UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 8-K/A
CURRENT REPORT
Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
Date of Report (date of earliest event reported):
October 14, 2003
ROTO-ROOTER, INC.
(Exact name of registrant as specified in its charter)
Delaware 1-8351 31-0791746
(State or other jurisdiction (Commission File Number) (I.R.S. Employer
of incorporation) Identification Number)
2600 Chemed Center, 255 East Fifth Street, Cincinnati, OH 45202
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code:
(513) 762-6900
1
EXPLANATORY NOTE
On October 29, 2003, Roto-Rooter, Inc. ("Company") filed with the
S.E.C. a Report on Form 8-K dated October 14, 2003 ("Original Form 8-K")
disclosing the Company had exercised two of its three Vitas Healthcare
Corporation ("Vitas") Stock Purchase Warrants ("Warrants A and B") to acquire
4,158,000 shares of Vitas common stock for $18.0 million in cash.
This Report on Form 8-K/A updates the Original Form 8-K by providing
the audited financial statements of Vitas as of September 30, 2003 and 2002, and
for each of the three years in the period ended September 30, 2003. This Form
8-K/A also provides the Company's unaudited pro forma consolidated financial
statements as of and for the nine months ended September 30, 2003 and for the
year ended December 31, 2002, assuming the Company exercised Warrants A and B at
the beginning of each period presented.
ITEM 2. ACQUISITION OR DISPOSITION OF ASSETS
On October 14, 2003, the Company exercised Warrants A and B to acquire
4,158,000 shares of Vitas common stock for $18.0 million in cash. The cash was
taken from the Company's balance of cash and cash equivalents, which totaled
$72.6 million at September 30, 2003. The Company's common stock ownership in
Vitas has a carrying value of $19.5 million and now represents approximately 37%
of Vitas' outstanding common stock based on its capitalization as of September
30, 2003. Timothy S. O'Toole, a director and executive officer of the Company,
is also a director of Vitas and serves as Chairman of Vitas' Board of Directors'
Audit Committee.
The Company is party to an Amended and Restated Investor Agreement with
Vitas that restricts in a number of ways its full ownership rights in the shares
purchased on exercise of Warrants A and B. A copy of such agreement was filed as
an exhibit to the Company's Report on Form 8-K filed October 29, 2003.
The Company is accounting for its 37% common stock interest in Vitas
using the equity method of accounting including appropriate provisions for
deferred income taxes.
The Company's third Stock Purchase Warrant ("Warrant C") provides for
the purchase of up to 1,636,000 shares of Vitas common stock at a price of $5.50
per share. Warrant C or the shares acquired upon exercise of Warrant C ("Warrant
C Shares") are subject to repurchase by Vitas during the 90-day period following
the date Vitas receives the Company's notice of exercise of Warrant C. The
repurchase price of Warrant C or the Warrant C Shares is their fair market value
as determined in good faith by the Vitas Board of Directors. Warrant C has a
carrying value of $2.6 million and expires in April 2005.
2
ITEM 7. FINANCIAL STATEMENTS, PRO FORMA FINANCIAL INFORMATION AND EXHIBITS
(a) Financial statements of business acquired.
The consolidated financial statements for Vitas Healthcare
Corporation and Subsidiaries as of September 30, 2003 and 2002,
and for each of the three years in the period ending September 30,
2003, are included in this Report on Form 8-K/A:
Page No.
--------
Report of Independent Accountants F-1
Consolidated Balance Sheets F-2
Consolidated Statements of Income F-3
Consolidated Statements of Changes in Redeemable
Preferred Stock and Stockholders' Deficit F-4
Consolidated Statements of Cash Flows F-5 - F-6
Notes to Consolidated Financial Statements F-7 - F-32
3
(b) Pro forma financial information.
The unaudited pro forma consolidated statements of operations for the
nine months ended September 30, 2003 and for the year ended December
31, 2002 have been prepared using the following assumptions:
i) It is assumed that the Company exercised Warrants A and B on
January 1 of each period presented to purchase 4,158,000
common shares of Vitas for a cost of $18 million.
ii) For the 2003 period, it is assumed that the source of cash to
exercise the warrants was cash and cash equivalents on hand.
It is estimated that this reduction in cash would have reduced
other income by $135,000 pretax or $88,000 aftertax for the
nine months in 2003.
iii) For the 2002 period, it is assumed that the source of cash to
exercise the warrants was the Company's unused lines of
credit. It is estimated that this increase in debt would have
increased interest expense by $540,000 pretax or $351,000
aftertax for 2002.
iv) It is assumed that $10 million of the excess of the fair value
of Vitas over its book value relates to amortizable assets
with an average life of five years. The remaining excess is
assumed to be goodwill.
v) It is assumed that Vitas used the $18 million cash proceeds from
the Company's purchase of common stock to reduce its debt on
January 1 of each period. The estimated pretax interest
savings was $689,000 ($427,000 aftertax) for the nine months
ended September 30, 2003 and $1,062,000 ($658, 000 aftertax)
for the year ended December 31, 2002.
The unaudited pro forma consolidated balance sheet as of September 30,
2003 has been prepared assuming the Company exercised Warrants A and B
on September 30, 2003 for a cost of $18 million. The carrying value of
the Company's 4,158,000 shares totals $19.5 million ($18 million cash
plus $1.5 carrying value of Warrants A and B) and is included in Other
Investments.
The Company's consolidated pro forma financial statements are listed
below:
Page No.
--------
Unaudited Pro Forma Consolidated Statement of Operations
for the Nine Months Ended September 30, 2003 P-1
Unaudited Pro Forma Consolidated Statement of Operations
for the Year Ended December 31, 2002 P-2
Unaudited Pro Forma Consolidated Balance Sheet
as of December 31, 2002 P-3
4
(c) Exhibits
Exhibit SK 601 Page
No. Ref. No. Description No.
------- -------- ----------- ----
1* (10) Amended and Restated Investor Agreement E-1 to
as of April 27, 2001, between Vitas Healthcare E-39
Corporation and Chemed Corporation.
*Incorporated by reference from Current Report on Form 8-K filed with
the S.E.C. on October 29, 2003.
CERTIFICATION AND SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Roto-Rooter, Inc.
(Registrant)
Dated: December 19, 2003 By /s/ Arthur V. Tucker, Jr.
---------------------------------
Arthur V. Tucker, Jr.
(Vice President and Controller)
5
Report of Independent Certified Public Accountants
The Board of Directors and Stockholders
Vitas Healthcare Corporation and Subsidiaries
We have audited the accompanying consolidated balance sheets of Vitas
Healthcare Corporation and Subsidiaries as of September 30, 2003 and 2002, and
the related consolidated statements of income, changes in redeemable preferred
stock and stockholders' deficit and cash flows for each of the three years in
the period ended September 30, 2003. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards 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. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present
fairly, in all material respects, the consolidated financial position of Vitas
Healthcare Corporation and Subsidiaries at September 30, 2003 and 2002, and the
results of their operations and their cash flows for each of the three years in
the period ended September 30, 2003, in conformity with accounting principles
generally accepted in the United States.
As discussed in Note 1 to the consolidated financial statements, the
Company changed its method of accounting for goodwill during the year ended
September 30, 2002.
/s/ Ernst & Young LLP
Miami, Florida
November 10, 2003
F - 1
Vitas Healthcare Corporation and Subsidiaries
Consolidated Balance Sheets
(In thousands, except share and per share amounts)
SEPTEMBER 30
2003 2002
-------------------------
ASSETS
Current assets:
Cash and cash equivalents $ 9,103 $ 5,466
Restricted cash 6,000 -
Accounts receivable from patient services, net of allowance for doubtful
accounts of $6,455 and $5,098 at September 30, 2003 and 2002, respectively 52,311 40,125
Income tax receivable - 4,233
Other current assets 2,477 1,956
-------------------------
Total current assets 69,891 51,780
Property and equipment, net 12,355 10,845
Intangible assets, net 40,443 38,401
Other assets 9,862 10,441
-------------------------
Total assets $132,551 $111,467
=========================
LIABILITIES, REDEEMABLE PREFERRED STOCK, AND STOCKHOLDERS' DEFICIT
Current liabilities:
Accounts payable $ 18,203 $ 14,678
Accrued compensation and benefits 17,195 14,103
Other accrued expenses 10,481 9,550
Current portion of long-term debt 6,426 6,593
Income taxes payable 107 -
Deferred taxes--current 1,634 1,957
-------------------------
Total current liabilities 54,046 46,881
Long-term debt 89,243 34,639
Unsecured subordinated notes - 23,643
Other long-term liabilities 810 724
Commitments and contingencies
Redeemable preferred stock - 9% - 22,006
Stockholders' deficit:
Common stock, $.001 par value:
Authorized shares--40,000,000; 6,980,326 and 6,998,858 shares issued
and outstanding at September 30, 2003 and 2002, respectively 7 7
Additional paid-in capital (deficit) (24,986) (24,186)
Promissory note receivable for purchase of common stock (8,053) (8,053)
Retained earnings 21,484 15,806
-------------------------
Total stockholders' deficit (11,548) (16,426)
-------------------------
Total liabilities, redeemable preferred stock, and stockholders' deficit $132,551 $111,467
=========================
See accompanying notes.
