar
expenses 24,734
--------
Total $ 27,211
========
The combined aftertax impact of the restructuring and similar expenses
and other charges for 2001 was $16,943,000 ($1.74 per share).
F-17
During 2002, the Company decided to retain several of Plumbing and
Drain Cleaning's non-branded plumbing and HVAC businesses. In the aggregate, the
retained operations generated $16,162,000 of net revenues and $241,000 of
operating profit in 2002. For 2003, these businesses have been assimilated into
the Plumbing and Drain Cleaning segment.
The operating results for businesses divested within the Plumbing and
Drain Cleaning and Service America segments as a part of the restructuring in
2001 were (in thousands):
FOR THE YEARS ENDED
DECEMBER 31,
--------------------
2002 2001
------- -------
Service revenues and sales:
Non-Roto-Rooter-
branded businesses $ 403 $ 6,275
Service America's
Tucson branch - 1,664
Operating loss:
Non-Roto-Rooter-
branded businesses (106) (754)
Service America's
Tucson branch - (430)
Accruals related to restructuring charges recorded in 2001 are
summarized below (in thousands):
Cost of exiting HVAC and non-Roto-Rooter-
branded plumbing businesses $ 11,205
Cost of closing Service America's Tucson branch 1,171
--------
Total restructuring expenses for 2001 12,376
Less: noncash charge for reduction in carrying value of goodwill (10,626)
Less: noncash charge for reduction in carrying value of identifiable
intangible assets (527)
Less: noncash charge for property and equipment impairment (380)
Less: noncash charge for reduction in carrying value of other tangible assets (288)
--------
Accrual balance at December 31, 2001 555
Plus: Proceeds from HVAC operation disposed of in 2002 in excess of
adjusted book value (400)
Less: Accrual of additional expenses and exposure on disposal of HVAC
operation in 2002 377
Less: Cash payments during the year (255)
--------
Accrual balance at December 31, 2002 277
Less: Accrual adjustment for property and equipment impairment (117)
Less: Noncash charge for property and equipment impairment (39)
Less: Cash payments during the year (51)
--------
Accrual balance at December 31, 2003 $ 70
========
Management believes that these accrual balances are adequate and justifiable as
of December 31, 2003.
F-18
6. DISCONTINUED OPERATIONS
Discontinued operations comprise (in thousands, except per share
amounts):
FOR THE YEARS ENDED
DECEMBER 31,
---------------------------------
2003 2002 2001
------- ------- -------
Patient Care (2002):
Income before income taxes $ - 5,233 262
Income taxes - (2,142) 264
------- ------- -------
Income from operations, net of income taxes - 3,091 526
Gain on disposal, net of income taxes of $594 - 304 -
------- ------- -------
Total Patient Care - 3,395 526
======= ======= =======
Cadre Computer (2001):
Loss before income taxes - - (734)
Income tax benefit - - 255
Minority interest - - 46
------- ------- -------
Loss from operations, net of income taxes - - (433)
Loss on disposal, net of income tax benefit of $829 - - (1,540)
------- ------- -------
Total Cadre Computer - - (1,973)
------- ------- -------
Adjustment to accruals of operations discontinued in prior years:
Sublease accrual (1991) - (1,145) (1,700)
Allowance for uncollectible notes receivable (2001) 99 477 -
Severance and other accruals (1997) - 180 (170)
------- ------- -------
Gain/(loss) before income taxes 99 (488) (1,870)
Income tax refund (1997) - 2,861 -
State income tax accrual (1997) - - 1,700
All other income taxes (35) 541 170
------- ------- -------
Total adjustments 64 2,914 -
======= ======= =======
Total discontinued operations $ 64 $ 6,309 $(1,447)
======= ======= =======
Earnings/(loss) per share $ - $ 0.64 $ (0.15)
======= ======= =======
Diluted earnings/(loss) per share $ - $ 0.64 $ (0.15)
======= ======= =======
The $99,000 and $477,000 reductions to the allowance for uncollectible
notes receivable from Cadre Computer (sold in 2001) are attributable to Cadre
Computer's experiencing better than anticipated financial results and to the
expiration and nonuse of $350,000 of Cadre Computer's line of credit with the
Company. In anticipation that Cadre Computer would draw down the full $500,000
line of credit to finance operating losses, this line of credit had been fully
reserved in 2001 when Cadre Computer was sold to its employees. The remainder
of the adjustment in 2002 ($127,000) and 2003 ($99,000) was recorded because
Cadre Computer began making payments on its existing notes that previously were
fully reserved.
During 2002, the Company sold Patient Care to an investor group that
included Schroder Ventures Life Sciences Group, Oak Investment Partners,
Prospect Partners and Salix Ventures. Patient Care provides home-healthcare
services primarily in the New York-New Jersey-Connecticut area. The proceeds to
the Company from the sale of Patient Care comprised the following (in
thousands):
Cash $52,500
Note receivable 12,500
Cash placed in escrow 5,000
Common stock purchase warrant 1,445
Purchase price adjustment
due to seller 1,251
-------
Total $72,696
=======
The note receivable is a senior subordinated note ("Note") due October
11, 2007, that bears interest at the annual rate of 7.5% through September 30,
2004, 8.5% from October 1, 2004 through September 30, 2005, and 9.5% thereafter.
The Note is presented on a separate line in the consolidated balance sheet. The
$5,000,000 cash placed in escrow is subject to the collection of Patient Care's
receivables with third party payers. Of this amount, $2,500,000 (included in
prepaid expenses and other current assets in 2002) was
F-19
distributed as of October 2003 and $2,500,000 (included in prepaid expenses and
other current assets in 2003 and in other assets in 2002) is expected to be
distributed as of October 2004. Based on the collection history of Patient Care,
the Company expects to collect the funds held in escrow in full. The common
stock purchase warrant permits the Company to purchase up to 2% of Patient Care.
The warrant is recorded at its estimated fair value on the date acquired and is
included in other investments in the consolidated balance sheet. The final value
of the estimated balance sheet valuation is expected to be determined in 2004,
based on Patient Care's closing balance sheet, and could impact the amount of
the gain recorded on the sale of Patient Care.
The adjustments to the sublease accrual ($1,145,000 in 2002 and
$1,700,000 in 2001) were made to cover rental charges for vacant space
previously occupied by the Company's former subsidiary, DuBois Chemicals, Inc.
("DuBois"), sold in 1991. The adjustments made in 2001 moved the dates the floor
space was assumed to be sublet further into the future, but assumed all
unoccupied space would be sublet at market rental rates. Although the Company
was able to sublease varying amounts of space during the past two years, as of
December 31, 2003, the Company was unable to sublease one of the floors covered
under its lease. The adjustments made in 2002 decreased the amount of sublease
rentals that were assumed to be received to include rentals only from current
sublessees. As a result, the sublease accrual will now cover the cost of all
unoccupied space and the shortfall of current subleased rentals versus lease
rental rates and operating costs.
The $2,861,000 federal income tax refund received in 2002 related to
the tax provision recorded as a part of the sale of Omnia in 1997. As a result
of a tax case settled in 2001, the Company filed an amended 1997 federal income
tax return in August 2001 and claimed a tax benefit on its loss on the sale of
Omnia -- a loss previously treated as nondeductible.
During 2001, the Company discontinued its Cadre Computer segment and on
August 31, 2001, completed the sale of the business and assets of Cadre Computer
to a company owned by the former Cadre Computer employees for a note receivable
that was fully reserved on the date of sale. During 2002, Cadre Computer
borrowed an additional $150,000 from the Company and made principal payments of
$31,000 on the first note. During 2003, Cadre made principal payments of $96,000
on the first note. As of December 31, 2003, the Company's notes receivable from
Cadre Computer totaled $422,000, against which the Company has an allowance for
uncollectible notes totaling $323,000. The balances in the allowances for
uncollectible notes receivable from Cadre Computer are considered adequate at
December 31, 2003 and 2002.
Revenues generated by discontinued operations comprise (in thousands):
FOR THE YEARS ENDED
DECEMBER 31,
-------------------
2002 2001
-------- --------
Patient Care $116,191 $139,208
Cadre Computer - 5,089
-------- --------
Total $116,191 $144,297
======== ========
The $1,700,000 reduction of the state income tax accrual in 2001
relates to the tax provision recorded on the 1997 sale of National. During 2001,
the statutes of limitations on various Company 1997 state returns expired, with
the result being that the Company's state income tax accrual exceeded its
estimated exposures. The accrual was reduced and credited to the income tax
provision in 2001.
