Quarterly Report

 

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

þ		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended October 1, 2006

OR

o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                      to                     

Commission File No. 1-15669

Gentiva Health Services, Inc.

(Exact name of registrant as specified in its charter)

3 Huntington Quadrangle, Suite 200S, Melville, NY		11747-4627
(Address of principal executive offices)		(Zip Code)

     Registrant’s telephone number, including area code: (631) 501-7000

     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 þ     No o

     Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

Large accelerated filer o       Accelerated filer þ       Non-accelerated filer o

     Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o       No þ

     The number of shares outstanding of the registrant’s Common Stock, as of November 6, 2006, was 27,293,444.

 

 

INDEX

		Page No.
PART I — FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets (Unaudited) – October 1, 2006 and January 1, 2006			3
Consolidated Statements of Income (Unaudited) – Three Months and Nine Months Ended October 1, 2006 and October 2, 2005			4
Consolidated Statements of Cash Flows (Unaudited) – Nine Months Ended October 1, 2006 and October 2, 2005			5
Notes to Consolidated Financial Statements (Unaudited)			6-27
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			27-42
Item 3. Quantitative and Qualitative Disclosures About Market Risk			42
Item 4. Controls and Procedures			43
PART II — OTHER INFORMATION
Item 1. Legal Proceedings			44
Item 1A. Risk Factors			44
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds			44
Item 3. Defaults Upon Senior Securities			44
Item 4. Submission of Matters to a Vote of Security Holders			44
Item 5. Other Information			44
Item 6. Exhibits			45
SIGNATURES			46
EX-31.1: CERTIFICATION
EX-31.2: CERTIFICATION
EX-32.1: CERTIFICATION
EX-32.2: CERTIFICATION

PART I – FINANCIAL INFORMATION

See notes to consolidated financial statements.

Gentiva Health Services, Inc. and Subsidiaries

      Short-Term Investments

     The Company’s short-term investments consist primarily of AAA-rated auction rate securities and other debt securities with an original maturity of more than three months and less than one year on the acquisition date in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 115, “Accounting for Certain Investments in Debt and Equity Securities.” Investments in debt securities are classified by individual security into one of three separate categories: available-for-sale, held-to-maturity or trading.

     Available-for-sale investments are carried on the balance sheet at fair value which for the Company approximates cost. Auction rate securities of $33.6 million and $49.8 million at October 1, 2006 and January 1, 2006, respectively, are classified as available-for-sale and are expected to be available to meet the Company’s current operational needs and accordingly are classified as short-term investments. The interest rates on auction rate securities are reset to current interest rates periodically, typically 7, 14 and 28 days. Contractual maturities of the auction rate securities exceed ten years.

     Debt securities which the Company has the intent and ability to hold to maturity are classified as held-to-maturity investments and are reported at amortized cost which approximates fair value. The Company has no investments classified as held-to-maturity investments.

     The Company has no investments classified as trading securities.

      Cash Flow Hedge

     The Company utilizes a derivative financial instrument to manage interest rate risk. Derivatives are held only for the purpose of hedging such risk, not for speculative purposes. The Company’s derivative instrument consists of a two year interest rate swap agreement designated as a cash flow hedge of the variability of cash flows associated with a portion of the Company’s variable rate term loan (see Note 9).

     While the Company believes the derivative will effectively help manage its risk, the derivative is subject to the risk that the counterparty is unable to perform under the terms of the swap agreement. The Company executed the derivative with a counterparty that is a well known major financial institution. The Company has monitored the credit worthiness of its counterparty and based on this analysis considers nonperformance by its counterparty to be unlikely.

     In accordance with SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” the derivative instrument is recorded at fair value on the Company’s consolidated balance sheet. Changes in the fair value of the derivative are reported in shareholders’ equity in accumulated other comprehensive income (loss) until earnings are affected by the hedged item. The effectiveness of the Company’s derivative was assessed at inception and is assessed on an ongoing basis, with any ineffective portion of the designated hedge reported currently in earnings. As of October 1, 2006, the Company had unrealized losses on the derivative of $1.1 million recorded in accumulated other comprehensive loss.

     3.  New Accounting Standards

     In September 2006, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 157, “Fair Value Measurements” (“SFAS No. 157”), which defines fair value, establishes a framework for measuring fair value under Generally Accepted Accounting Principles (“GAAP”) and expands disclosures about fair value measurements. This Statement will be effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. The Company is evaluating the impact of adopting this standard and expects it to have no material impact on the Company’s consolidated financial statements.

     In September 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans—an amendment of FASB Statements No. 87, 88, 106, and 132(R)” (“SFAS No. 158”), which requires an employer to recognize the overfunded or underfunded status of a defined benefit postretirement plan (other than a multiemployer plan) as an asset or liability in its consolidated balance sheet and to recognize changes in that funded status in the year in which the changes occur through an adjustment in comprehensive income of a business entity. This Statement will be effective for financial statements of an employer with publicly traded equity securities as of the end of the fiscal year ending after December 15, 2006. The Company does not expect the adoption of this Statement to impact its consolidated financial statements.

     In July 2006, the FASB issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (“FIN 48”), which requires that realization of an uncertain income tax position must be more likely than not (i.e., greater than 50 percent likelihood of receiving a benefit) before it can be recognized in the financial statements. FIN 48 further prescribes the benefit to be recorded in the financial statements as the amount most likely to be realized assuming a review by tax authorities having all relevant information and applying current conventions. The Interpretation also clarifies the financial statement classification of tax-related penalties and interest and sets forth new disclosures regarding unrecognized tax benefits. This Interpretation is effective as of the beginning of an entity’s fiscal year that begins after December 15, 2006. The Company will adopt this Interpretation in the first quarter of fiscal 2007 and is evaluating the impact on its consolidated financial statements.