F - 2
Vitas Healthcare Corporation and Subsidiaries
Consolidated Statements of Income
(In thousands)
YEAR ENDED SEPTEMBER 30
2003 2002 2001
-------------------------------------------
Net revenue from patient services $420,074 $359,200 $319,517
Operating expenses:
Hospice program expenses 331,820 281,359 249,544
Central support services 45,735 39,458 34,736
Provision for bad debts 5,413 5,488 5,185
Depreciation and amortization 5,084 4,876 6,238
-------------------------------------------
388,052 331,181 295,703
-------------------------------------------
Income from operations 32,022 28,019 23,814
Interest and other income 716 680 604
Interest expense (5,886) (5,717) (3,552)
Loss from early extinguishment of debt (4,117) - -
-------------------------------------------
Income before income taxes 22,735 22,982 20,866
Provision for income taxes 9,046 9,193 8,555
-------------------------------------------
Net income $ 13,689 $ 13,789 $ 12,311
===========================================
See accompanying notes.
F - 3
Vitas Healthcare Corporation and Subsidiaries
Consolidated Statements of Changes in Redeemable Preferred Stock and
Stockholders' Deficit
(In thousands)
REDEEMABLE PREFERRED STOCK
-------------------------------------------
9% SERIES B
------------------ ------------------
SHARES DOLLARS SHARES DOLLARS
------------------ ------------------
Balance at September 30, 2000 270 $ 26,529 263 $ 46,148
9% Preferred Stock dividends paid - - - -
Accretion of Preferred Stock to
redemption value and accrued dividends - 1,924 - 1,845
Redemption of Series B Preferred Stock - - (263) (26,250)
Conversion of Series B accrued dividends to
convertible unsecured subordinated note - - - (21,743)
Discount on 9% Preferred Stock related to
warrant extension and issuance of new warrant - (8,079) - -
Warrants issued for debt issuance costs - - - -
Common stock issued upon exercise of stock
options, net of shares retained for employee
withholding taxes and tax benefit - - - -
Common stock purchased by the Company and
retired - - - -
Net income - - - -
------------------------------------------------
Balance at September 30, 2001 270 20,374 - -
9% Preferred Stock dividends paid - - - -
Accretion of Preferred Stock to redemption
value - 1,632 - -
Common stock issued upon exercise of stock
options, net of shares retained for employee
withholding taxes and tax benefit of $1,229 - - - -
Acceptance of promissory note for purchase of
common stock - - - -
Net income - - - -
------------------------------------------------
Balance at September 30, 2002 270 22,006 - -
9% Preferred Stock dividends paid - - - -
Accretion of Preferred Stock to
redemption value - 5,264 - -
Common stock issued upon exercise of stock
options, net of tax benefit of $60 - - - -
Common stock purchased by the Company and
retired - - - -
Other - - - -
Redemption of 9% Preferred Stock (270) (27,270) - -
Net income - - - -
------------------------------------------------
Balance at September 30, 2003 - $ - - $ -
================================================
PROMISSORY
NOTE
ADDITIONAL RECEIVABLE
COMMON STOCK PAID-IN FOR PURCHASE TOTAL
------------------ CAPITAL OF COMMON RETAINED STOCKHOLDERS'
SHARES DOLLARS (DEFICIT) STOCK EARNINGS DEFICIT
----------------------------------------------------------------------
Balance at September 30, 2000 4,441 $ 4 $(40,145) $ - $(2,593) $(42,734)
9% Preferred Stock dividends paid - - - - (2,430) (2,430)
Accretion of Preferred Stock to
redemption value and accrued dividends - - (2,560) - (1,209) (3,769)
Redemption of Series B Preferred Stock - - - - - -
Conversion of Series B accrued dividends to
convertible unsecured subordinated note - - - - - -
Discount on 9% Preferred Stock related to
warrant extension and issuance of new warrant - - 8,079 - - 8,079
Warrants issued for debt issuance costs - - 2,364 - - 2,364
Common stock issued upon exercise of stock
options, net of shares retained for employee
withholding taxes and tax benefit 93 - 148 - - 148
Common stock purchased by the Company and
retired (121) - (619) - - (619)
Net income - - - - 12,311 12,311
--------------------------------------------------------------------
Balance at September 30, 2001 4,413 4 (32,733) - 6,079 (26,650)
9% Preferred Stock dividends paid - - - - (2,430) (2,430)
Accretion of Preferred Stock to redemption
value - - - - (1,632) (1,632)
Common stock issued upon exercise of stock
options, net of shares retained for employee
withholding taxes and tax benefit of $1,229 2,586 3 8,547 - - 8,550
Acceptance of promissory note for purchase of
common stock - - - (8,053) - (8,053)
Net income - - - - 13,789 13,789
--------------------------------------------------------------------
Balance at September 30, 2002 6,999 7 (24,186) (8,053) 15,806 (16,426)
9% Preferred Stock dividends paid - - - - (2,747) (2,747)
Accretion of Preferred Stock to
redemption value - - - - (5,264) (5,264)
Common stock issued upon exercise of stock
options, net of tax benefit of $60 63 1 300 - - 301
Common stock purchased by the Company and
retired (82) (1) (1,003) - - (1,004)
Other - - (97) - - (97)
Redemption of 9% Preferred Stock - - - - - -
Net income - - - - 13,689 13,689
--------------------------------------------------------------------
Balance at September 30, 2003 6,980 $ 7 $(24,986) $(8,053) $21,484 $(11,548)
====================================================================
See accompanying notes.
F - 4
Vitas Healthcare Corporation and Subsidiaries
Consolidated Statements of Cash Flows
(In thousands)
YEAR ENDED SEPTEMBER 30
2003 2002 2001
------------------------------------------
OPERATING ACTIVITIES
Net income $13,689 $13,789 $12,311
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation 5,495 5,072 4,553
Amortization, including deferred financing costs 2,303 1,473 2,262
Deferred interest on subordinated notes 1,198 1,339 561
Deferred income taxes (323) 3,113 311
Provision for bad debts 5,413 5,488 5,185
Loss on sale of assets 3 - -
Loss on early extinguishment of debt 4,117 - -
Changes in operating assets and liabilities:
Accounts receivable (17,599) (13,674) (14,312)
Restricted cash (6,000) - -
Income tax receivable (payable) 4,340 (3,197) 327
Other current assets (521) (582) (259)
Accounts payable and accrued expenses 7,547 1,022 358
Other long-term liabilities 85 (552) 951
------------------------------------------
Net cash provided by operating activities 19,747 13,291 12,248
INVESTING ACTIVITIES
Purchases of property and equipment (7,007) (5,368) (4,670)
Cash paid for hospice acquisition, net (2,068) - -
Change in other assets (518) (1,500) (1,341)
------------------------------------------
Net cash used in investing activities (9,593) (6,868) (6,011)
Continued on next page.
F - 5
Vitas Healthcare Corporation and Subsidiaries
Consolidated Statements of Cash Flows (continued)
(In thousands)
YEAR ENDED SEPTEMBER 30
2003 2002 2001
--------------------------------------------
FINANCING ACTIVITIES
Principal payments on Term Note, net $ (9,556) $ (7,214) $ (4,250)
Principal payments on capital lease obligations (345) (191) (43)
Dividends paid on 9% Preferred Stock (2,747) (2,430) (2,430)
Proceeds from exercise of Employee Stock Options 301 497 148
Proceeds from issuance of Loan 95,000 - 50,000
Repayment of Term Loan - - (2,568)
Repayment of Subordinated Notes (24,431) - -
Interest payments on Subordinated Notes (410) - -
Net principal payments on debt (30,662) - (13,000)
Redemption of 9% Series B Preferred Stock (27,270) - (26,250)
Debt issuance costs (5,296) - (3,902)
Common stock purchased by the Company and retired (1,101) - (619)
-------------------------------------------
Net cash used in financing activities (6,517) (9,338) (2,914)
-------------------------------------------
Net increase (decrease) in cash and cash equivalents 3,637 (2,915) 3,323
Cash and cash equivalents, beginning of year 5,466 8,381 5,058
-------------------------------------------
Cash and cash equivalents, end of year $ 9,103 $ 5,466 $ 8,381
===========================================
SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING AND FINANCING
ACTIVITIES
Acceptance of promissory note for purchase of common stock $ - $ 8,053 $ -
===========================================
Warrants issued in connection with the extension of the 9%
Preferred Stock $ - $ - $ 8,079
===========================================
Warrants issued for debt issuance costs $ - $ - $ 2,364
===========================================
Conversion of Series B preferred stock accrued dividends to
convertible unsecured subordinated note $ - $ - $ 21,743
===========================================
Equipment purchased under capital lease obligations $ - $ 1,000 $ 248
===========================================
SUPPLEMENTAL CASH FLOW INFORMATION
Cash interest paid $ 2,511 $ 4,786 $ 2,514
===========================================
Cash income taxes paid $ 5,262 $ 8,029 $ 7,721
===========================================
See accompanying notes.