At December 31, 2003, other current liabilities include accruals of
$3,731,000 and other liabilities include accruals of $3,142,000 for costs
related to discontinued operations. The estimated timing of payments of these
liabilities, relating primarily to sublease and environmental liabilities,
follows (in thousands):
2004 $ 3,731
2005 1,791
2006 731
2007 200
2008 200
AFTER 2008 220
-------
TOTAL $ 6,873
=======
The Company's chairman, president and chief executive officer and the
former chief administrative officer (currently a director of the Company) are
directors of Cadre Computer. In addition, the former chief administrative
officer holds a 40% equity ownership interest in and is chairman and chief
executive officer of Cadre Computer.
7. BUSINESS COMBINATIONS
During 2003, six purchase business combinations were completed within
the Plumbing and Drain Cleaning segment for a total of $3.9 million in cash.
During 2002, one purchase business combination was completed within the Plumbing
and Drain Cleaning segment for a purchase price of $1.2 million in cash. During
2001, two purchase business combinations were completed within the Plumbing and
Drain Cleaning segment for an aggregate purchase price of $1.6 million in cash.
F-20
All of the aforementioned business combinations involved operations
primarily in the business of providing plumbing repair and drain cleaning
services. The unaudited pro forma results of operations, assuming purchase
business combinations completed in 2003, 2002 and 2001 were completed on January
1 of the preceding year, are presented below (in thousands, except per share
data):
FOR THE YEARS ENDED
DECEMBER 31,
-------------------------------------
2003 2002 2001
-------- --------- --------
Service revenues and sales $310,669 $ 317,010 $338,714
Net loss (3,298) (2,204) (12,057)
Loss per share and
loss per diluted share (0.33) (0.22) (1.24)
The excess of the purchase price over the fair value of the net assets
acquired in purchase business combinations is classified as goodwill. A summary
of net assets acquired in purchase business combinations follows (in thousands):
FOR THE YEARS ENDED
DECEMBER 31,
--------------------------------
2003 2002 2001
------- ------- -------
Working capital $ (114) $ 60 $ -
Identifiable intangible assets - 50 90
Goodwill 4,246 1,110 1,428
Other assets and liabilities--net (282) 16 37
------- ------- -------
Total net assets $ 3,850 $ 1,236 $ 1,555
======= ======= =======
All of the goodwill related to business combinations completed in 2003,
2002 and 2001 is expected to be deductible for income tax purposes. Since these
transactions occurred after June 30, 2001, the related goodwill is not being
amortized. The weighted average lives of the identifiable intangible assets
acquired in 2002 and 2001 are 7.0 years and 6.1 years, respectively.
8. OTHER INCOME -- NET
Other income -- net from continuing operations comprises the following
(in thousands):
FOR THE YEARS ENDED
DECEMBER 31,
--------------------------------
2003 2002 2001
------- ------- -------
Interest income $ 2,717 $ 3,308 $ 2,872
Dividend income 1,540 2,461 2,548
Market value gains/(losses) on
trading investments of
employee benefit trusts 1,600 (1,401) (820)
Investment impairment charge - (1,200) -
Gains on sales and redemption
of investments 5,390 1,141 993
Other--net 12 (27) (606)
------- ------- -------
Total other income--net $11,259 $ 4,282 $ 4,987
======= ======= =======
9. INCOME TAXES
The provision for income taxes comprises the following (in thousands):
FOR THE YEARS ENDED
DECEMBER 31,
---------------------------------
2003 2002 2001
------- ------- -------
Continuing Operations:
Current
U.S. federal $ 3,818 $ 3,938 $ 1,196
U.S. state and local 1,179 1,913 59
Foreign 253 141 (71)
Deferred
U.S. federal (485) 475 (6,139)
Foreign (16) (16) (34)
------- ------- -------
Total $ 4,749 $ 6,451 $(4,989)
======= ======= =======
Discontinued Operations:
Current U.S. federal $ (649) $(2,954) $(4,242)
Current U.S. state and local - 794 (1,454)
Deferred U.S. federal 684 1,494 2,478
------- ------- -------
Total $ 35 $ (666) $(3,218)
======= ======= =======
F-21
A summary of the significant temporary differences for continuing
operations that give rise to deferred income tax assets/(liabilities) follows
(in thousands):
DECEMBER 31,
----------------------
2003 2002
-------- --------
Deferred compensation $ 7,015 $ 6,117
Accrued insurance expense 6,091 5,987
Accruals related to discontinued operations 2,872 3,556
Severance payments 1,779 1,380
Allowances for uncollectible accounts receivable 1,052 1,184
Accrued state taxes 974 1,047
Market valuation of investments 475 -
Amortization of intangibles - 314
Other 2,463 2,527
-------- --------
Gross deferred income tax assets 22,721 22,112
-------- --------
Accelerated tax depreciation (2,631) (4,388)
Investment basis difference (2,050) (248)
Amortization of intangibles (619) -
Market valuation of investments - (960)
Other (1,776) (2,096)
-------- --------
Gross deferred income tax liabilities (7,076) (7,692)
-------- --------
Net deferred income tax assets $ 15,645 $ 14,420
======== ========
Included in other assets at December 31, 2003, are deferred income tax
assets of $5,589,000 (December 31, 2002 -- $4,526,000). Based on the Company's
history of prior operating earnings and its expectations for future growth,
management has determined that the operating income of the Company will, more
likely than not, be sufficient to ensure the full realization of the deferred
income tax assets. The difference between the actual income tax
provision/(benefit) for continuing operations and the income tax
provision/(benefit) calculated at the statutory U.S. federal tax rate is
explained as follows (in thousands):
FOR THE YEARS ENDED
DECEMBER 31,
-----------------------------------
2003 2002 2001
-------- -------- -------
Income tax provision/(benefit) calculated
using the statutory rate of 35% $ 115 $ (841) $(5,504)
Nondeductible goodwill impairment charge 3,513 7,120 -
Nondeductible intangibles impairment charge 562 - -
State and local income taxes, less federal
income tax effect 767 1,243 39
Domestic dividend exclusion (441) (686) (706)
Unfavorable/(favorable) federal adjustments 103 (314) 337
Foreign income taxes, less federal income
tax effect 26 (85) (277)
Nondeductible amortization of goodwill - - 1,203
Other--net 104 14 (81)
-------- -------- -------
Actual income tax provision/(benefit) $ 4,749 $ 6,451 $(4,989)
======== ======== =======
Effective tax rate 1,447.9% (268.5)% 31.7%
======== ======== =======
Income tax benefits attributable to the exercise of non-qualified
employee stock options were $960,000 during the year ended December 31, 2003
(2002 - $122,000; 2001 - $219,000) and were credited directly to additional
paid-in capital.
Income taxes included in the components of other comprehensive loss are
as follows (in thousands):
FOR THE YEARS ENDED
DECEMBER 31,
----------------------------------
2003 2002 2001
-------- ------ -------
Unrealized holding gains/(losses) $ (180) $ 132 $ 905
Reclassification adjustment (2,039) (366) (290)
F-22
Summarized below are the total amounts of income taxes paid/(refunded)
during the years ended December 31 (in thousands):
2003 $ 2,715
2002 (910)
2001 5,772
10. CASH EQUIVALENTS
Included in cash and cash equivalents at December 31, 2003, are cash
equivalents in the amount of $49,356,000 (2002 -- $37,075,000). The cash
equivalents at both dates consist of investments in various money market funds
and repurchase agreements yielding interest at a weighted average rate of 0.9%
in 2003 and 1.1% in 2002.
From time to time throughout the year, the Company invests its excess
cash in repurchase agreements directly with major commercial banks. The Company
does not physically hold the collateral, but the term of such repurchase
agreements is less than 10 days. Investments of significant amounts are spread
among a number of banks, and the amounts invested in each bank are varied
constantly.
11. PROPERTIES AND EQUIPMENT
A summary of properties and equipment follows (in thousands):
DECEMBER 31,
------------------------
2003 2002
--------- ---------
Land $ 2,238 $ 2,538
Buildings 16,423 18,310
Transportation equipment 22,061 26,185
Machinery and equipment 36,281 34,440
Computer software 6,947 4,327
Furniture and fixtures 19,700 18,354
Projects under construction - 6,577
--------- ---------
Total properties and equipment 103,650 110,731
Less accumulated depreciation (62,646) (62,370)
--------- ---------
Net properties and equipment $ 41,004 $ 48,361
========= =========
12. LONG-TERM DEBT AND LINES OF CREDIT
A summary of the Company's long-term debt follows (in thousands):
DECEMBER 31,
----------------------
2003 2002
-------- --------
Senior notes, due 2005-2009 $ 25,000 $ 25,000
Other 1,379 1,012
-------- --------
Subtotal 26,379 26,012
Less: current portion (448) (409)
-------- --------
Long-term debt, less
current portion $ 25,931 $ 25,603
======== ========
LINES OF CREDIT
The Company had approximately $51,357,000 of unused short-term lines of
credit with various banks at December 31, 2003.
SENIOR NOTES
In March 1997, the Company borrowed $25,000,000 from several insurance
companies. Principal is repayable in five annual installments of $5,000,000
beginning on March 15, 2005, and bears interest at the rate of 7.31% per annum.