     4.  Medicare Revenues

     Medicare revenues for the first nine months of fiscal 2006 included approximately $1.9 million received in settlement of the Company’s appeal filed with the U.S. Provider Relations Review Board (“PRRB”) related to the reopening of all of its 1999 cost reports. (See Note 12).

     5.  Acquisitions

      Carolina Vital Care and Lazarus House Hospice

     During the second quarter of fiscal 2006, the Company completed two acquisitions to expand home infusion services in the Carolinas and hospice services into Tennessee.

     The Company acquired the assets of Carolina Vital Care, a home infusion pharmacy business based in Charlotte, North Carolina, and commitments related to certain contracts and office leases with respect to the period after the closing date, pursuant to an asset purchase agreement.

     The Company acquired certain assets and the operations of Lazarus House Hospice, a not-for-profit provider of licensed hospice services based in Tennessee, pursuant to an asset purchase agreement.

     The combined purchase price for the two acquisitions was $4.5 million. As of October 1, 2006, the combined purchase price was allocated to goodwill ($1.0 million), identifiable intangible assets ($3.1 million), and other assets ($0.4 million) and reflects reclassifications made during the third quarter of fiscal 2006 based on the preliminary results of an independent valuation analysis. The purchase price allocation is subject to further adjustment following the completion of an independent valuation analysis of certain net assets acquired.

      Healthfield

     On February 28, 2006, the Company completed the acquisition of 100 percent of the equity interest of Healthfield, a leading provider of home healthcare, hospice and related services with approximately 130 locations primarily in eight southeastern states. Total consideration for the acquisition was $466.0 million in cash and shares of Gentiva common stock, including transaction costs of $11.2 million. Total consideration included $2.0 million in adjustments recorded since the acquisition to reflect a change in estimate relating to the final true-up of working capital and net debt as of the Healthfield closing date, as well as incremental closing costs. Final consideration is subject to various post closing adjustments. In connection with the transaction, the Company repaid Healthfield’s existing long-term debt, including accrued interest and prepayment penalties, aggregating $195.3 million. The Company funded the purchase price using (i) $363.3 million of borrowings under a new senior term loan facility, exclusive of debt issuance costs, (see Note 9); (ii) 3,194,137 shares of Gentiva common stock at a fair value of $53.3 million, determined based on the average stock price for the period beginning two days prior and ending two days after the measurement date, February 24, 2006; and (iii) existing cash balances of $49.4 million.

     The Company acquired Healthfield to strengthen and expand the Company’s presence in the Southeast United States, which has favorable demographic trends and includes important Certificate of Need states, diversify the Company’s business mix, provide a meaningful platform for the Company to enter the hospice business, as well as expansion into respiratory therapy and HME services and infusion therapy as a direct provider of services, and expand its current specialty programs.

     The transaction was accounted for in accordance with the provisions of SFAS No. 141, “Business Combination” (“SFAS 141”). Accordingly, Healthfield’s results of operations are included in the Company’s consolidated financial statements from the acquisition date. The purchase price was allocated to the underlying assets acquired and liabilities assumed based on their estimated fair values at the date of the acquisition. The excess of the purchase price over the fair value of the net identifiable tangible and intangible assets acquired is recorded as goodwill. The Company has determined the estimated fair values based on independent appraisals, discounted cash flows, quoted market prices, and management estimates derived from an independent valuation analysis of the intangible assets acquired.

     The following table summarizes the estimated fair values of the assets acquired and liabilities assumed as of the acquisition date (in thousands):

     The valuation of the intangible assets by component and their respective useful life is as follows (in thousands):

     The estimated fair values of the assets acquired and liabilities assumed as noted above reflect the completion of the independent valuation analysis and post closing adjustments through October 1, 2006. The Company expects that between 15 percent and 20 percent of the aggregate amount of goodwill and identifiable intangible assets will be amortizable for tax purposes.

Pro Forma Results

     The following unaudited pro forma financial information presents the combined results of operations of the Company and Healthfield as if the acquisition had occurred at January 3, 2005, the beginning of the first quarter of fiscal 2005. The pro forma results presented below for the nine months ended October 1, 2006 combine the results of the Company for such period and the historical results of Healthfield from January 1, 2006 through February 28, 2006. The pro forma results presented below for the three months and nine months ended October 2, 2005 combine the results of the Company for such periods and the historical results of Healthfield for the respective three month and nine month periods (in thousands, except per share data):

     The pro forma results above reflect adjustments for (i) interest on debt incurred, at the Company’s weighted average interest rate of 7.1 percent, (ii) amortization of identifiable intangibles related to the Healthfield acquisition and (iii) income tax provision at a normalized tax rate of 39 percent for each period. The information presented above is for illustrative purposes only and is not necessarily indicative of results that would have been achieved if the acquisition had occurred as of the beginning of the Company’s 2006 and 2005 fiscal years.