F - 6
Vitas Healthcare Corporation and Subsidiaries
Notes to Consolidated Financial Statements
September 30, 2003
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
COMPANY
Vitas Healthcare Corporation and subsidiaries (Vitas or the Company) provides
palliative medical care and related services to terminally ill patients through
state-licensed and federally-certified hospice programs. Palliative medical care
focuses primarily on improving the quality of life of terminally ill patients
and their families, which includes symptoms and pain management and certain
counseling and bereavement care. Patient care is provided in the patient's home
which could include a long-term care facility or in an inpatient facility. The
Company provides its services through interdisciplinary teams of professionals
and staff that include physicians, registered nurses, social workers, chaplains
and other counselors, home health aides, volunteers and homemakers managing care
in various settings. These services include physician care, nursing care, home
health aide services, social work, counseling services and pastoral care, as
well as drugs, medical equipment and supplies and other ancillary services
related to the treatment of terminal illness. The Company's corporate
headquarters is located in Miami, Florida and currently operates hospice
programs in eight states including Florida, California, Illinois, Ohio,
Pennsylvania, Wisconsin, New Jersey and Texas.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of Vitas Healthcare
Corporation and its subsidiaries. All significant intercompany accounts and
transactions have been eliminated in consolidation.
ACCOUNTS RECEIVABLE
The Company's patients are primarily insured under third-party payor agreements.
The composition of accounts receivable from third-party payors and patients is
as follows:
SEPTEMBER 30
2003 2002
----------------------
Medicare 61% 60%
Medicaid 29 31
Commercial insurers 9 8
Other 1 1
--------------------
100% 100%
====================
F - 7
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Credit is granted to all payors without collateral.
The Company 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.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities, the disclosure of
contingent assets and liabilities at the date of the financial statements, and
the reported amounts of revenues and expenses during the reporting period. The
Company's actual results in subsequent periods may differ from the estimates and
assumptions used in the preparation of the accompanying consolidated financial
statements.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents include currency, checks on hand and overnight
repurchase agreements. Cash in excess of daily requirements invested in
short-term investments with original maturities of three months or less is
considered to be a cash equivalent for financial statement purposes. Under the
terms of its credit agreement (see Note 5), the Company is required to maintain
a cash balance equal to its PIP settlements ($0 and $505,000 at September 30,
2003 and 2002, respectively) throughout the term of the credit agreement. Such
amount is included in cash and cash equivalents in the accompanying consolidated
balance sheet.
Deposits in banks may exceed the amount of insurance provided on such deposits.
The Company performs reviews of the credit worthiness of its depository banks.
The Company has not experienced any losses on its deposits of cash.
RESTRICTED CASH
In connection with the 2003 Recapitalization (see Notes 2 and 5), the Company
had $6 million in escrow at September 30, 2003. The cash was restricted to
repurchasing the Company's common stock in the event certain shareholders'
exercised put rights prior to the end of October 2003.
F - 8
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
In the event those certain shareholders' put rights were not exercised, the cash
in escrow would be applied against the Company's outstanding debt. Subsequent to
year end, the restricted cash was in fact applied against the Company's
outstanding debt.
FINANCIAL INSTRUMENTS
The carrying amount of financial instruments including cash and cash
equivalents, restricted cash, accounts receivable, and accounts payable
approximate fair value as of September 30, 2003. The carrying amounts of the
Company's borrowings approximate fair value as the interest rates are variable.
CHARITY CARE
The Company provides care to all patients regardless of ability to pay. Patients
who meet certain criteria under its charity care policy are cared for without
charge or at amounts less than established rates. Amounts determined to qualify
as charity care are not reported as revenue because the Company does not pursue
collection.
Charity care was $5.8 million, $4.6 million and $3.4 million for the years ended
September 30, 2003, 2002 and 2001, respectively.
NET REVENUE
Revenue is recognized as services are rendered. Net revenue is reported at the
estimated net realizable amounts due from third-party payors which are 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. Management estimates denials each period and makes adequate
provision for them in the financial statements. The percentage of net revenue
derived under the Medicare and Medicaid programs was 95% in 2003, 2002 and 2001.
The Company is subject to limits for payments for routine home care and for
inpatient services. Routine home care, which represented approximately 68% of
gross patient service revenue in 2003, is subject to limits based on aggregate
length of stay by hospice provider for the year, and the limit by hospice
provider is effective for average lengths of stay in excess of 180 days. For
inpatient
F - 9
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
services, which represented approximately 16% of gross patient service revenue
in 2003, the limit is based on inpatient care days. If inpatient care days
provided to patients at a hospice exceeded 20% of the total days of hospice care
provided for the year, then payment for days in excess of this limit are paid
for at the routine home care rate. The Company did not exceed the payment limits
on routine home care or inpatient services in 2003, 2002, or 2001.
GOODWILL
In July 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards (SFAS) No. 141, Business Combinations and SFAS
No. 142, Goodwill and Other Intangible Assets. SFAS No. 141 requires that the
purchase method of accounting be used for all business combinations initiated
after June 30, 2001. SFAS No. 141 also specifies the criteria which must be met
for intangible assets acquired in a purchase method business combination to be
recognized and reported apart from goodwill, noting that any purchase price
allocable to an assembled workforce may not be accounted for separately. The
requirements of SFAS No. 141 are effective for any business combination
accounted for by the purchase method that is completed after June 30, 2001.
Under SFAS No. 142, goodwill and intangible assets with indefinite useful lives
are no longer amortized, but are reviewed annually or more frequently if
indicators arise for impairment. SFAS No. 142 also requires that intangible
assets with definite useful lives be amortized over their respective estimated
useful lives to their estimated residual values, and reviewed for impairment in
accordance with SFAS No. 121, Accounting for the Impairment of Long-Lived Assets
and for Long-Lived Assets to Be Disposed Of. The amortization provisions of SFAS
No. 142 apply to goodwill and intangible assets acquired after June 30, 2001.
With respect to goodwill and intangible assets acquired prior to July 1, 2001,
the amortization provisions of SFAS No. 142 were effective upon adoption of SFAS
No. 142. Companies were required to adopt SFAS No. 142 in fiscal years beginning
after December 15, 2001 (i.e. October 1, 2002 for the Company). Early adoption
was permitted for companies with fiscal years ending after March 15, 2001. The
Company adopted SFAS No. 142 effective October 1, 2001. At this time, the
Company tested goodwill for impairment pursuant to the guidance of SFAS No. 142
and concluded that there was no impairment.
F - 10
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
The Company completed its annual impairment test using the two-step process
prescribed by SFAS No. 142 on May 1, 2003 and May 1, 2002 and determined that no
impairment existed. The first step is a screen for potential impairment, while
the second step measures the amount of the impairment, if any. Upon completing
the first step, the Company determined that its goodwill was not impaired and,
thus, was not required to perform the second step. The useful lives and
amortization periods of the Company's other identifiable intangible assets
(which primarily consist of debt issuance costs and non-compete agreements) did
not change as a result of the Company's adoption of SFAS No. 142. Had SFAS No.
142 been effective for all periods presented herein, the Company's net income
would have been adjusted as follows (in thousands):
2003 2002 2001
-------------------------------------------
Net income as reported $13,689 $13,789 $12,311
Goodwill amortization - - 1,660
Income tax effect - - (664)
------------------------------------------
Net income, as adjusted for the
impact of SFAS No. 142 $13,689 $13,789 $13,307
==========================================
LONG-LIVED ASSETS
The Company periodically reviews its long-lived assets to determine if the
carrying value of these assets is recoverable based on the future cash flows
expected from such assets. The Company believes that no impairment of long-lived
assets exists at September 30, 2003.
PROPERTY AND EQUIPMENT
Property and equipment, including improvements to existing facilities, are
recorded at cost.
Depreciation is calculated principally using the straight-line method over the
estimated useful lives of the assets. Estimated useful lives for major asset
categories are five years for leasehold improvements, five to seven years for
equipment, three years for capitalized software and software development costs,
and five years for office furniture.
F - 11
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Certain software development costs for internally developed software are
capitalized in accordance with the provisions of Statement of Position 98-1,
Accounting for the Costs of Computer Software Developed or Obtained for Internal
Use. Amortization of capitalized software costs begins when the software is
placed into service and is included in depreciation expense.
OTHER ASSETS
Other assets include approximately $4.7 million and $5.1 million at September
31, 2003 and 2002, respectively, of deferred debt issuance costs related to the
2003 and 2001 Credit Facilities respectively, (see Note 5). The costs related to
the 2003 Recapitalization (see Note 2 and 5) are being amortized over the term
of the 2003 Credit Facility using the interest method. The costs related to the
2001 Credit Facility were being amortized to interest expense over the term of
the 2001 Credit Facility on a straight-line basis, which approximated the
interest method, prior to the 2003 Recapitalization.