Interest is payable on March 15 and September 15 of each year.
F-23
On December 31, 2001, the Company prepaid the outstanding balances of
its 8.15% senior notes due 2002 through 2004 and its 10.67% senior notes due in
2002 and 2003. The principal balances outstanding at the time of prepayment were
$30,000,000 and $2,000,000, respectively. Pretax penalties incurred on these
prepayments aggregated $2,617,000 ($1,701,000 aftertax or $.18 per share) and
are presented as a loss on extinguishment of debt in the statement of
operations.
OTHER
Other long-term debt has arisen from loans in connection with
acquisitions of various businesses and properties. Interest rates range from
7.3% to 8.0%, and the obligations are due on various dates through December
2010.
The following is a schedule by year of required long-term debt payments
as of December 31, 2003 (in thousands):
2004 $ 448
2005 5,190
2006 5,200
2007 5,210
2008 5,162
AFTER 2008 5,169
--------
TOTAL LONG-TERM DEBT $ 26,379
========
Summarized below are the total amounts of interest paid during the
years ended December 31 (in thousands):
2003 $ 3,197
2002 3,979
2001 7,007
No interest was capitalized during the years ended December 31, 2003,
2002 and 2001.
NEW CREDIT AGREEMENTS
On February 24, 2004, in conjunction with the Company's acquisition of
the Vitas shares not previously owned, the Company retired its senior notes due
2005 through 2009 and cancelled its revolving credit agreement with Bank One,
N.A. ("Bank One"). To fund this acquisition, the Company issued 2 million shares
of capital stock in a private placement and borrowed $335 million as follows:
- $75 million drawn down under a $135 million secured
revolving credit/term loan facility ("New Credit
Facility") with Bank One. The facility comprises a $35
million term loan and $100 million revolving credit
facility, including up to $40 million in letters of
credit. For the term loan, principal payments of
$1,250,000 plus interest (LIBOR + 3.50%) are due
quarterly beginning in May 2004. For the revolving line
of credit, interest payments (LIBOR + 3.25%) are due
quarterly beginning in May 2004. Payment of unpaid
principal and interest is due February 2009.
- $110 million from the issuance of privately placed
floating rate senior secured notes ("Floating Rate
Notes") due 2010. Interest payments (LIBOR + 3.75%) are
due quarterly beginning in May 2004, and payment of
unpaid principal and interest is due February 2010.
- $150 million from the issuance of privately placed 8.75%
senior notes ("Fixed Rate Notes") due 2011. Quarterly
interest payments are due beginning in May 2004 and
payment of unpaid principal and interest is due February
2011.
In addition, the Company anticipates drawing down approximately $26
million of letters of credit under the New Credit Facility in March 2004. After
these borrowings and letters of credit, the Company will have $34 million of
unused lines of credit under the New Credit Facility. Combined payments for the
New Credit Facility, the Floating Rate Notes and the Fixed Rate Notes are
summarized as follows (in thousands):
2004 $ 3,750
2005 5,000
2006 5,000
2007 5,000
2008 5,000
2009 AND LATER 311,250
---------
TOTAL $ 335,000
=========
F-24
Collectively, the New Credit Facility, the Floating Rate Notes and the
Fixed Rate Notes provide for affirmative and restrictive covenants including,
without limitation, requirements or restrictions (subject to exceptions) related
to the following:
- use of proceeds of loans,
- restricted payments, including payments of dividends and retirement of
stock (permitting $.48 per share dividends so long as the aggregate
amount of dividends in any fiscal year does not exceed $7.0 million and
providing for additional principal prepayments to the extent dividends
exceed $5.0 million in any fiscal year), with exceptions for existing
employee benefit plans and stock option plans,
- mergers and dissolutions,
- sales of assets,
- investments and acquisitions,
- liens,
- transactions with affiliates,
- hedging and other financial contracts,
- restrictions on subsidiaries,
- contingent obligations,
- operating leases,
- guarantors,
- collateral,
- sale and leaseback transactions,
- prepayments of indebtedness, and
- maximum annual capital expenditures of $20 million subject to one-year
carry-forwards on amounts not used during the previous year.
In addition, the credit agreements provide that the Company will be
required to meet the following financial covenants, to be tested quarterly,
beginning with the quarter ending June 30, 2004:
- a minimum net worth requirement, which requires a net worth of at least
(i) $232 million plus (ii) 50% of consolidated net income (if positive)
beginning with the quarter ending June 30, 2004, plus (iii) the net
cash proceeds from issuance of the Company's capital stock or the
capital stock of the Company's subsidiaries;
- a maximum leverage ratio, calculated quarterly, based upon the ratio of
consolidated funded debt to consolidated EBITDA, which will require
maintenance of a ratio of 5.5 to 1.00 through December 31, 2004, a
ratio of 4.75 to 1.00 from January 1 through December 31, 2005, and
4.25 to 1.00 thereafter;
- a maximum senior leverage ratio, calculated quarterly, based upon the
ratio of senior consolidated funded debt to consolidated EBITDA (which
ratio excludes indebtedness in respect of the Fixed Rate Notes), which
will require maintenance of a ratio of 3.375 to 1.00 through December
31, 2004, a ratio of 2.875 to 1.00 from January 1 through December 31,
2005, and 2.625 to 1.00 thereafter; and
- a minimum fixed charge coverage ratio, based upon the ratio of
consolidated EBITDA minus capital expenditures to consolidated interest
expense plus consolidated current maturities (including capitalized
lease obligations) plus cash dividends paid on equity securities plus
expenses for taxes, which will require maintenance of a ratio of 1.15
to 1.00 through December 31, 2004, 1.375 to 1.00 from January 1 through
December 31, 2005, and 1.50 to 1.00 thereafter.
13. OTHER LIABILITIES
At December 31, 2003, other current liabilities comprised the following
(in thousands):
DECEMBER 31,
-------------------
2003 2002
------- -------
Accrued incentive compensation $ 4,140 $ 3,738
Accrued divestiture expenses 3,731 3,661
Accrued savings and retirement
contribution 3,338 3,642
Accrued advertising 1,103 3,195
Other 8,811 9,277
------- -------
Total other current liabilities $21,123 $23,513
======= =======
F-25
Other liabilities at December 31, 2003, included income tax liabilities totaling
$10,215,000 (2002 -- $9,194,000).
At December 31, 2003, the Company's accrual for its estimated liability
for potential environmental cleanup and related costs arising from the sale of
DuBois amounted to $2,070,000. Of this balance, $870,000 is included in other
liabilities and $1,200,000 is included in other current liabilities. The Company
is contingently liable for additional DuBois-related environmental cleanup and
related costs up to a maximum of $18,036,000. On the basis of a continuing
evaluation of the Company's potential liability, management believes it is not
probable this additional liability will be paid. Accordingly, no provision for
this contingent liability has been recorded. The potential liability is not
insured, and the recorded liability does not assume the recovery of insurance
proceeds. Also, the environmental liability has not been discounted because it
is not possible to reliably project the timing of payments. It is currently
expected that approximately $1,200,000 of the liability will be paid out in
2004; the timing of the remainder of the payments is not currently estimable.
Management believes that any adjustments to its recorded liability will not
materially adversely affect its financial position or results of operations.
At December 31, 2003, the Company's accrual for losses on subleases of
office space formerly occupied by DuBois amounted to $2,847,000 (2002 --
$4,017,000), of which, $1,200,000 (2002 -- $1,200,000) is included in other
current liabilities. The accrual is based on the expectation that space
currently unoccupied will not be sublet during the remainder of the lease term,
which ends April 2006.
Net proceeds/(uses) of cash from discontinued operations in the
statement of cash flows represent the net proceeds from the sale of Patient Care
in 2002 and the payment of severance, lease and other liabilities relating to
operations disposed of in 1991, 1997 and 2001.
14. PENSION AND RETIREMENT PLANS
Retirement obligations under various plans cover substantially all
full-time employees who meet age and/or service eligibility requirements. The
major plans providing retirement benefits to the Company's employees are defined
contribution plans.
The Company has established two ESOPs that purchased a total of
$56,000,000 of the Company's capital stock. In December 1997, the Company
restructured the ESOP loans and internally financed $16,201,000 of the
$21,766,000 ESOP loans outstanding at December 31, 1997.
Substantially all eligible employees of the Plumbing and Drain Cleaning
segment participate in the ESOPs. Eligible employees of the Company are also
covered by other defined contribution plans.