      Heritage Home Care Services

     On May 1, 2005, the Company completed the purchase of certain assets and the operations of Heritage Home Care Services, Inc. (“Heritage”), a Utah-based provider of home healthcare services, and assumed certain liabilities related to contracts and office leases with respect to the period after the closing date, pursuant to an asset purchase agreement, for cash consideration of $11.5 million, exclusive of working capital requirements. In connection with the acquisition, the Company also incurred transaction costs of $0.6 million. A valuation analysis of the purchase price was performed and costs have been recorded as goodwill ($5.4 million), fixed assets and other assets ($0.4 million), and identifiable intangible assets ($6.3 million).

6. Restructuring and Integration Costs

     During the third quarter and first nine months of fiscal 2006, the Company recorded restructuring and integration costs of approximately $1.7 million and $4.4 million, respectively, as further described below.

      CareCentrix Restructuring Activities

     During the first nine months of fiscal 2006, the Company recorded charges of $0.7 million and in the fourth quarter of fiscal 2005 recorded charges of $0.8 million, in connection with a restructuring plan associated with its CareCentrix operations. This plan included the closing and consolidation of two Regional Care Centers in response to changes primarily in the nature of services provided to CIGNA Health Corporation (“Cigna”) members under an amended contract entered into in late 2005. The Company completed this restructuring during the second quarter of fiscal 2006.

      Integration Activities

     The Company recorded charges of $1.7 million and $3.7 million during the third quarter and first nine months of fiscal 2006, respectively, in connection with integration activities relating to the Healthfield acquisition. Charges include severance costs in connection with the termination of personnel, discretionary bonuses to certain employees in connection with the Healthfield acquisition and write off of prepaid fees in connection with the former credit facility that was terminated on February 28, 2006. The Company expects to incur additional integration costs throughout fiscal 2006, but the aggregate amount of such costs cannot be determined at this time.

     The costs incurred and cash expenditures associated with CareCentrix restructuring and Healthfield integration activities by component were as follows (in thousands):

		CareCentrix Restructuring												Integration Activities
		Compensation				Facility								Compensation
		and Severance				Lease and								and Severance
		Costs				Other Costs				Total				Costs				Other Costs				Total
Beginning Balance at January 2, 2005		$	—			$	—			$	—			$	—			$	—			$	—
Charge in 2005			770				19				789				—				—				—
Cash expenditures			—				(19	)			(19	)			—				—				—
Ending Balance at January 1, 2006			770				—				770				—				—				—
Charge in first quarter 2006			643				15				658				1,232				107				1,339
Cash expenditures			(1,407	)			(14	)			(1,421	)			(816	)			—				(816	)
Asset write off			—				—				—				—				(107	)			(107	)
Ending Balance at April 2, 2006			6				1				7				416				—				416
Charge in second quarter 2006			52				—				52				196				475				671
Cash expenditures			(58	)			(1	)			(59	)			(223	)			(475	)			(698	)
Ending Balance at July 2, 2006			—				—				—				389				—				389
Charge in third quarter 2006			—				—				—				939				753				1,692
Cash expenditures			—				—				—				(422	)			(751	)			(1,173	)
Ending Balance at October 1, 2006			—				—				—				906				2				908

     The balance of unpaid charges relating to Healthfield integration activities as well as a restructuring plan adopted in fiscal 2002 aggregated $2.1 million at October 1, 2006 and January 1, 2006, of which the 2002 plan had remaining lease obligations of $1.2 million and $1.4 million at October 1, 2006 and January 1, 2006, respectively, which was included in other accrued expenses in the consolidated balance sheets.

     7.  Goodwill and Other Intangible Assets

     Goodwill and identifiable intangible assets were recorded during first nine months of fiscal 2006 in connection with acquisition activity further described in Note 5. The gross carrying amount and accumulated amortization of each category of identifiable intangible assets and goodwill as of October 1, 2006 and January 1, 2006 were as follows (in thousands):

     Goodwill acquired in connection with the Healthfield acquisition has been assigned to the Home Health segment. All intangible assets have been assigned to the Home Health segment with the exception of $9.3 million in certificate of need associated with a Hospice certificate of need that has been assigned to the Other Related Services segment. The estimated amortization expense for the remainder of 2006 is $1.0 million and for each of the next five succeeding years approximates $4.0 million for fiscal years 2007 through 2009, $3.8 million for fiscal year 2010 and $3.7 million for fiscal year 2011.

     8.  Earnings Per Share

     Basic and diluted earnings per share for each period presented has been computed by dividing net income by the weighted average number of shares outstanding for each respective period. The computations of the basic and diluted per share amounts were as follows (in thousands, except per share amounts):

     9.  Revolving Credit Facility and Long-Term Debt

Credit Arrangements

     Prior to February 28, 2006, the Company had a Credit Facility that provided up to $55 million in borrowings, including up to $40 million which was available for letters of credit. The Company could borrow up to a maximum of 80 percent of the net amount of eligible accounts receivable, as defined, less any reasonable and customary reserves, as defined, required by the lender.

     On February 28, 2006, in connection with the Healthfield acquisition, the Company entered into a new credit agreement (“Credit Agreement”). The Credit Agreement provides for an aggregate borrowing amount of $445.0 million of senior secured credit facilities consisting of (i) a seven year term loan of $370.0 million repayable in quarterly installments of 1 percent per annum (with the remaining balance due at maturity on March 31, 2013) and (ii) a six year revolving credit facility of $75.0 million, of which $55.0 million is available for the issuance of letters of credit and $10.0 million is available for swing line loans. There is a pre-approved $25.0 million increase available to the revolving credit facility. Upon the occurrence of certain events, including the issuance of capital stock, the incurrence of additional debt (other than that specifically allowed under the Credit Agreement), certain asset sales where the cash proceeds are not reinvested, or if the Company has excess cash flow (as defined), mandatory prepayments of the term loan are required in the amounts specified in the Credit Agreement.