On August 6, 2003 approximately $4.1 million of deferred debt issuance costs
related to the 2001 Credit Facility was written off and included in Loss from
early extinguishment of debt in the accompanying Income Statement.
PROMOTIONAL AND EDUCATIONAL MATERIALS
The Company produces and purchases education, communication and clinical
materials for general distribution. Expenses related to these materials totaled
$1,451,000, $1,282,000 and $891,000 for the years ended September 30, 2003, 2002
and 2001, respectively.
STOCK-BASED COMPENSATION
In 1995, the Financial Accounting Standards Board issued Statement of Financial
Accounting Standards (SFAS) No. 123, Accounting for Stock Based Compensation.
SFAS No.123 allows either adoption of a fair value method of accounting for
stock-based compensation plans or a continuation of accounting under Accounting
Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees,
and related interpretations with supplemental disclosures. The Company has
chosen to account for all employee stock-based compensation arrangements in
accordance with APB Opinion No. 25 with related disclosures under SFAS No. 123,
which requires pro forma net income disclosure as well as various other
disclosures not required under APB No. 25.
F - 12
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
The following pro forma net income information has been determined as if the
Company had accounted for its employee stock options under the fair value method
of SFAS No. 123:
YEAR ENDED SEPTEMBER 30
2003 2002 2001
-----------------------------------------
(In thousands)
Net income as reported $13,689 $13,789 $12,311
Deduct: Fair value stock-based compensation
expense, net of tax 550 288 240
-----------------------------------------
Pro forma net income $13,139 $13,501 $12,071
=========================================
The grant date fair value of options granted during fiscal 2003, 2002 and 2001
was $2.58, $2.69 and $1.98 per share, respectively. Fair value was estimated
using the Black-Scholes option pricing model, minimum value method, and the
following assumptions:
2003 2002 2001
----------------------------------------------
Risk-free interest rate 3.79% - 4.06% 4.99% 5.00%
Expected dividend yield 0% 0% 0%
Volatility 0% 0% 0%
Expected life 8 YEARS 8 years 10 years
Option valuation models were developed for estimating the fair value of traded
options which have no vesting restrictions and are fully transferable. In
addition, option valuation models require the input of highly subjective
assumptions including the expected stock price volatility. Because the Company's
employee stock options have characteristics significantly different from those
of traded options, and because changes in the subjective input assumptions can
materially affect the fair value estimate, in management's opinion, the existing
models do not necessarily provide a reliable single measure of the fair value of
its employee stock options.
For purposes of pro forma disclosures, the estimated fair value of the options
is amortized to expense over the options' vesting period. Because compensation
expense associated with a stock option award is recognized over the vesting
period, the initial impact of applying SFAS No. 123 may not be indicative of
compensation expense in future years, when the effect of the amortization of
multiple awards will be reflected in pro forma net income.
F - 13
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
DERIVATIVE FINANCIAL INSTRUMENTS
The Company is exposed to market risk arising from changes in interest rates. To
protect against such risks, the Company has one derivative financial instrument,
an interest rate cap agreement, which is more fully disclosed in Note 6.
During 1998, the FASB issued SFAS No. 133, Accounting for Derivative
Instruments and Hedging Activities (SFAS No. 133), effective as of January 1,
2001. SFAS No. 133 requires companies to recognize all of its derivative
instruments as either assets or liabilities in the statement of financial
position at fair value. The accounting for changes in the fair value (i.e.,
gains or losses) of a derivative instrument depends on whether it has been
designated and qualifies as part of a hedging relationship and on the type of
hedging relationship. For those derivative instruments that are designated and
qualify as hedging instruments, a company must designate the hedging instrument,
based upon the exposure being hedged, as either a fair value hedge, cash flow
hedge or a hedge of a net investment in a foreign operation. Fluctuations in the
fair value of the effective portion of a hedging instrument are recorded as a
component of other comprehensive income. The estimated fair value of the rate
cap will fluctuate over time based on changes in floating interest rates and
such changes in fair value will be recognized in earnings as they occur as it
does not qualify as a hedging instrument.
COMPREHENSIVE INCOME
The FASB issued SFAS No. 130, Comprehensive Income (SFAS No. 130),
which requires that an enterprise (a) classify items of other comprehensive
income by their nature in the financial statements, and (b) display the
accumulated balance of other comprehensive income separately from retained
earnings and additional paid-in capital in the equity section of the balance
sheet. The items of other comprehensive income that are typically required to be
displayed are foreign currency items, minimum pension liability adjustments,
unrealized gains and losses on certain investments in debt and equity securities
and the effective portion of certain derivative instruments. There are no
components of comprehensive income other than the Company's net income for the
years ended September 30, 2003, 2002 and 2001.
F - 14
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
RECENT ACCOUNTING PRONOUNCEMENTS
In May 2003, the FASB issued SFAS No. 150 Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity (SFAS 150). SFAS
150 establishes standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities and equity. SFAS
150 is effective for financial instruments entered into or modified after May
31, 2003, and otherwise is effective beginning after July 1, 2004. The Company
does not expect SFAS 150 to have a material impact on the results of operations
or financial position of the Company.
RECLASSIFICATIONS
Certain reclassifications have been made to the 2002 and 2001 financial
statements to conform to the 2003 presentation.
2. REDEEMABLE PREFERRED STOCK
On April 27, 2001, the Company completed a recapitalization and refinancing
transaction which included, among other things, a new credit facility (see Notes
5 and 6) and the restructuring, extension and/or repurchase of Redeemable
Preferred Stock as described herein. After the recapitalization and refinancing
transaction, the Company had authorized 4,500,000 shares of redeemable preferred
stock with a $1.00 par value.
The Company's 9% Preferred Stock had a stated value of $100 per share, accrued
cumulative dividends at $9.00 per share on a semiannual basis payable quarterly
in certain circumstances, and was nonvoting and mandatory redeemable at June 30,
2007 as follows:
NUMBER OF SHARES REDEMPTION PRICE
TO BE REDEEMED PER SHARE
-----------------------------------------------------------------
81,000 $102
81,000 101
108,000 100
F - 15
2. REDEEMABLE PREFERRED STOCK (CONTINUED)
At any time prior to the mandatory redemption date, the Company was able to
redeem all or any portion of the 9% preferred Stock at a redemption price of
$101 per share. The 9% Preferred Stock also had a liquidation preference equal
to the stated value plus all unpaid dividends.
On August 6, 2003, the Company completed a recapitalization and refinancing
transaction (the 2003 Recapitalization) (see Notes 5 and 6). Following this
transaction, on August 18, 2003, the Company redeemed all of the outstanding
270,000 shares of 9% Preferred Stock at a redemption price of $101 per share
plus $1.18 per share, representing all accrued and unpaid dividends of $317,500.
In connection with the issuance and prior year redemption date extensions of the
9% Preferred Stock, the Company issued three series of Common Stock purchase
Warrants A, B and C. As of September 30, 2003, Warrant A consists of 2,688,899
shares of common stock with an exercise price of $4.325 per share, Warrant B
consists 1,469,344 shares of common stock with an exercise price of $4.335 per
share and Warrant C consists of 1,636,364 shares of common stock with an
exercise price of $5.50 per share (collectively, the Warrants), all of which
contain anti-dilution provisions.
The expiration dates of the Warrants are based in part on a formula that takes
into account the redemption date of the 9% Preferred Stock. As a result of the
redemption of the 9% Preferred Stock on August 18, 2003, Warrant A has an
expiration date of the earlier of May 5, 2005 or the closing of a qualified
initial public offering, Warrant B has an expiration date of April 28, 2005 and
Warrant C has an expiration date of the earlier of April 28, 2005 or the closing
of a qualified initial public offering. On October 15, 2003, Warrants A and B
were exercised with cash proceeds of $17,999,094.
The extension of the expiration dates of Warrants A and B in prior periods
increased the value of these warrants by approximately $5,477,000. The Company
computed the value of Warrant C (which was granted during fiscal 2001) to be
$2,602,000 on the date of grant using the Black-Scholes option valuation model.
The fair value of the Warrants (either as a result of extending the life of the
Warrants or as a result of the initial granting of such warrants) has been
recorded as a decrease in the carrying value of the 9% Preferred Stock and a
charge to additional paid-in capital, which was being accreted ratably through
June 30, 2007.
F - 16
3. STOCK OPTIONS AND WARRANTS
The Company has granted nonqualified stock options (NQSOs) to purchase shares of
the Company's Common Stock to various employees, officers, directors and
consultants in conjunction with their employment with or service to the Company.
All NQSOs generally expire between five and ten years after the initial grant
date and are only transferable under certain circumstances. Proceeds from the
exercise of options under these plans are included in stockholders' equity and
are subject to certain credit facility restrictions.