Expenses charged to continuing operations for the Company's pension and
profit-sharing plans, ESOPs, excess benefit plans and other similar plans
comprise the following (in thousands):
FOR THE YEARS ENDED
DECEMBER 31,
----------------------------
2003 2002 2001
------ ------ ------
Compensation cost of ESOPs $1,138 $1,746 $2,144
Pension, profit-sharing
and other similar plans 3,837 3,312 3,934
------ ------ ------
Total $4,975 $5,058 $6,078
====== ====== ======
Dividends on ESOP shares
used for debt service $ 138 $ 197 $ 280
====== ====== ======
At December 31, 2003, there were 227,346 allocated shares (2002 --
212,712 shares) and 52,212 unallocated shares (2002 -- 83,653 shares) in the
ESOP trusts.
The Company has excess benefit plans for key employees whose
participation in the qualified plans is limited by ERISA rules. Benefits are
determined based on theoretical participation in the qualified ESOPs. Prior to
September 1, 1998, the value of these benefits was invested in shares of the
Company's stock and in mutual funds, which were held by grantor trusts.
Currently, benefits are invested in only mutual funds, and participants are not
permitted to diversify accumulated benefits invested in shares of the Company's
stock. Trust assets invested in shares of the Company's capital stock are
included in treasury stock, and the corresponding liability is included in a
separate component of shareholders' equity. At December 31, 2003, these trusts
held 67,174 shares or $2,328,000 of the Company's stock (December 31, 2002 --
66,141 shares or $2,290,000). The diversified assets of the Company's excess
benefit and deferred compensation plans, all of which are invested in various
mutual funds, totaled $17,743,000 at December 31, 2003 (December 31, 2002 --
$15,176,000), and are included in other assets. The corresponding liabilities
are included in other liabilities.
15. LEASE ARRANGEMENTS
The Company, as lessee, has operating leases that cover its corporate
office headquarters, various warehouse and office facilities, office equipment
and transportation equipment. The remaining terms of these leases range from one
year to 15 years, and in
F-26
most cases, management expects that these leases will be renewed or replaced by
other leases in the normal course of business. Substantially all equipment is
owned by the Company.
The following is a summary of future minimum rental payments and
sublease rentals to be received under operating leases that have initial or
remaining noncancellable terms in excess of one year at December 31, 2003 (in
thousands):
2004 $ 6,064
2005 5,532
2006 2,570
2007 792
2008 21
AFTER 2008 205
---------
TOTAL MINIMUM RENTAL PAYMENTS 15,184
LESS MINIMUM SUBLEASE RENTALS (3,526)
---------
NET MINIMUM RENTAL PAYMENTS $ 11,658
=========
Total rental expense incurred under operating leases for continuing
operations follows (in thousands):
FOR THE YEARS ENDED
DECEMBER 31,
--------------------------------
2003 2002 2001
---------- --------- -------
Total rental payments $ 6,371 $ 6,037 $ 6,716
Less: sublease rentals (1,602) (1,196) (929)
---------- --------- -------
Net rental expense $ 4,769 $ 4,841 $ 5,787
========== ========= =======
16. FINANCIAL INSTRUMENTS
The following methods and assumptions are used in estimating the fair
value of each class of the Company's financial instruments:
- For cash and cash equivalents, accounts receivable, statutory deposits
and accounts payable, the carrying amount is a reasonable estimate of
fair value because of the liquidity and short-term nature of these
instruments.
- For other investments and other assets, fair value is based upon quoted
market prices for these or similar securities, if available. Included
in other investments, below, is the Company's investment in privately
held Vitas, which provides palliative and medical care and related
services to terminally ill patients. In connection with Vitas'
refinancing its debt obligations in April 2001, the Company and Vitas
agreed to extend the maturity of the Vitas 9% Cumulative Preferred
Stock ("Preferred") to April 1, 2007. In addition, Vitas issued a
Common Stock Purchase Warrant ("Warrant C") to the Company for
approximately 1,636,000 common shares and extended the expiration dates
of the Company's other Vitas Common Stock Purchase Warrants ("Other
Warrants") to December 31, 2007. Warrant C was recorded at its
estimated fair value of $2,601,000, and at the same time, a discount of
$2,601,000 to the Preferred was recorded. The appraised value of the
Other Warrants was estimated to be $4,048,000 in 2001 (versus a
carrying value of $1,500,000). The value of the Preferred for 2002 was
based on the present value of the mandatory redemption payments, using
an interest rate of 9.0%, a rate which management believes is
reasonable in view of risk factors attendant to the investment.
On August 18, 2003, Vitas retired the Company's investment in the 9%
Redeemable Preferred Stock of Vitas. Cash proceeds to the Company
totaled $27,270,000, and the Company realized a pretax gain of
$1,846,000 ($1,200,000 aftertax or $.12 per share) on the redemption.
On October 14, 2003, the Company exercised two of its three warrants
(Warrants A and B) to purchase 4,158,000 common shares of Vitas for
$18.0 million in cash. At December 31, 2003, the Company's common stock
ownership in Vitas had a carrying value of $21.0 million. The estimated
fair value of the Company's common stock ownership and Warrant C at
December 31, 2003, assumes a $30 share price based on the Company's
offer to purchase Vitas common stock.
- The fair value of the Company's long-term debt is estimated by
discounting the future cash outlays associated with each debt
instrument using interest rates currently available to the Company for
debt issues with similar terms and remaining maturities.
- The fair value of the Mandatorily Redeemable Convertible Preferred
Securities of the Chemed Capital Trust ("Preferred Securities") is
based on the quoted market value at the end of the period.
F-27
The estimated fair values of the Company's financial instruments are as
follows (in thousands, except footnote):
DECEMBER 31,
-----------------------------------------------
2003 2002
--------------------- ---------------------
CARRYING FAIR CARRYIN FAIR
AMOUNT VALUE AMOUNT VALUE
-------- -------- -------- --------
OTHER INVESTMENTS:
EQUITY INVESTMENT IN VITAS $ 21,035 $124,747 $ - $ -
OTHER (a) 4,046 41,536 37,326 39,874
-------- -------- -------- --------
TOTAL $ 25,081 $166,283 $ 37,326 $ 39,874
======== ======== ======== ========
LONG-TERM DEBT $ 26,379 $ 28,307 $ 26,012 $ 28,622
PREFERRED SECURITIES 14,126 17,657 14,186 14,112
(a) Amounts for 2002 include $27,243,000 invested in the Preferred.
Disclosures regarding the Company's equity investments in Vitas and
equity securities classified as available-for-sale, are summarized below (in
thousands):
DECEMBER 31,
-----------------------
2003 2002
---------- --------
Aggregate fair value:
Equity investment in Vitas $ 124,747 $ -
Other 41,536 39,874
---------- --------
Total $ 166,283 $ 39,874
========== ========
Gross unrealized holding gains $ - $ 8,239
Gross unrealized holding losses - (1,223)
Amortized cost:
Equity investment in Vitas $ 21,035 $ -
Other 4,046 32,858
---------- --------
Total $ 25,081 $ 32,858
========== ========
The chart below summarizes information with respect to
available-for-sale securities sold during the period (in thousands):
FOR THE YEARS ENDED
DECEMBER 31,
----------------------------
2003 2002 2001
-------- -------- -------
Proceeds from redemption and sales $ 31,763 $ 1,917 $ 1,377
Gross realized gains 7,157 1,223 1,112
Gross realized losses 1,767 82 119
17. DILUTED LOSS PER SHARE
Due to the Company's losses from continuing operations in 2003, 2002
and 2001, all potentially dilutive securities were antidilutive for these years.
Therefore, the diluted losses per share were the same as the losses per share in
2003, 2002 and 2001.
During 2003, 2002 and 2001, all options were excluded from the
computation of diluted loss per share since their impact on the loss per share
was antidilutive. Those options comprise the following:
NUMBER OF OPTIONS OUTSTANDING
AT DECEMBER 31,
EXERCISE -------------------------------------------
GRANT DATE PRICE 2003 2002 2001
---------- -------- --------- --------- ---------
May 2002 $ 36.90 256,800 265,600 -
May 2003 35.85 236,138 - -
May 1999 32.19 234,577 371,625 429,250
March 1998 39.13 130,700 153,250 155,550
May 1997 35.94 123,650 152,600 159,413
May 1996 38.75 117,625 159,275 159,425
February 1995 33.63 44,750 67,250 68,000
May 1995 32.19 13,950 35,300 39,950
April 1998 40.53 12,000 12,000 12,000
March 1994 32.13 2,675 24,825 24,825
February 1992 25.38 - - 3,050
February 1993 28.56 - 1,875 6,875
May 1998 37.78 - - 750
--------- --------- ---------
Total 1,172,865 1,243,600 1,059,088
========= ========= =========
F-28
Due to the Company's loss from continuing operations in 2003, 2002 and
2001, the dilution from the potential conversion of the Preferred Securities was
excluded from the computation of diluted earnings per share. During these
periods, the Preferred Securities were convertible into an average of 383,035
shares, 383,686 shares and 392,704 shares of capital stock, respectively.