     Interest under the Credit Agreement accrues at Base Rate or Eurodollar Rate (plus 1.25 percent for Base Rate Loans and 2.25 percent for Eurodollar Rate Loans) for both the revolving credit facility and the term loan. Overdue amounts bear interest at 2 percent per annum above the applicable rate. After the completion of two post-closing fiscal quarters, the interest rates under the Credit Agreement are reduced if the Company meets certain reduced leverage targets (as defined) as follows:

     The Company is also subject to a revolving credit commitment fee equal to 0.5 percent per annum of the average daily difference between the total revolving credit commitment and the total outstanding borrowings and letters of credit, excluding amounts outstanding under swing loans. After the completion of two post-closing fiscal quarters, the commitment fee is reduced to 0.375 percent per annum if the Company’s consolidated leverage ratio (as defined) is less than 3.5. As of October 1, 2006, the consolidated leverage ratio (as defined) approximated 4.2.

     The Credit Agreement requires the Company to meet certain financial tests. These tests include a consolidated leverage ratio (as defined) and a consolidated interest coverage ratio (as defined). The Credit Agreement also contains additional covenants which, among other things, require the Company to deliver to the lenders specified financial information, including annual and quarterly financial information, and limit the Company’s ability to do the following, subject to various exceptions and limitations: (i) merge with other companies; (ii) create liens on its property; (iii) incur additional debt obligations; (iv) enter into transactions with affiliates, except on an arms-length basis; (v) dispose of property; (vi) make capital expenditures; and (vii) pay dividends or acquire capital stock of the Company or its subsidiaries. As of October 1, 2006, the Company was in compliance with the covenants in the Credit Agreement.

     To assist in managing the potential interest rate risk associated with its floating rate term loan under the Credit Agreement, on July 3, 2006, the Company entered into a two year interest rate swap agreement with a notional value of $170 million. Under the swap agreement, the Company pays a fixed rate of 5.665 percent per annum plus an applicable margin (an aggregate of 7.915 percent per annum) on the $170 million rather than a fluctuating rate plus an applicable margin. (See also Note 2.)

     During the quarter ended October 1, 2006, the Company made prepayments of $7.0 million under its term loan. As of October 1, 2006, the Company had outstanding borrowings under the term loan of $353.0 million. The term loan requires the Company to make quarterly installment payments of $925,000, beginning June 30, 2006, with the remaining balance due at maturity on March 31, 2013. Prepayments are first applied against the quarterly installments in direct order of maturity for eight installments and then pro rata based on the remaining outstanding principal amount of such installments, including the balance due at maturity. As of October 1, 2006, maturities under the term loan were as follows: no maturities through fiscal 2007, $1.8 million for fiscal 2008, $3.6 million per year for fiscal 2009 through fiscal 2010 and $336.7 million thereafter. There were no borrowings outstanding under the revolving credit facility as of October 1, 2006.

     Total outstanding letters of credit were approximately $20.1 million at October 1, 2006, under the current Credit Agreement, and $20.2 million at January 1, 2006, under the former Credit Facility. The letters of credit, which expire one year from the date of issuance, were issued to guarantee payments under the Company’s workers’ compensation program and for certain other commitments. The Company also had outstanding surety bonds of $2.6 million at October 1, 2006 and $2.5 million at January 1, 2006.

Guarantee and Collateral Agreement

     On February 28, 2006, the Company also entered into a Guarantee and Collateral Agreement, among the Company and certain of its subsidiaries, in favor of the Administrative Agent (the “Guarantee and Collateral Agreement”). The Guarantee and Collateral Agreement grants a collateral interest in all real property and personal property of the Company and its subsidiaries, including stock of its subsidiaries. The Guarantee and Collateral Agreement also provides for a guarantee of the Company’s obligations under the Credit Agreement by substantially all subsidiaries of the Company.

Other

     The Company has no off-balance sheet arrangements and has not entered into any transactions involving unconsolidated, limited purpose entities or commodity contracts.

     For the third quarter and first nine months of fiscal 2006, net interest expense was approximately $6.5 million and $14.9 million, respectively, consisting primarily of interest expense associated with the term loan borrowings and fees associated with the Credit Agreement and outstanding letters of credit and amortization of debt issuance costs, partially offset by interest income of $0.9 million and $2.5 million, respectively, earned on short-term investments and existing cash balances. Net interest income for the third quarter and first nine months of fiscal 2005 represented interest income of approximately $0.7 million and $2.1 million, respectively, partially offset by fees relating to the Credit Facility and outstanding letters of credit.

     10.  Shareholders’ Equity

     Changes in shareholders’ equity for the nine months ended October 1, 2006 were as follows (in thousands except share amounts):

     Comprehensive income amounted to $4.2 million and $4.3 million for the third quarter of fiscal 2006 and fiscal 2005, respectively, and $14.1 million and $17.0 million for the first nine months of fiscal 2006 and fiscal 2005, respectively.

     During the three months ended October 2, 2005, the Company purchased 65,800 shares of its common stock at an aggregate cost of approximately $1.2 million or $18.07 per share. For the first nine months of fiscal 2005, the Company purchased 822,100 shares of its common stock at an aggregate cost of approximately $13.5 million or $16.44 per share. On April 14, 2005, the Company extended its stock repurchase activity with the announcement of the Company’s fifth stock repurchase program authorized by the Company’s Board of Directors, under which the Company could repurchase and retire up to an additional 1,500,000 shares of its outstanding common stock. The repurchases can occur periodically in the open market or through privately negotiated transactions based on market conditions and other factors. The Company made no repurchases of its common stock during the nine months ended October 1, 2006.