On October 30, 1997, the Company adopted the 1997 Executive Incentive
Compensation Plan (EICP). Under the EICP, the Company is authorized to grant
options and other stock rights and awards to purchase up to 1,954,555 shares of
the Company's Common Stock. The Company granted 390,000 and 660,000 options
under this plan during fiscal 2003 and 2002, respectively, all of which remained
outstanding at September 30, 2003. The options vest ratably over a five-year
period and have a life of ten years from date of grant.
The Company, in prior years, adopted two Management Equity Incentive Plans
(MEIPs). The MEIPs are authorized to issue options to purchase a total of
2,282,000 shares of the Company's Common Stock at prices not less than market
value at the date of grant and generally vest at 25% per year beginning the year
subsequent to the grant. At September 30, 2003, the MEIPs have 1,041,656 options
that are outstanding. MEIP options granted generally become exercisable under
certain conditions upon the earlier of (i) completion of a qualified initial
public offering of the Company's common stock, (ii) nine years ten months from
the date of grant or (iii) any dissolution, liquidation, sale of assets, or
reorganization in which Vitas is not the surviving entity. Options granted under
these plans expire 10 years from the date of grant. Beginning in fiscal year
2003, the Company does not intend to issue any additional MEIP option awards.
Prior to 1997, the Company issued 2,927,500 options which were not part of the
MEIPs or any other Company plan, none of which are outstanding at September 30,
2003. In 2001, the Company issued options for 500,000 shares which were not part
of the MEIPs or any other Company plan, all of which are outstanding.
F - 17
3. STOCK OPTIONS AND WARRANTS (CONTINUED)
The following table summarizes the Company's stock option activity:
SHARES WEIGHTED
UNDER OPTION AVERAGE
OPTION PRICES EXERCISE PRICE
---------------------------------------------
Options outstanding at September 30, 2000 5,130,156 $0.70 - $ 7.00 $3.98
Granted 500,000 6.00 6.00
Exercised (125,000) 0.70 0.70
Canceled (27,125) 5.00 - 7.00 6.14
---------------------------------------
Options outstanding at September 30, 2001 5,478,031 0.70 - 7.00 4.23
Granted 660,000 9.25 9.25
Exercised (2,978,500) 0.70 - 3.90 3.41
Canceled (705,250) 3.90 - 4.75 3.91
---------------------------------------
Options outstanding at September 30, 2002 2,454,281 0.70 - 9.25 6.66
Granted 390,000 9.75 - 10.25 9.80
Exercised (63,250) 4.75 4.75
Canceled (189,375) 4.75 4.75
---------------------------------------
Options outstanding at September 30, 2003 2,591,656 $5.00 - $10.25 $7.31
=======================================
Exercisable at September 30, 2001 2,927,500 $0.70 - $ 4.75 $3.41
=======================================
Exercisable at September 30, 2002 173,750 $4.75 - $ 6.00 $5.65
=======================================
Exercisable at September 30, 2003 382,000 $6.00 - $ 9.25 $7.12
=======================================
F - 18
3. STOCK OPTIONS AND WARRANTS (CONTINUED)
The following table summarizes information about stock options outstanding at
September 30, 2003:
NUMBER WEIGHTED NUMBER
OUTSTANDING AVERAGE WEIGHTED EXERCISABLE
RANGE AS OF REMAINING AVERAGE AS OF
OF EXERCISE SEPTEMBER 30, CONTRACTUAL EXERCISE SEPTEMBER 30,
PRICES 2003 LIFE PRICE 2003
------------------------------------------------------------------------------------------
$5.00 - $5.50 442,531 4.02 years $ 5.35 -
$5.75 - $6.00 994,250 4.20 $ 5.96 250,000
$7.00 104,875 2.01 $ 7.00 -
$9.25 - $9.75 1,010,000 8.76 $ 9.42 132,000
$10.25 40,000 9.86 $ 10.25 -
--------- -------
2,591,656 382,000
========= =======
At September 30, 2003 the Company has available Common Stock for future issuance
under warrant and option agreements as follows:
Stock option plans and other option grants outstanding 2,591,656
Shares available for option grants under MEIPs 1,197,094
Shares available for awards under EICP 904,555
Warrants issued with 9% Preferred Stock 5,794,607
Warrants issued in connection with credit facilities 1,596,804
----------
12,084,716
==========
F - 19
4. DETAILS OF BALANCE SHEET
Details of select balance sheet accounts are as follows:
SEPTEMBER 30
2003 2002
--------------------------
(In thousands)
Property and equipment:
Leasehold improvements $ 5,141 $ 4,161
Equipment (including equipment under
capital leases) 10,007 9,175
Software 30,530 27,013
Office furniture 5,043 4,391
-------------------------
50,721 44,740
Accumulated depreciation (38,366) (33,895)
-------------------------
$ 12,355 $ 10,845
=========================
Intangible assets:
Goodwill $ 51,079 $ 49,011
Trade name 526 526
Accumulated amortization (11,162) (11,136)
-------------------------
$ 40,443 $ 38,401
=========================
Intangible assets subject to amortization relates to a trade name that is being
amortized over a 20 year life and is included in intangibles in the accompanying
consolidated balance sheets. Amortization expense of the asset that still
requires amortization under SFAS No. 142 was $26,000 for the years ended
December 31, 2003, 2002 and 2001, respectively. Amortization expense relating to
these intangible assets will be approximately $26,000 for the next five fiscal
years.
F - 20
4. DETAILS OF BALANCE SHEET (CONTINUED)
Other assets include deferred financing costs of approximately $4,745,000 net of
accumulated amortization of $61,000 at September 30, 2003. The estimated annual
amortization expense for intangible assets subject to amortization, including
deferred financing costs and trade name, for the next five fiscal years is as
follows (in thousands):
September 30:
2004 $ 762
2005 817
2006 876
2007 941
2008 953
Other assets include an amount owed to the Company by the Foundation for
End-of-Life Care, Inc. (the Foundation). The Company helped organize the
Foundation during the year ended September 30, 2000 and has continued to provide
it with financial and other support. The Foundation is a not-for-profit publicly
supported organization whose primary mission is to support academic and
scientific research and education in end-of-life care. The Foundation's acting
president is also a director, executive officer, and employee of the Company.
The Foundation entered into an agreement with the Company to repay such advances
in installments of $25,000 per quarter which commenced on March 31, 2001. The
remaining balance outstanding was $548,000 and $613,000 at September 30, 2003
and 2002, respectively.
The allowance for uncollectible accounts for patient accounts receivable is as
follows (in thousands):
BALANCE AT CHARGED TO WRITEOFFS BALANCE AT
BEGINNING COSTS AND AND END OF
DESCRIPTION OF PERIOD EXPENSES ADJUSTMENTS PERIOD
--------------------------------------------------------------------------------------------------
Allowance for doubtful accounts:
Year ended December 31, 2003 $5,098 $5,413 $4,056 $6,455
Year ended December 31, 2002 4,848 5,488 5,238 5,098
Year ended December 31, 2001 4,351 5,185 4,688 4,848
F - 21
5. BORROWINGS
On August 6, 2003, the Company refinanced its then existing credit facility (the
2001 Credit Facility) with a new $120 million credit facility pursuant to an
amended and restated credit agreement (the 2003 Credit Facility) in connection
with the recapitalization and refinancing transaction discussed in Note 2. The
2003 Credit Facility consists of a $60 million senior secured term loan (Senior
Term Loan), a $35 million second lien term loan (Second Lien Term Loan) and a
$25 million senior secured revolving loan commitment (Revolving Loan).
Borrowings under the Revolving Loan are limited to an amount equal to 85% of the
book value of the Company's eligible accounts receivable, as defined in the
agreement. The 2003 Credit Facility also provides for the periodic issuance, at
the request of the Company and subject to limitations based on outstanding
indebtedness and other factors, of letters of credit of up to $5,000,000, of
which $3,300,000 has been issued as of September 30, 2003.
Under the 2003 Credit Facility, the Senior Term Loan requires quarterly
amortization payments ranging from $1,500,000 to $4,500,000 plus interest
beginning November 1, 2003 through August 1, 2008. The Senior Term Loan and
Revolving Loan accrue interest, at the Company's option, at either LIBOR or the
Base Rate, as defined, plus a margin ranging from 2.25% to 3.00% for base rate
loans and 3.25% to 4.00% for LIBOR rate loans based on the Senior Leverage Ratio
of the Company. At September 30, 2003, the interest rate based on the Company's
Senior Leverage Ratio is LIBOR plus 4% or Base Rate plus 3%. The base rate is
equal to the higher of the Prime Rate or the Federal Funds Rate plus .5%. LIBOR
was 1.13% at September 30, 2003. Interest on the Revolving Loan is payable
monthly with any outstanding principal due in full August 1, 2008. The Company
is required to pay 0.5% annually on the unused portion of the Revolving Loan.
Interest on the Second Lien Term Loan is LIBOR plus 10% or Base Rate plus 9%.
The Company can prepay outstanding amounts on the Senior Term Loan and Revolving
Loan under the 2003 Credit Facility at its discretion and without penalty.