18. STOCK INCENTIVE PLANS
The Company has eight Stock Incentive Plans under which 3,150,000
shares of Roto-Rooter Capital Stock are issued to key employees pursuant to the
grant of stock awards and/or options to purchase such shares. All options
granted under these plans provide for a purchase price equal to the market value
of the stock at the date of grant. The latest plan, covering a total of 450,000
shares, was adopted in May 2002.
Under the plan adopted in 1983, both nonstatutory and incentive stock
options have been granted. Incentive stock options granted under the 1983 plan
become exercisable in full six months following the date of grant; nonstatutory
options granted under the 1983 plan become exercisable in four annual
installments commencing six months after the date of grant. Under the Long-Term
Incentive Plan, adopted in 1999, up to 250,000 shares may be issued to employees
who are not officers or directors of the Company or its subsidiaries.
The other plans are not qualified, restricted or incentive stock option
plans under the Internal Revenue Code. Options generally become exercisable six
months following the date of grant in four equal annual installments.
Data relating to the Company's stock issued to employees follow:
2003 2002 2001
--------------------- --------------------- ---------------------
NUMBER WEIGHTED NUMBER WEIGHTED NUMBER WEIGHTED
OF AVERAGE OF AVERAGE OF AVERAGE
SHARES PRICE SHARES PRICE SHARES PRICE
--------- -------- --------- -------- --------- --------
Stock options:
Outstanding at January 1 1,243,600 $ 35.50 1,059,088 $ 34.91 1,194,756 $ 34.62
Granted 241,100 35.85 268,600 36.90 - -
Exercised (245,184) 33.10 (66,738) 31.87 (103,538) 31.74
Forfeited (300) 28.56 (17,350) 34.76 (25,725) 34.43
Expired (66,351) 38.23 - - (6,405) 34.60
--------- --------- ---------
Outstanding at December 31 1,172,865 35.92 1,243,600 35.50 1,059,088 34.91
========= ========= =========
Exercisable at December 31 860,187 35.79 1,037,771 35.23 941,149 35.25
========= ========= =========
Stock awards issued 4,606 34.72 9,034 37.51 17,073 37.73
========= ========= =========
Options outstanding at December 31, 2003, comprise the following:
Range of Exercise Prices
---------------------------------------
$32.13 to $35.94 $36.90 to $40.53
---------------- ----------------
Options outstanding 419,602 753,263
Average exercise price
of options outstanding $ 33.45 $ 37.30
Average contractual life 4.2 yrs. 7.0 yrs.
Options exercisable 419,602 440,585
Average exercise price
of options exercisable $ 33.45 $ 33.50
There were 142,311 shares available for granting of stock options and awards at
December 31, 2003.
Total compensation cost recognized for stock awards for continuing
operations was $147,000 in 2003 (2002 -- $184,000; 2001 -- $6,328,000). The
expense for 2001 included $4,263,000 resulting from the acceleration of vesting
of restricted stock awards in connection with the restructuring of the Company's
long-term incentive plans, effective December 31, 2001. The shares of capital
stock were issued to key employees and directors at no cost and generally were
previously restricted as to the transfer of ownership.
During 1999, the Company purchased 101,500 shares of its capital stock
in open-market transactions and sold these shares to certain employees at fair
market value in exchange for interest-bearing notes secured by the shares.
Interest rates on these notes are set at the beginning of each year based on
rates used by the Internal Revenue Service for demand loans (1.80% for 2003;
2.73% for 2002; 5.88% for 2001).
The notes receivable have no maturity date but become immediately due
and payable at the option of the Company upon the occurrence of any of the
following: (a) the Company, as note holder, deems itself insecure, (b) the
death, insolvency, assignment for the benefit of creditors, or the commencement
of any bankruptcy or insolvency proceedings of, or against, the employee, (c)
any attempted transfer by the employee of the shares of capital stock purchased
by the employee with the notes, or (d) termination of employment. The terms of
the notes receivable place restrictions upon the sale of the underlying shares
of stock, but the shares of stock are not physically restricted from sale.
Should the Company demand payment of the notes and the value of the underlying
F-29
shares be insufficient to satisfy the remaining note liability, the employee
would be required to pay the Company the difference in cash.
Activity in the notes receivable accounts, which are presented as a
reduction of stockholders' equity in the consolidated balance sheet, is
summarized below (in thousands):
Balance at December 31, 2000 $ 2,886
Accrual of interest 100
Cash payments (196)
Value of shares surrendered (1,288)
-------
Balance at December 31, 2001 1,502
Accrual of interest 26
Cash payments (239)
Value of shares surrendered (337)
-------
BALANCE AT DECEMBER 31, 2002 952
ACCRUAL OF INTEREST 16
CASH PAYMENTS (11)
VALUE OF SHARES SURRENDERED (23)
-------
BALANCE AT DECEMBER 31, 2003 $ 934
=======
Shares surrendered in payment of notes receivable are valued at their fair
market value on the date of surrender.
19. EXECUTIVE LONG-TERM INCENTIVE PLAN
In May 2002, the shareholders of the Company approved the adoption of
the 2002 Executive Long-Term Incentive Plan ("LTIP") covering officers and key
employees of the Company. The LTIP is administered by the Compensation/Incentive
Committee ("CIC") of the Board of Directors and was adopted to replace the
restricted stock program, which was terminated at the end of 2001. Based on
guidelines established by the CIC, the LTIP covers the granting of cash awards
based on two independent elements: 1) a totally discretionary award based on
operating performance of the Company covering a period greater than one year and
less than four years and 2) an award based on the attainment of a target stock
price of $50 per share during 10 consecutive trading days prior to the fourth
anniversary of the plan.
As of December 31, 2003, no accrual for awards under the LTIP was made
since it was not possible to estimate the amount of such awards, if any, which
was earned.
During January 2004, the price of the Company's stock exceeded $50 per
share for more than 10 consecutive trading days. In February 2004, the CIC
approved a payout under the LTIP in the aggregate amount of $7.8 million ($2.8
million in cash and 84,633 shares of capital stock). The pretax expense of this
award, including payroll taxes and benefit costs, totaled $9.1 million ($5.9
million aftertax) and will be recorded in the operating results for the first
quarter of 2004.
20. PREFERRED SECURITIES
Effective February 1, 2000, the Company completed an Exchange Offer
whereby stockholders exchanged 575,503 shares of capital stock for shares of
Preferred Securities of the wholly owned Chemed Capital Trust ("CCT") on a
one-for-one basis. The Preferred Securities, which carry a redemption value of
$27.00 per security, pay an annual cash distribution of $2.00 per security
(payable at the quarterly rate of $.50 per security commencing March 2000) and
are convertible into capital stock at a price of $37.00 per security. The
Preferred Securities mature 30 years from date of issuance and are callable
beginning March 15, 2003, at a price of $27.27 for each $27.00 principal amount.
On March 15, 2004, and later, the Preferred Securities are callable without
premium. At December 31, 2003, there were 523,172 shares of the Preferred
Securities outstanding (December 31, 2002 -- 525,401 shares). The number of
Preferred Securities purchased and converted and shares of capital stock issued
upon conversion are summarized below:
FOR THE YEARS ENDED
DECEMBER 31,
---------------------------
2003 2002 2001
----- ----- ------
Number of Preferred Securities purchased - 1,533 13,720
Number of Preferred Securities converted 2,229 432 1,200
Shares of capital stock
issued upon conversion
of Preferred Securities 1,626 315 876
The sole assets of the CCT are Junior Subordinated Debentures ("JSD")
of the Company in the principal amount of $14,126,000. The JSD mature March 15,
2030, and the interest rate of the JSD is $2.00 per annum per $27.00 principal
amount. In February 2000, the Company executed an Indenture relating to the JSD,
an Amended and Restated Declaration of Trust relating to the Preferred
Securities and a Guarantee Agreement for the benefit of the holders of the
Preferred Securities (collectively "Back-up Undertakings"). Considered together,
the Back-up Undertakings constitute a full and unconditional guarantee by the
Company of the CCT's obligations under the Preferred Securities.
F-30
The Company intends to call all of the Preferred Securities as soon
after March 15, 2004 as practicable. Management anticipates that most of the
securities will be redeemed for capital stock rather than cash. However, were
all the Preferred Securities redeemed for cash, the Company would be obligated
to pay approximately $14.1 million.
21. LOANS RECEIVABLE FROM INDEPENDENT CONTRACTORS
The Plumbing and Drain Cleaning segment subcontracts with independent
contractors to operate plumbing repair and drain cleaning businesses in
lesser-populated areas of the country. At December 31, 2003, the Company has
notes receivable from 37 of its 60 independent contractors totaling $2,599,000
(December 31, 2002 -- $2,127,000). In most cases these loans are partially
secured by equipment owned by the contractor. The interest rates on the loans
range from 5% to 8% per annum and the remaining terms of the loans range from
one month to 7.7 years at December 31, 2003. During 2003, the Company recorded
revenues of $14,125,000 (2002 -- $12,350,000; 2001 -- $11,873,000) and pretax
profits of $4,356,000 (2002 -- $4,866,000; 2001 -- $3,980,000) from all of its
independent contractors.