     As of October 1, 2006, the Company had remaining authorization to repurchase an aggregate of 683,396 shares of its outstanding common stock.

     11.  Equity-Based Compensation Plans

     In 2004, the shareholders of the Company approved the 2004 Equity Incentive Plan (the “2004 Plan”) as a replacement for the 1999 Stock Incentive Plan (the “1999 Plan”). Under the 2004 Plan, 3.5 million shares of common stock plus any remaining shares authorized under the 1999 Plan as to which awards had not been made are available for grant. The maximum number of shares of common stock for which grants may be made in any calendar year to any 2004 Plan participant is 500,000. The 2004 Plan permits the grant of (i) incentive stock options, (ii) non-qualified stock options, (iii) stock appreciation rights, (iv) restricted stock, (v) stock units and (vi) cash. The exercise price of options granted under the 2004 Plan can generally not be less than the fair market value of the Company’s common stock on the date of grant.

     In 1999, the Company adopted the Stock & Deferred Compensation Plan for Non-Employee Directors, which was amended and restated on January 1, 2004 and further amended on May 6, 2005. Under the plan, each non-employee director receives an annual deferred stock unit award valued at $40,000 credited quarterly to the director’s share unit account, which will be paid to the director in shares of the Company’s common stock following termination of the director’s service on the Board. The total number of shares of common stock reserved for issuance under this plan is 150,000.

     In 1999, the Company adopted an employee stock purchase plan (“ESPP”), as amended on February 24, 2005, subject to shareholder approval which was obtained on May 6, 2005, to provide an aggregate of 2,400,000 shares of common stock available for issuance under the ESPP. All employees of the Company, who have been employed for 60 days or more prior to the beginning of an offering period and who customarily work at least twenty hours per week, are eligible to purchase stock under this plan. The Compensation, Corporate Governance and Nominating Committee of the Company’s Board of Directors administers the plan and has the power to determine the terms and conditions of each offering of common stock. The purchase price of the shares under the ESPP is the lesser of 85 percent of the fair market value of the Company’s common stock on the first business day or the last business day of the six month offering period. Employees may purchase shares having a fair market value of up to $25,000 per calendar year. The maximum number of shares of common stock that may be sold to any employee in any offering, however, will generally be 10 percent of that employee’s compensation during the period of the offering.

     On December 15, 2005, the Compensation, Corporate Governance and Nominating Committee of the Board of Directors of the Company approved the acceleration of vesting of stock options exercisable for approximately 716,000 shares of the Company’s common stock under the Company’s 1999 Plan, so that the options became fully vested and exercisable as of the close of business on December 30, 2005. The other terms of the options remain unchanged. The affected options, which represented approximately 20 percent of the Company’s total outstanding options, were granted from June 14, 2002 through January 27, 2004 and have exercise prices that range from $7.50 to $12.87 per share and a weighted average exercise price of $11.08 per share. These options include approximately 393,000 options held by the executive officers of the Company. Of the options subject to accelerated vesting, approximately 52 percent had original vesting dates between January 27, 2006 and January 3, 2007 and approximately 37 percent had original vesting dates between January 27, 2007 and December 31, 2007, with the remainder vesting after December 31, 2007.

     Accelerating the vesting of these options eliminates the future compensation expense that the Company would have otherwise recognized in its consolidated statements of income with respect to these options when SFAS No. 123(Revised), “Share-Based Payment” (“SFAS 123(R)”), became effective. SFAS 123(R) became effective for the Company on January 2, 2006 and requires that compensation expense associated with stock options be recognized in the Company’s consolidated statements of income, instead of as previously presented on a pro forma basis within a footnote disclosure included in the Company’s consolidated financial statements. The future compensation expense that was eliminated as a result of the acceleration of the vesting of these options was approximately $2.3 million on an after tax basis.

     Prior to January 2, 2006, the Company accounted for equity-based compensation using the intrinsic value method prescribed in Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”), and related interpretations. Under this approach, the imputed cost of stock option grants and discounts offered under the Company’s ESPP is disclosed, based on the vesting provisions of the individual grants, but not charged to expense.

     Effective January 2, 2006, the Company adopted the fair value method of accounting for equity-based compensation arrangements in accordance with SFAS 123(R). Under the provisions of SFAS 123(R), the estimated fair value of share based awards granted under the Company’s equity-based compensation plans is recognized as compensation expense over the vesting period of the award. The Company used the modified prospective method of transition under which compensation expense is recognized for all share-based payments (i) granted after the effective date of adoption and (ii) granted prior to the effective date of adoption and that remain unvested on the date of adoption. In accordance with the modified prospective method of transition to SFAS 123(R), the Company has not restated prior period financial statements to reflect compensation expense under SFAS 123(R).

     Stock option grants in fiscal 2006 fully vest over a four year period based on a vesting schedule that provides for one-half vesting after year two and an additional one-fourth vesting after each of years three and four. Stock option grants in fiscal 2005 fully vest over a four year period based on a vesting schedule that provides for one-third vesting after each of years one, three and four. Prior to the acceleration of vesting of certain stock options, as discussed in more detail above, stock option grants that were awarded in fiscal 2004 and prior years were scheduled to fully vest over periods ranging from three to six years.