Without the consent of all Senior Lenders, no prepayments can be made on the
Second Lien Term Loan prior to the payment in full of the Senior Term Loan and
the Revolving Loan. There are also mandatory prepayment provisions based upon
quarterly excess cash flows, as defined, the sale of significant assets,
disposition of a subsidiary, or the issuance of equity instruments, and other
specified transactions or events.
The 2003 Credit Facility restricts future borrowings, payment of dividends and
requires the Company to meet certain financial covenants related to fixed charge
coverage, senior and total leverage, EBITDA, and others. The Company was in
compliance with its financial covenants at September 30, 2003. The Company must
also maintain an interest rate cap agreement that will
F - 22
5. BORROWINGS (CONTINUED)
protect the Company against any increase in interest rates after August 6, 2003
through September 30, 2006 with respect to 50% of the outstanding principal on
the Senior Term Loan and Second Lien Term Loan at closing, or approximately
$47.5 million (see Note 6). The 2003 Credit Facility is secured by substantially
all of the assets of the Company.
In connection with the 2003 Recapitalization, the Company used proceeds of
approximately $27.2 million to redeem the 9% Preferred Stock at a redemption
price per share of $101 plus $1.18 per share, representing all accrued and
unpaid dividends to the redemption date (see Note 2). Also, the Company used
$22.7 million of proceeds from the 2003 Credit Facility to repay the unsecured
subordinated notes (collectively the Subordinated Notes) bearing interest at 6%
annually and maturing on November 1, 2006 subject to extensions under certain
circumstances. The conversion rights of the Subordinated Notes expired during
the year ended September 30, 2002.
The 2001 Credit Facility, as amended October 2002, consisted of a $50 million
term loan (the 2001 Term Loan) and a $25 million revolving loan commitment (2001
Revolving Loan). Borrowings under the 2001 Revolving Loan were limited to an
amount equal to 85% of the book value of the Company's eligible accounts
receivable, as defined in the agreement. The 2001 Credit Facility also provided
for the periodic issuance, at the request of the Company and subject to
limitations based on outstanding indebtedness and other factors, of letters of
credit of up to $5,000,000, of which $1,600,000 had been issued as of September
30, 2002.
Under the 2001 Credit Facility, the 2001 Term Loan required quarterly
amortization payments ranging from $1,250,000 to $3,750,000 plus interest
beginning July 1, 2001 through April 1, 2006. The 2001 Term Loan and 2001
Revolving Loan accrued interest, at the Company's option, at LIBOR plus 4% or
the base rate plus 2.5%, (5.869% at September 30, 2002). The base rate was equal
to the higher of the Prime Rate or the Federal Funds Rate plus .5%. Interest on
the 2001 Revolving Loan was payable monthly with any outstanding principal due
in full April 2006. Additionally, the Company was required to pay 0.5% annually
on the unused portion of the 2001 Revolving Loan.
The Company could prepay all amounts outstanding under the 2001 Credit Facility
at its discretion and without penalty. There were also mandatory prepayment
provisions based upon quarterly excess cash flows, as defined, the sale of
significant assets, disposition of a subsidiary, or the issuance of equity
instruments, and other specified transactions or events.
F - 23
5. BORROWINGS (CONTINUED)
The 2001 Credit Facility restricted future borrowings and required the Company
to meet certain financial covenants related to net worth, fixed charge coverage,
EBITDA, and others. The Company also maintained an interest rate cap agreement
that protected the Company against any increase in interest rates after April
27, 2001 through April 2004 with respect to 50% of the outstanding principal on
the 2001 Term Loan at closing, or approximately $24.4 million (see Note 6). The
2001 Credit Facility was secured by substantially all of the assets of the
Company.
The Company issued warrants to purchase an aggregate of 801,005 shares of common
stock in connection with the execution of the 2001 Credit Facility. Of the
801,005 warrants, 320,402 have an exercise price of $.01 per share and 480,603
have an exercise price of $6.00 per share. These warrants terminate April 27,
2011, or earlier upon occurrence of certain fundamental corporate changes of the
Company as defined in the applicable warrant agreement, and contain certain
anti-dilution provisions. The fair value of the warrants, based on the
Black-Scholes valuation method on the date granted of approximately $2.4 million
was being amortized through April 1, 2006, the maturity date of the 2001 Term
Loan. However, in connection with the recapitalization and refinancing
transaction described above, the unamortized balance of these costs was written
off and included in the loss from early extinguishment of debt in the
accompanying consolidated income statement.
Prior to fiscal 2001, the Company granted warrants to purchase an aggregate of
778,450 shares of common stock at an exercise price of $.01 per share in
connection with the Company's previous credit facility. The number of shares and
the exercise price of such warrants are subject to certain anti-dilution
adjustments. The fair value of these warrants, based on the Black-Scholes
valuation method on the date granted, was amortized over the life of the related
extensions which ended in fiscal 1998. In 2001, events surrounding the
recapitalization transaction triggered the antidilution adjustment provisions of
the warrants which increased the number of shares of common stock issuable upon
exercise of the warrants from 778,450 to 818,600 (an increase of 40,150 warrant
shares) and decreased the exercise price per share of the warrants from $.01 to
$.00948, provided the Subordinated Notes were converted into shares of common
stock prior to the expiration of the conversion rights of the Subordinated Notes
in 2002. When the Subordinated Notes were not so converted, the antidilution
adjustment provisions of the warrants were again triggered, which decreased the
number of shares of common stock issuable upon exercise of the warrants from
818,600 to 795,799 (a decrease of 22,801 warrant shares) and increased the
exercise price per share
F - 24
5. BORROWINGS (CONTINUED)
of the warrants from $.00948 to $.00978. The fair value of the 22,801 warrants
of approximately $125,000, based on the Black-Scholes Valuation method on the
date granted, was being amortized through the maturity date of the 2001 Credit
Facility. However, in connection with the 2003 recapitalization and refinancing
transaction described above, the unamortized balance of these costs was written
off and included in the loss from early extinguishment of debt in the
accompanying consolidated income statement.
The Company's outstanding borrowings are as follows:
SEPTEMBER 30
2003 2002
-------------------------
(In thousands)
Senior Term Loan $60,000 $40,218
Second Lien Term Loan 35,000
Revolving Loan - -
Other 669 1,014
------------------------
95,669 41,232
Less current portion (6,426) (6,593)
------------------------
$89,243 $34,639
========================
Unsecured subordinated notes $ - $23,643
========================
Scheduled maturities of the Company's outstanding borrowings at September 30,
2003, by fiscal year are (in thousands):
September 30:
2004 $ 6,669
2005 9,000
2006 12,000
2007 15,000
2008 18,000
Thereafter 35,000
-------
$95,669
=======
F - 25
5. BORROWINGS (CONTINUED)
At September 30, 2003 and 2002, the Company has outstanding a standby letter of
credit of $3,300,000 in favor of the Company's workers compensation program
administrator in addition to a $2,300,000 and $1,881,250 deposit at September
30, 2003 and 2002, respectively, both of which are pledged as security for the
obligation for unpaid claims and recorded as part of other assets.
6. INTEREST RATE CAP AGREEMENT
The 2003 Credit Facility requires that the Company maintain an interest rate
protection agreement on a portion of the Term Loan. Effective September 30,
2003, the Company entered into a rate cap agreement (the Agreement) with a
financial institution. The Agreement limits the LIBOR rate used to calculate the
interest rate paid by the Company to 6% over the life of the agreement without
an exchange of the underlying notional amount. The Company entered into the
Agreement to reduce the exposure to adverse fluctuations in floating interest
rates on the underlying debt obligation as required by the 2003 Credit Facility
and not for trading purposes.
The Agreement matures on September 30, 2006 and has an underlying notional
amount of approximately $47.5 million. The $135,000 cost of the rate cap will be
amortized into interest expense during fiscal 2004. The fair value of the rate
caps were negligible and were determined based on quoted market prices for
similar instruments at September 30, 2003 and 2002. The estimated fair value of
the remaining rate cap will fluctuate over time based on changes in floating
interest rates and such changes in fair value will be recognized in earnings as
they occur.
The Company has no plans to terminate the Agreement earlier than the maturity
date. The Company is exposed to credit loss in the event of nonperformance by
the counter party to the Agreement. The amount of such exposure is limited to
the unpaid portion of amounts due to the Company, if any, pursuant to the
Agreement. Management considers the risk of counter party default to be minimal.
In connection with the 2003 Recapitalization (see Notes 2 and 5), the Company
terminated its previous interest rate protection agreement related to the 2001
Credit Facility, which was outstanding at September 30, 2002.
F - 26
7. BUSINESS ACQUISITION
In November 2002, the Company purchased certain assets related to the ongoing
operations of North Broward Hospital District doing business as Gold Coast
Hospice of Palm Beach, a hospice located in Palm Beach County, Florida. The
purchase price, including transaction costs, totaled $2.1 million. Assets
acquired include furniture and fixtures and goodwill of $2.1 million. The
acquisition was completed for the purpose of expanding the Company's operations
in Florida. The accompanying consolidated income statements include the results
of the acquired operation from the date of acquisition.