The arrangements give the contractors the right to conduct a plumbing
and drain cleaning business using the Roto-Rooter name in a specified territory
in exchange for a royalty based on a percentage of cash labor sales, generally
approximately 40%. The Company also pays for yellow pages advertising in these
areas and provides operating manuals to be used as guidelines for operating a
plumbing and drain cleaning business. The contracts are generally cancellable
upon 90 days' written notice (without cause) or upon a few days' notice (with
cause). The independent contractors are responsible for running the businesses
as they believe best.
The Company has four contractors that entered into independent
contractor agreements with the Company during 2003, subsequent to January 31
("2003 Contractors"). The Company has loans totaling $238,000 receivable from
the 2003 Contractors that are secured by equipment with an estimated value of
$99,000. Information to determine whether the Company's contractual interests,
including the loans receivable, are variable interests that are required to be
consolidated under FIN No. 46, Consolidation of Variable Interest Entities and
Interpretation of ARB No. 51, is not available. Based on an analysis of
Roto-Rooter's operating results relative to these operations, management
believes that consolidation of these four businesses would not yield materially
different results for the Company. During 2003, the Company recorded $528,000 of
service revenues and a combined operating loss of $3,000 related to the 2003
Contractors.
22. LITIGATION
The Company is party to a class action lawsuit filed in the Third
Judicial Circuit Court of Madison County, Illinois in June of 2000 by Robert
Harris, alleging certain Roto-Rooter plumbing was performed by unlicensed
employees. The Company contests these allegations and believes them without
merit. Plaintiff moved for certification of a class of customers in 32 states
who allegedly paid for plumbing work performed by unlicensed employees.
Plaintiff also moved for a partial summary judgment on grounds the licensed
apprentice plumber who installed his faucet did not work under the direct
personal supervision of a licensed master plumber. On June 19, 2002, the trial
judge certified an Illinois-only plaintiffs class and granted summary judgment
for the named party Plaintiff on the issue of liability, finding violation of
the Illinois Plumbing License Act and the Illinois Consumer Fraud Act, through
Roto-Rooter's representation of the licensed apprentice as a plumber. The court
has not yet ruled on certification of a class in the remaining 31 states. Due to
complex legal and other issues involved, it is not presently possible to
estimate the amount of liability, if any, related to this matter.
On April 5, 2002 Michael Linn, an attorney, filed a class action
complaint against the Company in the Court of Common Pleas, Cuyahoga County,
Ohio. He alleges Roto-Rooter Services Company's miscellaneous parts charge,
ranging from $4.95 to $12.95 per job, violates the Ohio Consumer Sales Practices
Act. The Company contends that this charge, which is included within the
estimate approved by its customers, is a fully disclosed component of its
pricing. On February 25, 2003, the trial court certified a class of customers
who paid the charge from October 1999 to July 2002. The Company is appealing
this order and believes the ultimate disposition of this lawsuit will not have a
material affect on its financial position.
However, management cannot provide assurance the Company will
ultimately prevail in either of the above two cases. Regardless of outcome, such
litigation can adversely affect the Company through defense costs, diversion of
management's time, and related publicity.
23. ACQUISITION OF VITAS
On December 18, 2003, the Company and Marlin Merger Corp., a wholly
owned indirect subsidiary ("Marlin"), entered into a merger agreement with
Vitas. The merger agreement provided for the merger of Marlin into Vitas, with
Vitas surviving the merger as an indirect wholly owned subsidiary of the Company
(the "Acquisition"). To secure its interest in the merger, the Company placed a
$10 million deposit in escrow (included in other assets at December 31, 2003).
F-31
In connection with the completion of the Acquisition on February 24,
2004, the Company paid to the holders of the 63% of Vitas common stock the
Company did not own consideration of approximately $313.9 million. In addition,
the Company paid the former chairman and chief executive officer of Vitas $25.0
million pursuant to a noncompetition and consulting agreement and made severance
payments totaling $2.3 million to two other officers of Vitas. The total
purchase price, including $5.5 million of estimated expenses and the Company's
$23.6 million previous investment in Vitas, was $370.3 million. Based on Vitas'
balance sheet at December 31, 2003, the preliminary allocation of the purchase
price to Vitas' assets and liabilities is estimated to be (in thousands):
Cash and cash equivalents $ 25,115
Other current assets 62,557
Property and equipment 22,613
Consulting agreement 7,000
Covenant not to compete 18,000
Goodwill 361,228
Other assets 6,074
Current liabilities (60,191)
Long-term debt (67,625)
Other liabilities (4,428)
---------
Net assets acquired 370,343
Less: cash and cash equivalents acquired (25,115)
---------
Net outlay $ 345,228
=========
As of February 24, 2004, the Company will consolidate Vitas' assets and
liabilities and begin consolidating Vitas' operating results.
To fund the Acquisition and retire Vitas' and the Company's long-term
debt, the Company completed the following transactions ("Financing") on February
24, 2004:
- The Company borrowed $75.0 million under a new $135 million revolving
credit/term loan agreement at an initial weighted average interest rate
of 4.50%. Principal payments of $1.25 million are due quarterly under
the term loan. The term loan/revolving credit agreement matures in five
years.
- The Company sold 2,000,000 shares of its capital stock in a private
placement at price of $50 per share, before expenses.
- The Company issued $110 million principal amount of floating rate
senior secured notes due 2010 at an initial interest rate of 4.88%.
- The Company issued $150 million principal amount of 8.75% senior notes
due 2011.
- The Company incurred estimated financing transaction fees and expenses
of approximately $14.5 million.
The unaudited pro forma operating data of the Company for the year
ended December 31, 2003, giving effect to the Acquisition and Financing as if
they had occurred on January 1, 2003, follow (in thousands):
Service revenues and sales $ 749,888
=========
Net loss $ (4,070)
=========
Net loss per share $ (0.34)
=========
Average shares outstanding 11,924
=========
The Acquisition is being accounted for using the purchase method of
accounting. The fair values of Vitas' assets and related liabilities are based
on preliminary estimates. Additional analysis will be required to determine the
fair values of Vitas' assets and liabilities, including the identification and
valuation of intangible assets acquired. Additional intangible assets acquired
may include customer contracts and related customer relationships and other
contract-based intangibles such as lease agreements and service contracts.
Should the Company identify and value additional intangible assets, everything
else being equal, goodwill will be reduced. In addition, such additional
intangible assets may have finite lives and be subject to amortization. The
final allocation of the Acquisition consideration may result in significant
differences from the preliminary amounts reflected in the above financial
information.
The unaudited pro forma operating data are for informational purposes
only and do not purport to represent what the Company's results of operations
would actually have been had the Acquisition and the Financing occurred as of
the date indicated, nor does the unaudited pro forma operating data purport to
project the Company's results for any future date or any future period.
F-32
The unaudited pro forma operating data reflect pro forma adjustments that are
based on available information and certain assumptions management believes are
reasonable, but are subject to change. Such adjustments include an increase in
the average shares of capital stock outstanding and in interest expense from the
Financing, elimination of interest expense on existing debt, elimination of
dividend income from Vitas and reduction of interest income on cash used for the
Acquisition. Management has made, in its opinion, all adjustments that are
necessary to present fairly the pro forma information.