     For the third quarter and the first nine months ended October 1, 2006, the Company recorded equity-based compensation expense of $1.2 million and $3.0 million, respectively, which is reflected as selling, general and administrative expense in the consolidated statements of income, as calculated on a straight-line basis over the vesting periods of the related options in accordance with the provisions of SFAS 123(R). For the third quarter and the first nine months ended October 2, 2005, the Company recorded no compensation expense pursuant to the provisions of APB 25.

     The weighted-average fair values of the Company’s stock options granted during the first nine months of fiscal 2006 and fiscal 2005, calculated using the Black-Scholes option-pricing model and other assumptions, are as follows:

     For stock options granted during the fiscal 2005 and 2006 periods, the expected life of an option is estimated to be 2.5 years following its vesting date and forfeitures are reflected in the calculation using an estimate based on experience.

     Compensation expense is calculated for the fair value of the employee’s purchase rights under the ESPP, using the Black-Scholes option pricing model. Assumptions for the first nine months of fiscal 2006 and fiscal 2005 are as follows:

     A summary of Gentiva stock option activity as of October 1, 2006 and changes during the nine months then ended is presented below:

     During the first nine months of fiscal 2006, the Company granted 947,500 stock options to officers and employees under its 2004 Plan at an average exercise price of $18.22 and a weighted-average, grant-date fair value of options of $7.28. The total intrinsic value of options exercised during the nine months ended October 1, 2006 and October 2, 2005 was $7.9 million and $4.0 million, respectively.

     A summary of the status of the Company’s nonvested options as of October 1, 2006 and changes during the nine months then ended is presented below:

     As of October 1, 2006, the Company had $6.4 million of total unrecognized compensation cost related to nonvested stock options. This compensation expense is expected to be recognized over a weighted-average period of 1.2 years. The total fair value of options vested during the first nine months of fiscal 2006 and 2005 was $2.0 million and $1.1 million, respectively.

     The following table presents net income and basic and diluted income per common share, for the third quarter and first nine months ended October 2, 2005, had the Company elected to recognize compensation cost based on the fair value at the grant dates for stock option awards and discounts for stock purchases under the Company’s ESPP, consistent with the method prescribed by SFAS 123, as amended by SFAS No. 148 “Accounting for Stock-Based Compensation — Transition and Disclosure” (“SFAS 148”) (in thousands, except per share amounts):

     In addition to the matters referenced in this Note 12, the Company is party to certain legal actions arising in the ordinary course of business, including legal actions arising out of services rendered by its various operations, personal injury and employment disputes. Management does not expect that these other legal actions will have a material adverse effect on the business or financial condition of the Company.

Indemnifications

     Gentiva became an independent, publicly owned company on March 15, 2000, when the common stock of the Company was issued to the stockholders of Olsten Corporation, a Delaware corporation (“Olsten”), the former parent corporation of the Company (the “Split-Off”). In connection with the Split-Off, the Company agreed to assume, to the extent permitted by law, and to indemnify Olsten for, the liabilities, if any, arising out of the home health services business.

     In connection with the Healthfield transaction, the parties have agreed to indemnify each other for certain liabilities and representations as set forth in the related acquisition agreement.

Government Matters

PRRB Appeal

     The Company’s annual cost reports, which were filed with the Centers for Medicare & Medicaid Services (“CMS”), were subject to audit by the fiscal intermediary engaged by CMS. In connection with the audit of the Company’s 1997 cost reports, the Medicare fiscal intermediary made certain audit adjustments related to the methodology used by the Company to allocate a portion of its residual overhead costs. The Company filed cost reports for years subsequent to 1997 using the fiscal intermediary’s methodology. The Company believed the methodology it used to allocate such overhead costs was accurate and consistent with past practice accepted by the fiscal intermediary; as such, the Company filed appeals with the PRRB concerning this issue with respect to cost reports for the years 1997, 1998 and 1999. The Company’s consolidated financial statements for the years 1997, 1998 and 1999 had reflected use of the methodology mandated by the fiscal intermediary.

     In June 2003, the Company and its Medicare fiscal intermediary signed an Administrative Resolution relating to the issues covered by the appeals pending before the PRRB. Under the terms of the Administrative Resolution, the fiscal intermediary agreed to reopen and adjust the Company’s cost reports for the years 1997, 1998 and 1999 using a modified version of the methodology used by the Company prior to 1997. This modified methodology will also be applied to cost reports for the year 2000, which are currently under audit. The Administrative Resolution required that the process to (i) reopen all 1997 cost reports, (ii) determine the adjustments to allowable costs through the issuance of Notices of Program Reimbursement and (iii) make appropriate payments to the Company, be completed in early 2004. Cost reports relating to years subsequent to 1997 were to be reopened after the process for the 1997 cost reports was completed. During fiscal 2004, the Company received an aggregate of $10.4 million in connection with the reopening of the 1997 and 1998 cost reports.

     The fiscal intermediary completed the reopening of the 1999 cost reports. In connection with the reopening of the 1999 cost reports, the Company received an aggregate amount of $5.5 million, of which $1.9 million and $3.6 million was recorded as net revenues during the first quarter of fiscal 2006 and the fourth quarter of fiscal 2005, respectively. The time frame for resolving all items relating to the 2000 cost reports cannot be determined at this time.