8. INCOME TAXES
Deferred income tax assets and liabilities are determined based upon differences
between the financial reporting and tax bases of assets and liabilities and are
measured using the enacted tax rates and laws that will be in effect when the
differences are expected to reverse.
Significant components of the provision for income taxes are as follows:
YEAR ENDED SEPTEMBER 30
2003 2002 2001
-----------------------------------------
(In thousands)
Current:
Federal $7,925 $5,313 $7,196
State 1,444 767 1,047
Deferred:
Federal (273) 2,720 272
State (50) 393 40
-----------------------------------------
$9,046 $9,193 $8,555
=========================================
Deferred income taxes reflect the net tax effect of temporary differences
between the carrying amount of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components of
the Company's deferred tax assets and liabilities are as follows:
F - 27
8. INCOME TAXES (CONTINUED)
SEPTEMBER 30
2003 2002
--------------------------
(In thousands)
Deferred tax assets:
Deferred compensation $ 131 $ 129
Book over tax depreciation 1,356 1,165
Accrued expenses 2,757 2,474
Allowance for doubtful accounts 174 -
Amortization of warrants 969 269
------------------------
Total deferred tax assets 5,387 4,037
Deferred tax liabilities:
Tax over book amortization 6,422 5,319
Prepaid insurance 211 88
Allowance for doubtful accounts - 475
Other 388 112
------------------------
Total deferred tax liabilities 7,021 5,994
------------------------
Net deferred tax liabilities $(1,634) $(1,957)
========================
The reconciliation of income tax attributable to continuing operations computed
at the U.S. federal statutory tax rates to income tax expense is:
YEAR ENDED SEPTEMBER 30
2003 2002 2001
------------------------------------------
(In thousands)
Tax at U.S. statutory rate $7,915 $8,043 $7,095
State income tax--net of federal
tax benefit 931 760 1,079
Permanent differences 438 473 319
Other items (238) (83) 62
-----------------------------------------
$9,046 $9,193 $8,555
=========================================
F - 28
9. EMPLOYEE BENEFIT PLANS
Since October 1, 1989, the Company has maintained an Employee Stock Ownership
Plan (ESOP) for the benefit of its employees. Contribution expense related to
the ESOP was approximately $1,406,000, $1,223,000, and $78,000 for the years
ended September 30, 2003, 2002 and 2001, respectively. Contribution expense in
fiscal 2003 and 2002 primarily consisted of plan contributions and costs related
to the administration of the ESOP, and in fiscal 2001, primarily for plan
administration costs.
The ESOP distributed 2,431 shares of common stock during fiscal 2003. Under the
terms of the ESOP Plan, holders of ESOP shares have the right to require the
Company to purchase eligible shares (as defined in the ESOP Plan) at fair market
value. At September 30, 2003, the Company estimates that 221,000 such shares
were eligible for repurchase at a price of $9.50 per share based on the most
recent valuation.
The Company has a 401(k) tax deferred savings plan (the Plan), covering
substantially all full and part-time employees over age 21 meeting a 60 day
minimum service requirement. The Plan is administered by an independent trustee.
Contributions made by the Company to the Plan are based on a specified
percentage of employee contributions. The Company's contributions to the Plan
totaled approximately $1,124,000, $905,000 and $443,000 for the years ended
September 30, 2003, 2002 and 2001, respectively.
10. RELATED PARTY TRANSACTIONS
At September 30, 2002, notes receivable from an executive officer, director and
stockholder were approximately $185,500 and bore interest at 9.5%. These notes
receivable were included in other assets until they were repaid during October
2002. Notes receivable from an executive officer, director and stockholder of
$50,000 were forgiven during 2001.
The Company has noncompete agreements with two principal stockholders, executive
officers and directors. Payments made to executives under certain noncompete
agreements were $25,000, $50,000 and $135,000 for the years ended September 30,
2003, 2002 and 2001, respectively. At September 30, 2002, $20,833 of previously
paid noncompete payments were being deferred and amortized over the future
periods during which the noncompete agreements were in effect.
F - 29
10. RELATED PARTY TRANSACTIONS (CONTINUED)
Certain board members are paid directors' fees for participating in board
meetings and reimbursed out-of-pocket expenses to attend the board meetings. In
addition, certain members of the board provide consulting services to the
Company for which they were paid $46,750, $21,200 and $118,000 in the aggregate
during fiscal years 2003, 2002 and 2001, respectively.
During 2002, the Company accepted a full recourse promissory note approximating
$8,053,000 in connection with the exercise of 2,250,000 stock options by a
Family Limited Partnership controlled by an executive and principal stockholder
of the Company as permitted under the stock option agreement. The interest rate
is a floating rate equal to the prime rate plus 0.5% and interest is due
quarterly commencing March 31, 2002. The term of the note is eight years with
principal reduction payments totaling $1.65 million to be made in quarterly
installments ranging from $100,000 to $250,000 beginning December 31, 2007
through September 30, 2009 with the remaining balance due on the eighth
anniversary of the note (December 2009). In addition to the personal guarantee
of the executive and principal stockholder, the note is further secured by the
stock issued by the Company in connection with the stock option exercise.
11. COMMITMENTS AND CONTINGENCIES
The Company leases office and warehouse space at its various locations and also
leases space to operate inpatient units using its own employees.
Total rental expense was approximately $7,272,000, $7,934,000 and $7,868,000 for
fiscal years 2003, 2002 and 2001, respectively.
Future minimum rental commitments under noncancelable operating leases for the
years subsequent to September 30, 2003 are as follows (in thousands):
September 30:
2004 $ 6,331
2005 5,705
2006 4,982
2007 3,948
2008 5,750
-------
$26,716
=======
F - 30
11. COMMITMENTS AND CONTINGENCIES (CONTINUED)
The Company maintains self-insured retentions related to its workers
compensation insurance program. The Company's operations are insured for
professional and workers compensation liabilities on a claims-made basis and for
general liability on an occurrence basis. The Company records a liability for
the uninsured portion of workers compensation losses related to asserted and
unasserted claims arising from reported and unreported incidents based on
independent valuations which consider claim development factors, the specific
nature of the facts and circumstances giving rise to each reported incident and
the Company's history with respect to similar claims. The development factors
are based on a blending of the Company's actual experience with industry
standards. Additionally, the Company evaluates the professional and general
liability related to asserted and unasserted claims for reported and unreported
incidents based on the facts and circumstances surrounding such claims.
The Company procures professional liability coverage on a claims-made basis. The
insurance contracts specify that coverage is available only during the term of
each insurance contract. Management of the Company intends to renew or replace
the existing claims-made policy annually and expects to be able to continue to
obtain such coverage. During fiscal 2001, the Company was notified that one of
its prior carriers was ordered into rehabilitation and subsequently went into
liquidation, creating the possibility that certain prior year claims, if any,
could be underinsured or uninsured. Certain claims have been asserted where the
coverage would have been the responsibility of this prior carrier which have
been settled or a liability has been recorded based upon management's estimate
of the expected future settlement. Management does not believe that any future
liability, if any, will have a material effect on the financial condition or
operating results of the Company.
Laws and regulations governing the Medicare and Medicaid programs are complex
and subject to interpretation. The Company believes that it is in compliance
with all applicable laws and regulations and is not aware of any pending or
threatened investigations involving allegations of potential wrongdoing. While
no such regulatory inquiries have been made, compliance with laws and
regulations can be subject to future government review and interpretation as
well as significant regulatory action including fines, penalties and exclusion
from the Medicare and Medicaid programs.
F - 31
11. COMMITMENTS AND CONTINGENCIES (CONTINUED)
The Company intends to contribute $2.5 million to help fund the establishment of
the Duke University Institute for Care at the End of Life with equal quarterly
contributions of $125,000 beginning with the second quarter of fiscal 2000
through 2005. Future contributions are conditional on the Company attaining
certain operating results and cash flow sufficient to meet its operating needs
and remain in compliance with debt covenants.
12. SUBSEQUENT EVENTS
On October 14, 2003, the holder of the 9% Preferred Stock, which was redeemed in
connection with the 2003 Recapitalization, elected to exercise Warrants A and B
which are more fully described in Note 2. The Company issued approximately 4.1
million shares of common stock in exchange for approximately $18 million. The
proceeds from the exercise of the warrants triggered a mandatory repayment of
approximately $18 million pursuant to the terms of the 2003 Credit Facility of
which $5 million was set aside for other corporate purposes as permitted under
the 2003 Credit Facility.