F-33
ROTO-ROOTER, INC. AND SUBSIDIARY COMPANIES
UNAUDITED SUMMARY OF QUARTERLY RESULTS
FOR THE YEAR ENDED DECEMBER 31, 2003
(IN THOUSANDS, EXCEPT PER SHARE AND FOOTNOTE DATA)
FIRST SECOND THIRD FOURTH TOTAL
QUARTER QUARTER QUARTER QUARTER YEAR
--------- --------- --------- --------- ---------
Continuing Operations
Total service revenues and sales $ 77,645 $ 77,271 $ 75,172 $ 78,783 $ 308,871
========= ========= ========= ========= =========
Gross profit $ 31,493 $ 31,660 $ 30,957 $ 31,951 $ 126,061
========= ========= ========= ========= =========
Income/(loss) from operations (a,d) $ 2,384 $ 3,580 $ 2,367 $ (16,051) $ (7,720)
Interest expense (539) (599) (487) (515) (2,140)
Distributions on preferred securities (268) (268) (268) (267) (1,071)
Other income--net (b,c) 4,262 2,455 3,049 1,493 11,259
--------- --------- --------- --------- ---------
Income before income taxes (a,b,c,d) 5,839 5,168 4,661 (15,340) 328
Income taxes (2,282) (1,868) (1,748) 1,149 (4,749)
Equity in earnings of affiliate (e) - - - 922 922
--------- --------- --------- --------- ---------
Income/(loss) from continuing operations (a,b,c,d) 3,557 3,300 2,913 (13,269) (3,499)
Discontinued Operations - - - 64 64
--------- --------- --------- --------- ---------
Net Income/(Loss) (a,b,c,d) $ 3,557 $ 3,300 $ 2,913 $ (13,205) $ (3,435)
========= ========= ========= ========= =========
Earnings Per Share (a,b,c,d)
Income/(loss) from continuing operations $ 0.36 $ 0.33 $ 0.29 $ (1.33) $ (0.35)
========= ========= ========= ========= =========
Net income/(loss) $ 0.36 $ 0.33 $ 0.29 $ (1.33) $ (0.35)
========= ========= ========= ========= =========
Diluted Earnings Per Share (a,b,c,d)
Income/(loss) from continuing operations $ 0.36 $ 0.33 $ 0.29 $ (1.33) $ (0.35)
========= ========= ========= ========= =========
Net income/(loss) $ 0.36 $ 0.33 $ 0.29 $ (1.33) $ (0.35)
========= ========= ========= ========= =========
Average number of shares outstanding
Earnings/(loss) per share 9,890 9,908 9,941 9,954 9,924
========= ========= ========= ========= =========
Diluted earnings/(loss) per share 9,903 9,942 9,988 9,954 9,924
========= ========= ========= ========= =========
- ------------------
(a) Amounts include a pretax charge of $3,627,000 ($2,358,000 aftertax or $.24
per share) from severance charges in the first quarter and for the year.
(b) Amounts include a pretax gain of $1,846,000 ($1,200,000 aftertax or $.12
per share) from the redemption of Vitas preferred stock in the third
quarter and for the year.
(c) Amounts include a pretax capital gain of $3,544,000 ($2,151,000 aftertax or
$.22 per share) from the sales of investments in the first quarter and for
the year.
(d) Amounts include pretax asset impairment charges of $15,828,000 ($14,363,000
aftertax or $1.44 per share) in the fourth quarter and for the year.
(e) Amount represents equity in earnings of Vitas.
F-34
ROTO-ROOTER, INC. AND SUBSIDIARY COMPANIES
UNAUDITED SUMMARY OF QUARTERLY RESULTS
FOR THE YEAR ENDED DECEMBER 31, 2002
(IN THOUSANDS, EXCEPT PER SHARE AND FOOTNOTE DATA)
FIRST SECOND THIRD FOURTH TOTAL
QUARTER QUARTER QUARTER QUARTER YEAR
--------- --------- --------- --------- ---------
Continuing Operations
Total service revenues and sales $ 80,853 $ 79,082 $ 75,322 $ 78,919 $ 314,176
========= ========= ========= ========= =========
Gross profit $ 32,345 $ 32,458 $ 31,008 $ 32,080 $ 127,891
========= ========= ========= ========= =========
Income/(loss) from operations (a) $ 5,593 $ 6,306 $ 5,370 $ (19,947) $ (2,678)
Interest expense (773) (763) (709) (683) (2,928)
Distributions on preferred securities (270) (271) (268) (270) (1,079)
Other income--net (b) 2,589 953 268 472 4,282
--------- --------- --------- --------- ---------
Income before income taxes (a,b) 7,139 6,225 4,661 (20,428) (2,403)
Income taxes (2,432) (2,370) (1,725) 76 (6,451)
--------- --------- --------- --------- ---------
Income/(loss) from continuing operations (a,b) 4,707 3,855 2,936 (20,352) (8,854)
Discontinued Operations 867 1,124 3,929 389 6,309
--------- --------- --------- --------- ---------
Net Income/(Loss) (a,b) $ 5,574 $ 4,979 $ 6,865 $ (19,963) $ (2,545)
========= ========= ========= ========= =========
Earnings Per Share (a,b)
Income/(loss) from continuing operations $ 0.48 $ 0.39 $ 0.30 $ (2.06) $ (0.90)
========= ========= ========= ========= =========
Net income/(loss) $ 0.57 $ 0.51 $ 0.70 $ (2.02) $ (0.26)
========= ========= ========= ========= =========
Diluted Earnings Per Share (a,b)
Income/(loss) from continuing operations $ 0.48 $ 0.39 $ 0.30 $ (2.06) $ (0.90)
========= ========= ========= ========= =========
Net income/(loss) $ 0.56 $ 0.50 $ 0.70 $ (2.02) $ (0.26)
========= ========= ========= ========= =========
Average number of shares outstanding
Earnings/(loss) per share 9,843 9,857 9,861 9,872 9,858
========= ========= ========= ========= =========
Diluted earnings/(loss) per share 10,267 9,898 9,867 9,872 9,858
========= ========= ========= ========= =========
- ------------------
(a) Amounts for the fourth quarter and for the year include a pretax and
aftertax noncash goodwill impairment charge of $20,342,000 ($2.06 per
share).
(b) Amounts for the first quarter and for the year include pretax gains from
the sales of investments of $1,141,000 ($ 775,000 aftertax or $.08 per
share). Amounts for the fourth quarter and year include pretax investment
impairment charges of $1,200,000 ($780,000 after-tax or $.08 per share).
F-35
SCHEDULE II
ROTO-ROOTER, INC. AND SUBSIDIARY COMPANIES
VALUATION AND QUALIFYING ACCOUNTS
(IN THOUSANDS)
DR/(CR)
ADDITIONS
------------------------
(CHARGED) APPLICABLE
CREDITED (CHARGED) TO
BALANCE AT TO COSTS CREDITED COMPANIES BALANCE
BEGINNING AND TO OTHER ACQUIRED DEDUCTIONS AT END
DESCRIPTION OF PERIOD EXPENSES ACCOUNTS IN PERIOD (a) OF PERIOD
- --------------------------------- ---------- -------- -------- ---------- ---------- ---------
Allowances for doubtful
accounts (b)
For the year 2003 $(3,309) $ (2,019) $ - $ - $ 2,409 $(2,919)
======= ======== ======== ========= ======== =======
For the year 2002 $(4,091) $ (1,808) $ - $ - $ 2,590 $(3,309)
======= ======== ======== ========= ======== =======
For the year 2001 $(3,637) $ (2,866) $ - $ - $ 2,412 $(4,091)
======= ======== ======== ========= ======== =======
Allowances for doubtful
accounts - notes
receivable (c)
For the year 2003 $ (422) $ 99 $ - $ - $ - $ (323)
======= ======== ======== ========= ======== =======
For the year 2002 $ (900) $ 478 $ - $ - $ - $ (422)
======= ======== ======== ========= ======== =======
For the year 2001 $ (23) $ (900) $ - $ - $ 23 $ (900)
======= ======== ======== ========= ======== =======
Valuation allowance for
available-for-sale securities (d)
For the year 2003 $ 5,668 $ - $ (278) $ - $ (5,390) $ -
======= ======== ======== ========= ======== =======
For the year 2002 $ 6,483 $ - $ 326 $ - $ (1,141) $ 5,668
======= ======== ======== ========= ======== =======
For the year 2001 $ 4,980 $ - $ 2,496 $ - $ (993) $ 6,483
======= ======== ======== ========= ======== =======
- ------------------
(a) With respect to allowances for doubtful accounts, deductions include
accounts considered uncollectible or written off, payments, companies
divested, etc. With respect to valuation allowance for available-for-sale
securities, deductions comprise net realized gains on sales of investments.
(b) Classified in consolidated balance sheet as a reduction of accounts
receivable.
(c) Classified in consolidated balance sheet as a reduction of other assets.
(d) With respect to the valuation allowance for available-for-sale securities,
amounts charged or credited to other accounts comprise net unrealized
holding gains arising during the period.
S-1
INDEX TO EXHIBITS
Page Number
or
Incorporation by Reference
----------------------------------
Exhibit File No. and Previous
Number Filing Date Exhibit No.
- ------- ------------------- -----------
3.1 Certificate of Incorporation of Form S-3 4.1
Chemed Corporation Reg. No. 33-44177
11/26/91
3.2 Certificate of Amendment to Form S-8 E-1
Certificate of Incorporation Reg. No. 333-109104
9/25/03
3.3 By-Laws of Chemed Corporation Form 10-K 2
3/28/89
4.1 Offer to Exchange Chemed Capital Form T-3 T3E.1
Trust Convertible Trust Preferred 12/23/99
Securities for Shares of Capital
Stock, dated as of 12/23/99
4.2 Chemed Capital Trust, dated Schedule 13E-4 (b)(1)
as of 12/23/99 12/23/99
4.3 Amended and Restated Schedule 13E-4A (b)(2)
Declaration of Trust of Chemed 2/7/00, Amendment
Capital Trust, dated February No. 2
7, 2000
4.4 Indenture, dated as of February *
24, 2004, between Roto-Rooter, Inc.
and LaSalle Bank National
Association
4.5 Indenture, dated as of February *
24, 2004, among Roto-Rooter, Inc.,
the subsidiary guarantors listed
on Schedule I thereto and
Wells Fargo Bank, N.A.