Subpoena

     On April 17, 2003, the Company received a subpoena from the Department of Health and Human Services, Office of the Inspector General, Office of Investigations (“OIG”). The subpoena seeks information regarding the Company’s implementation of settlements and corporate integrity agreements entered into with the government, as well as the Company’s treatment on cost reports of employees engaged in sales and marketing efforts. With respect to the cost report issues, the government has preliminarily agreed to narrow the scope of production to the period from January 1, 1998 through September 30, 2000. On February 17, 2004, the Company received a subpoena from the U.S. Department of Justice (“DOJ”) seeking additional information related to the matters covered by the OIG subpoena. The Company has provided documents and other information requested by the OIG and DOJ pursuant to their subpoenas and similarly intends to cooperate fully with any future OIG or DOJ information requests. To the Company’s knowledge, the government has not filed a complaint against the Company.

     13.  Income Taxes

     The Company recorded a federal and state income tax provision of $1.5 million for the third quarter of fiscal 2006, of which $0.7 million represented a current tax benefit and $2.2 million represented a deferred tax provision. For the nine months ended October 1, 2006, the Company recorded a federal and state income tax provision of $8.8 million representing a current tax benefit of $0.1 million and a deferred tax provision of $8.9 million.

     The difference between the federal statutory income tax rate of 35 percent and the Company’s effective rate of 22.5 percent for the quarter ended October 1, 2006 is primarily due to (i) the impact of the adoption of SFAS 123(R) (approximately 4.8 percent), (ii) state taxes and other items partially offset by tax exempt interest (approximately 4.3 percent), offset by (iii) the release of $0.8 million of tax reserves associated with the expiration of the statute of limitations (approximately 11.6 percent) and (iv) additional state net operating loss carryforwards resulting from the finalization of prior year state tax audits (approximately 10.0 percent).

     The difference between the federal statutory income tax rate of 35 percent and the Company’s effective rate of 36.5 percent for the first nine months of fiscal 2006 is primarily due to (i) the impact of the adoption of SFAS 123(R) (approximately 3.4 percent), (ii) state taxes and other items partially offset by tax exempt interest (approximately 4.2 percent), offset by (iii) the release of $0.8 million of tax reserves associated with the expiration of the statute of limitations (approximately 3.3 percent) and (iv) additional state net operating loss carryforwards resulting from the finalization of prior year state tax audits (approximately 2.8 percent).

     The Company recorded federal and state income tax provisions of $2.8 million and $4.3 million for the third quarter and first nine months of fiscal 2005, respectively. The income tax provision for the first nine months of fiscal 2005 included a $4.2 million release of tax reserves related to the favorable resolution of tax audit issues for the years 1997 through 2000. The Company had agreed to assume the responsibility for these items in connection with its Split-Off from Olsten in March 2000. The difference between the federal statutory income tax rate of 35 percent and the Company’s effective tax rate of 20 percent for the first nine months is primarily due to the release of tax reserves and state taxes.

     Deferred tax assets and deferred tax liabilities were as follows (in thousands):

     At October 1, 2006, the Company had federal tax credit carryforwards of $1.5 million and federal net operating loss carryforwards of $37.3 million, all of which expire in 2025. Deferred tax assets relating to the federal net operating loss carryforwards approximate $13.1 million. In addition, the Company had state net operating loss carryforwards that expire between 2006 and 2013. Deferred tax assets relating to the state net operating loss carryforwards approximate $8.6 million. The Company maintains a valuation allowance of $4.1 million in recognition that certain state net operating loss carryforwards may expire before realization.

     14.  Business Segment Information

     The Company’s operations involve servicing patients and customers through its three reportable business segments: Home Health, CareCentrix and Other Related Services, which encompasses the Company’s hospice, respiratory therapy and HME, infusion therapy and consulting services businesses. Prior to the acquisition of Healthfield, the Home Health segment included the Company’s consulting business and one HME location.

Home Health

     The Home Health segment is comprised of direct home nursing and therapy services operations, including specialty programs.

     Direct home nursing and therapy services operations are conducted through licensed and Medicare-certified agencies from which the Company provides various combinations of skilled nursing and therapy services, paraprofessional nursing services and homemaker services to pediatric, adult and elder patients. The Company’s direct home nursing and therapy services operations also deliver services to its customers through focused specialty programs that include:

	•		Gentiva Orthopedics Program, which provides individualized home orthopedic rehabilitation services to patients recovering from joint replacement or other major orthopedic surgery;
	•		Gentiva Safe Strides (SM) Program, which provides therapies for patients with balance issues who are prone to injury or immobility as a result of falling;
	•		Gentiva Cardiopulmonary Program, which helps patients and their physicians manage heart and lung health in a home-based environment; and
	•		Gentiva Rehab Without Walls, which provides home and community-based neurorehabilitation therapies for patients with traumatic brain injury, cerebrovascular accident injury and acquired brain injury, as well as a number of other complex rehabilitation cases.

CareCentrix

     The CareCentrix segment encompasses Gentiva’s ancillary care benefit management and the coordination of integrated homecare services for managed care organizations and health benefit plans. CareCentrix operations provide an array of administrative services and coordinate the delivery of home nursing services, acute and chronic infusion therapies, home medical equipment, and respiratory products and services for managed care organizations and health benefit plans. CareCentrix accepts case referrals from a wide variety of sources, verifies eligibility and benefits and transfers case requirements to the providers for services to the patient. CareCentrix provides services to its customers, including the fulfillment of case requirements, care management, provider credentialing, eligibility and benefits verification, data reporting and analysis, and coordinated centralized billing for all authorized services provided to the customer’s enrollees.