F - 32
ROTO-ROOTER, INC AND SUBSIDIARY COMPANIES
UNAUDITED PRO FORMA CONSOLIDATED STATEMENT OF OPERATIONS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2003
(IN THOUSANDS, EXCEPT PER SHARE AND PERCENTAGE DATA)
Add/(Deduct)
---------------------------
Equity in
Vitas Other
Historical Earnings Adjustments Pro Forma
---------- --------- ----------- ---------
CONTINUING OPERATIONS
Service revenues and sales $ 230,088 $ - $ - $ 230,088
--------- ------- --------- ---------
Cost of services provided and goods sold
(excluding depreciation) 135,978 - - 135,978
General and administrative expenses 45,194 - - 45,194
Selling and marketing expenses 31,560 - - 31,560
Depreciation 9,025 - - 9,025
--------- ------- --------- ---------
Total costs and expenses 221,757 - - 221,757
--------- ------- --------- ---------
Income from operations 8,331 - - 8,331
Interest expense (1,625) - - (1,625)
Distributions on preferred securities (804) - - (804)
Other income--net 9,766 - (135) (b) 9,631
--------- ------- --------- ---------
Income before income taxes 15,668 - (135) 15,533
Income taxes (5,898) - 47 (b) (5,851)
Equity in earnings of affiliate - 2,825 (a) (1,130) (c) 1,695
--------- ------- --------- ---------
NET INCOME $ 9,770 $ 2,825 $ (1,218) 11,377
========= ======= ========= =========
EARNINGS PER SHARE
Net income $ 0.99 $ 1.15
========= =========
Average number of shares outstanding 9,913 9,913
========= =========
DILUTED EARNINGS/(LOSS) PER SHARE (d)
Net income $ 0.98 $ 1.14
========= =========
Average number of shares outstanding 9,940 9,940
========= =========
(a) Amount is computed as follows:
Vitas net income for the nine months ended September 30, 2003 $ 10,178 (e)
Aftertax reduction of interest expense resulting from using warrant proceeds to reduce debt 427
Less: dividends paid on preferred stock (1,532)
Less: estimated amortization of excess value of assets over book value (assumes 5-year life) (1,500)
---------
Adjusted Vitas earnings (100%) $ 7,573
Average Roto-Rooter ownership percentage during the period 37.3%
---------
Roto-Rooter pretax share of earnings $ 2,825
=========
(b) The reduction in interest income for the Company results from the assumed use of $18,000 of
cash and cash equivalents to purchase 4,158 shares of Vitas common stock on January 1, 2003.
(c) The reduction in the Company's equity earnings in Vitas represents the provision for
deferred income taxes related to the Company's share of Vitas' earnings.
(d) At December 31, 2002, Vitas has warrants and employee stock options outstanding which would
potentially dilute the Company's ownership. Since Vitas' stock is not publicly traded, it is not
possible to compute diluted earnings per share using the treasury stock method required under
current accounting standards. If all options and warrants were exercised, including the Company's
warrants for 1,636 shares, the Company's ownership would decline to 34%.
(e) Vitas' net income includes a pretax charge of $4,177 ($2,553 aftertax) for the cost of early
extinguishment of debt in 2003.
P - 1
ROTO-ROOTER, INC AND SUBSIDIARY COMPANIES
UNAUDITED PRO FORMA CONSOLIDATED STATEMENT OF OPERATIONS
FOR THE YEAR ENDED DECEMBER 31, 2002
(IN THOUSANDS, EXCEPT PER SHARE AND PERCENTAGE DATA)
Add/(Deduct)
-----------------------------
Equity in
Vitas Other
Historical Earnings Adjustments Pro Forma
---------- -------- ----------- ---------
CONTINUING OPERATIONS
Service revenues and sales $314,176 $ - $ - $ 314,176
-------- ------- -------- ---------
Cost of services provided and goods sold
(excluding depreciation) 186,285 - - 186,285
General and administrative expenses 51,096 - - 51,096
Selling and marketing expenses 45,544 - - 45,544
Depreciation 13,587 - - 13,587
Impairment, restructuring and similar expenses 20,342 - - 20,342
-------- ------- -------- ---------
Total costs and expenses 316,854 - - 316,854
-------- ------- -------- ---------
Income/(loss) from operations (2,678) - - (2,678)
Interest expense (2,928) - (540) (b) (3,468)
Distributions on preferred securities (1,079) - - (1,079)
Other income--net 4,282 - - 4,282
-------- ------- -------- ---------
Income/(loss) before income taxes (2,403) - (540) (2,943)
Income taxes (6,451) - 189 (b) (6,262)
Equity in earnings of affiliate - 3,679 (a) (1,471) (c) 2,208
-------- ------- -------- ---------
Income/(loss) from continuing operations (8,854) 3,679 (1,822) (6,997)
DISCONTINUED OPERATIONS 6,309 - - 6,309
-------- ------- -------- ---------
NET INCOME/(LOSS) $ (2,545) $ 3,679 $ (1,822) $ (688)
======== ======= ======== =========
EARNINGS/(LOSS) PER SHARE
Income/(loss) from continuing operations $ (0.90) $ (0.71)
======== =========
Net income/(loss) $ (0.26) $ (0.07)
======== =========
Average number of shares outstanding 9,858 9,858
======== =========
DILUTED EARNINGS/(LOSS) PER SHARE (d)
Income/(loss) from continuing operations $ (0.90) $ (0.71)
======== =========
Net income/(loss) $ (0.26) $ (0.07)
======== =========
Average number of shares outstanding 9,858 9,858
======== =========
(a) Amount is computed as follows:
Vitas net income for the twelve months ended December 31, 2002 $ 13,609
Afterttax reduction of interest expense resulting from using warrant proceeds to
reduce debt by $18,000 658
Less: dividends paid on preferred stock (2,430)
Less: estimated amortization of excess value of assets over book value (assumes 5-year life) (2,000)
---------
Adjusted Vitas earnings (100%) $ 9,837
Average Roto-Rooter ownership percentage during the period 37.4%
---------
Roto-Rooter pretax share of earnings $ 3,679
=========
(b) The additional interest expense for the Company represents the costs of borrowing $18,000 for the
assumed purchase of 4,158 common shares of Vitas on January 1, 2002.
(c) The reduction in the Company's equity earnings in Vitas is the provision for deferred income taxes related
to the Company's share of Vitas' earnings.
(d) At December 31, 2002, Vitas has warrants and employee stock options outstanding which would potentially
dilute the Company's ownership. Since Vitas' stock is not publicly traded, it is not possible to compute
diluted earnings per share using the treasury stock method required under current accounting standards.
If all options and warrants were exercised, including the Company's warrants for 1,636 shares, the
Company's ownership would decline to 34%.
P - 2
ROTO-ROOTER, INC AND SUBSIDIARY COMPANIES
UNAUDITED PRO FORMA CONSOLIDATED BALANCE SHEET
SEPTEMBER 30, 2003
(IN THOUSANDS)
Add/(Deduct)
Investment
Historical in Vitas Pro Forma
---------- ------------ ---------
ASSETS
Current assets
Cash and cash equivalents $ 72,607 $(18,000) $ 54,607
Accounts receivable less allowances 13,310 - 13,310
Inventories, primarily general merchandise and finished goods 8,548 - 8,548
Statutory deposits 9,852 - 9,852
Current deferred income taxes 9,167 - 9,167
Prepaid expenses and other current assets 8,616 - 8,616
-------- -------- --------
Total current assets 122,100 (18,000) 104,100
Investments of deferred compensation plans held in trust 16,832 16,832
Other investments 5,546 18,000 23,546 (a)
Note receivable 12,500 12,500
Properties and equipment, at cost less accumulated depreciation 47,456 - 47,456
Identifiable intangible assets less accumulated amortization 2,450 - 2,450
Goodwill less accumulated amortization 113,437 - 113,437
Other assets 16,907 - 16,907
-------- -------- --------
Total Assets $337,228 $ - $337,228
======== ======== ========
LIABILITIES
Current liabilities
Accounts payable $ 5,033 $ - $ 5,033
Current portion of long-term debt 463 - 463
Income taxes 7,294 - 7,294
Deferred contract revenue 16,053 - 16,053
Accrued insurance 16,844 16,844
Other current liabilities 20,347 - 20,347
-------- -------- --------
Total current liabilities 66,034 - 66,034
Long-term debt 25,635 - 25,635
Mandatorily Redeemable Convertible Preferred Securities
of the Chemed Capital Trust 14,146 - 14,146
Deferred compensation liabilities 16,824 16,824
Other liabilities 10,105 - 10,105
-------- -------- --------
Total Liabilities 132,744 - 132,744
-------- -------- --------
STOCKHOLDERS' EQUITY
Capital stock 13,452 - 13,452
Paid-in capital 169,406 - 169,406
Retained earnings 134,143 - 134,143
Treasury stock, at cost (110,492) - (110,492)
Unearned compensation (3,389) - (3,389)
Deferred compensation payable in Company stock 2,294 - 2,294
Notes receivable for shares sold (930) (930)
-------- -------- --------
Total Stockholders' Equity 204,484 - 204,484
-------- -------- --------
Total Liabilities and Stockholders' Equity $337,228 $ - $337,228
======== ======== ========
(a) Total investment in Vitas common stock, including cost of warrants
exercised, is $19,500.
P - 3