10.1 Agreement and Plan of Merger Form 8-K 1
among Diversey U.S. Holdings, 3/11/91
Inc., D.C. Acquisition Inc.,
Chemed Corporation and DuBois
Chemicals, Inc., dated as of
February 25, 1991
1
Page Number
or
Incorporation by Reference
----------------------------------
Exhibit File No. and Previous
Number Filing Date Exhibit No.
- ------- ------------ -----------
10.2 Stock Purchase Agreement between Form 10-K 5
Omnicare, Inc. and Chemed 3/25/93
Corporation dated as of August 5,
1992
10.3 Agreement and Plan of Merger Form 8-K 1
among National Sanitary 10/13/97
Supply Company, Unisource
Worldwide, Inc. and TFBD, Inc.
10.4 Stock Purchase Agreement dated Form 8-K 2.1
as of May 8, 2002 by and between 10/11/02
PCI Holding Corp. and Chemed
Corporation
10.5 Amendment No. 1 to Stock Purchase Form 8-K 2.2
Agreement dated as of October 11, 10/11/02
2002 by and among PCI Holding
Corp., PCI-A Holding Corp. and
Chemed Corporation
10.6 Senior Subordinated Promissory Form 8-K 2.3
Note dated as of October 11, 2002 10/11/02
by and among PCI Holding Corp.
and Chemed Corporation
10.7 Common Stock Purchase Warrant Form 8-K 2.4
dated as of October 11, 2002 by 10/11/02
and between PCI Holding Corp.
and Chemed Corporation
10.8 1986 Stock Incentive Plan, as Form 10-K 9
amended through May 20, 1991 3/27/92, **
10.9 1988 Stock Incentive Plan, as Form 10-K 10
amended through May 20, 1991 3/27/92, **
10.10 1993 Stock Incentive Plan Form 10-K 10.8
3/29/94, **
10.11 1995 Stock Incentive Plan Form 10-K 10.14
3/28/96, **
10.12 1997 Stock Incentive Plan Form 10-K 10.10
3/27/98, **
2
Page Number
or
Incorporation by Reference
----------------------------------
Exhibit File No. and Previous
Number Filing Date Exhibit No.
- ------- ------------ -----------
10.13 1999 Stock Incentive Plan Form 10-K 10.11
3/29/00, **
10.14 1999 Long-Term Employee Form 10-K 10.16
Incentive Plan as amended 3/28/03, **
through May 20, 2002
10.15 2002 Stock Incentive Plan Form 10-K 10.17
3/28/03, **
10.16 2002 Executive Long-Term Form 10-K 10.18
Incentive Plan 3/28/03, **
10.17 Employment Contracts with Form 10-K 10.12
Executives 3/28/89, **
10.18 Amendment to Employment Form 10-K 10.20
Agreements with Kevin J. 3/28/03, **
McNamara, Thomas C. Hutton
and Sandra E. Laney
dated August 7, 2002
10.19 Amendment to Employment Form 10-K 10.21
Agreements with Timothy 3/28/03, **
S. O'Toole and Arthur V.
Tucker dated August 7, 2002
10.20 Amendment to Employment *, **
Agreement with Spencer S. Lee
dated May 19, 2003
10.21 Amendment to Employment Form 10-K 10.16
Agreement with Executives dated 3/28/02, **
January 1, 2002
10.22 Consulting Agreement between Form 10-K 10.26
Timothy S. O'Toole and PCI 3/28/03, **
Holding Corp effective October
11, 2002.
3
Page Number
or
Incorporation by Reference
------------------------------
Exhibit File No. and Previous
Number Filing Date Exhibit No.
- ------- ------------- -----------
10.23 Amendment No. 16 to Employment Form 10-K 10.27
Agreement with Sandra E. Laney 3/28/03, **
dated March 1, 2003
10.24 Excess Benefits Plan, as restated *,**
and amended, effective June 1,
2001
10.25 Amendment No. 1 to Excess Benefits *,**
Plan, effective July 1, 2002
10.26 Amendment No. 2 to Excess Beneifts *,**
Plan, effective November 7, 2003
10.27 Non-Employee Directors' Deferred Form 10-K 10.10
Compensation Plan 3/24/88, **
10.28 Chemed/Roto-Rooter Savings & Form 10-K 10.25
Retirement Plan, effective 3/25/99, **
January 1, 1999
10.29 First Amendment to Chemed/ Form 10-K 10.22
Roto-Rooter Savings & Retirement 3/28/02, **
Plan effective September 6, 2000
10.30 Second Amendment to Chemed/ Form 10-K 10.23
Roto-Rooter Savings & Retirement 3/28/02, **
Plan effective January 1, 2001
10.31 Third Amendment to Chemed/ Form 10-K 10.24
Roto-Rooter Savings & Retirement 3/28/02, **
Plan effective December 12, 2001
10.32 Stock Purchase Plan by and Form 8-K 10.21
among Banta Corporation, Chemed 10/13/97
Corporation and OCR Holding
Company
10.33 Directors Emeriti Plan Form 10-Q 10.11
5/12/88, **
10.34 Second Amendment to Split Dollar Form 10-K 10.26
Agreement with Executives 3/29/00, **
4
Page Number
or
Incorporation by Reference
------------------------------
Exhibit File No. and Previous
Number Filing Date Exhibit No.
- ------- -------------- -----------
10.35 Split Dollar Agreement with Form 10-K 10.27
Sandra E. Laney 3/25/99, **
10.36 Split Dollar Agreements Form 10-K 10.15
with Executives 3/28/96, **
10.37 Split Dollar Agreement with Form 10-K 10.16
Edward L. Hutton 3/28/96, **
10.38 Split Dollar Agreement with Form 10-K 10.33
Spencer S. Lee 3/29/00, **
10.39 Promissory Note under the Form 10-K 10.40
Executive Stock Purchase Plan 3/28/01, **
with Edward L. Hutton
10.40 Promissory Note under the Form 10-K 10.41
Executive Stock Purchase Plan 3/28/01, **
with Kevin J. McNamara
10.41 Schedule to Promissory Note under *,**
the Executive Stock Purchase Plan
with Edward L. Hutton
10.42 Schedule to Promissory Note under *,**
the Executive Stock Purchase Plan
with Kevin J. McNamara
10.43 Roto-Rooter Deferred Compensation Form 10-K 10.37
Plan No. 1, as amended January 1, 3/28/01, **
1998
10.44 Roto-Rooter Deferred Compensation Form 10-K 10.38
Plan No. 2 3/28/01, **
10.45 Agreement and Plan of Merger, Form 8-K 99.2
dated as of December 18, 2003, 12/19/03
among Roto-Rooter, Inc., Marlin
Merger Corp. and Vitas Healthcare
Corporation
5
Page Number
or
Incorporation by Reference
Exhibit File No. and Previous
Number Filing Date Exhibit No.
- ------- ------------ -----------
10.46 Credit Agreement, dated as of *
February 24, 2004, among
Roto-Rooter, Inc., the lenders from
time to time parties thereto and
Bank One, NA, as Administrative Agent.
10.47 Pledge and Security Agreement, dated *
as of February 24, 2004, among
Roto-Rooter, Inc., the subsidiaries
of Roto-Rooter, Inc. listed on the
signature pages thereto and Bank One,
NA, as Collateral Agent.
10.48 Guaranty Agreement, dated as of *
February 24, 2004, among the
subsidiaries of Roto-Rooter, Inc.
listed on the signature pages
thereto and Bank One, NA, as
Administrative Agent.
13. 2003 Annual Report to Stockholders *
14. Policies on Business Ethics of *
Roto-Rooter, Inc.
21 Subsidiaries of Roto-Rooter, Inc. *
23 Consent of Independent Accountants *
24 Powers of Attorney *
31.1 Certification by Kevin J. McNamara *
Pursuant to Rule 13a-14(a)/15d-14(a)
of the Exchange Act of 1934.
31.2 Certification by David P. Williams *
Pursuant to Rule 13a-14(a)/15d-14(a)
of the Exchange Act of 1934.
31.3 Certification by Arthur V. Tucker, Jr. *
Pursuant to Rule 13a-14(a)/15d-14(a)
of the Exchange Act of 1934.
6
Page Number
or
Incorporation by Reference
---------------------------
Exhibit File No. and Previous
Number Filing Date Exhibit No.
- ------- ------------ -----------
32.1 Certification by Kevin J. McNamara *
pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
32.2 Certification by David P. Williams *
pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
32.3 Certification by Arthur V. Tucker, *
Jr. pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002
- ---------------
* Filed herewith.
**Management contract or compensatory plan or arrangement.
7