Other Related Services

      Hospice

     Hospice serves terminally ill patients in the southeast United States. Comprehensive management of the healthcare services and products needed by hospice patients and their families are provided through the use of an interdisciplinary team. Each hospice patient is assigned an interdisciplinary team comprised of a physician, nurse(s), home health aide(s), medical social worker(s) and a chaplain, as well as other care professionals.

      Respiratory Therapy and Home Medical Equipment

     Respiratory therapy and HME services are provided to patients at home through branch locations primarily in the southeast United States. Patients are offered a broad portfolio of products and services that serve as an adjunct to traditional home health nursing and hospice care. Respiratory therapy services are provided to patients who suffer from a variety of conditions including asthma, chronic obstructive pulmonary diseases, cystic fibrosis and other respiratory conditions. Home medical equipment includes hospital beds, wheelchairs, ambulatory aids, bathroom aids, patient lifts and rehabilitation equipment.

      Infusion Therapy

     Infusion therapy is provided to patients at home through pharmacy locations in Alabama, Georgia and North Carolina. Infusion therapy serves as a complement to the Company’s traditional service offering, providing clients with a comprehensive home health provider while diversifying the Company’s revenue base. Services provided include: (i) enteral nutrition, (ii) antibiotic therapy, (iii) total parenteral nutrition, (iv) pain management, (v) chemotherapy, (vi) patient education and training and (vii) nutrition management.

      Consulting

     The Company provides consulting services to home health agencies through its Gentiva Consulting unit. These services include billing and collection activities, on-site agency support and consulting, operational support and individualized strategies for reduction of days sales outstanding.

Corporate Expenses

     Corporate expenses consist of costs relating to executive management and corporate and administrative support functions that are not directly attributable to a specific segment, including equity-based compensation expense. Corporate and administrative support functions represent primarily information services, accounting and reporting, tax compliance, risk management, procurement, marketing, legal and human resource benefits and administration.

Other Information

     The Company’s senior management evaluates performance and allocates resources based on operating contributions of the reportable segments, which exclude corporate expenses, depreciation, amortization and net interest costs, but include revenues and all other costs directly attributable to the specific segment. Intersegment revenues represent Home Health segment revenues primarily generated from services provided to the CareCentrix segment. Segment assets represent net accounts receivable, inventory, identifiable intangible assets, goodwill and certain other assets associated with segment activities. Intersegment assets represent accounts receivable associated with services provided by the Home Health segment to the CareCentrix segment. All other assets are assigned to corporate assets for the benefit of all segments for the purposes of segment disclosure.

     For the third quarter and nine months ended October 1, 2006, net revenues relating to the Company’s participation in Medicare amounted to $136.1 million and $367.9 million, respectively, of which $119.1 million and $329.9 million, respectively, was included in the Home Health segment and $17.0 million and $38.0 million, respectively, was included in the Other Related Services segment. For the third quarter and first nine months ended October 2, 2005, net revenues from Medicare amounted to $67.3 million and $194.4 million, respectively, all of which was included in the Home Health segment. Revenues from Cigna amounting to $52.1 million and $64.7 million for the third quarter of fiscal 2006 and 2005, respectively, and $160.2 million and $186.2 million for the first nine months of fiscal 2006 and 2005, respectively, were included in the CareCentrix segment.

     Net revenues associated with the Other Related Services segment are as follows (in thousands):

										Other
		Home Health				CareCentrix				Related Services				Total
Three months ended October 1, 2006 (unaudited)
Net revenue — segments		$	192,343			$	64,829			$	32,048			$	289,220
Intersegment revenues															(3,051	)
Total net revenue														$	286,169
Operating contribution		$	23,567	(1)		$	5,661			$	6,333			$	35,561
Corporate expenses															(17,769	)(1)
Depreciation and amortization															(4,393	)
Interest expense, net															(6,546	)
Income before income taxes														$	6,853
Three months ended October 2, 2005 (unaudited)
Net revenue — segments		$	137,740			$	84,569			$	1,388			$	223,697
Intersegment revenues															(4,138	)
Total net revenue														$	219,559
Operating contribution		$	12,865			$	6,314			$	208			$	19,387
Corporate expenses															(10,398	)
Depreciation and amortization															(2,291	)
Interest income, net															385
Income before income taxes														$	7,083
Nine months ended October 1, 2006 (unaudited)
Net revenue — segments		$	549,791	(1,3)		$	199,411	(2)		$	74,071			$	823,273
Intersegment revenues															(9,803	)
Total net revenue														$	813,470
Operating contribution		$	68,648	(1,3)		$	18,346	(2)		$	13,839			$	100,833
Corporate expenses															(50,536	)(1)
Depreciation and amortization															(11,391	)
Interest expense, net															(14,863	)
Income before income taxes														$	24,043
Segment assets		$	588,250			$	49,870			$	28,147			$	666,267
Intersegment assets															(1,048	)
Corporate assets															175,042
Total assets														$	840,261
Nine months ended October 2, 2005 (unaudited)
Net revenue — segments		$	405,898			$	250,572			$	3,980			$	660,450
Intersegment revenues															(13,649	)
Total net revenue														$	646,801
Operating contribution		$	36,085			$	20,321			$	705			$	57,111
Corporate expenses															(31,154	)(4)
Depreciation and amortization															(5,938	)
Interest income, net															1,262
Income before income taxes														$	21,281
Segment assets		$	76,896			$	65,785			$	1,258			$	143,939
Intersegment assets															(1,288	)
Corporate assets															193,220
Total assets														$	335,871