FORM 10--Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
(Mark One)
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2005
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 number 0-8527
DIALYSIS CORPORATION OF AMERICA
(Exact name of registrant as specified in its charter)
Florida | 59-1757642 | |
(State or other jurisdiction of incorporation | (I.R.S. Employer | |
or organization) | Identification No.) |
1302 Concourse Drive, Linthicum, Maryland | 21090 | |
(Address of principal executive offices) | (Zip Code) |
(410) 694-0500
(Registrant’s telephone number, including area code)
NOT APPLICABLE
(Former name, former address and former fiscal year, if changed
since last report)
Indicate by check b whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes x or No o
Indicate by check b whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).
Yes o or No x
Common Stock Outstanding
Common Stock, $.01 par value - 8,666,565 shares as of July 31, 2005.
DIALYSIS CORPORATION OF AMERICA AND SUBSIDIARIES
INDEX
PART I -- FINANCIAL INFORMATION
The Consolidated Financial Statements (Unaudited) for the three months and six months ended June 30, 2005 and June 30, 2004, include the accounts of the Registrant and its subsidiaries.
Item 1. Financial Statements
1) | Consolidated Statements of Income for the three months and six months ended June 30, 2005 and June 30, 2004 (Unaudited). |
2) | Consolidated Balance Sheets as of June 30, 2005 (Unaudited) and December 31, 2004. |
3) | Consolidated Statements of Cash Flows for the six months ended June 30, 2005 and June 30, 2004 (Unaudited). |
4) | Notes to Consolidated Financial Statements as of June 30, 2005 (Unaudited). |
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Item 4. Controls and Procedures
PART II -- OTHER INFORMATION
Item 1. Legal Proceedings
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Item 6. Exhibits
PART I -- FINANCIAL INFORMATION
Item 1. Financial Statements
DIALYSIS CORPORATION OF AMERICA AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
Three Months Ended June 30, | Six Months Ended June 30, | ||||||||||||
2005 | 2004 | 2005 | 2004 | ||||||||||
Operating revenues: | |||||||||||||
Medical service revenue | $ | 11,021,524 | $ | 9,496,608 | $ | 21,505,625 | $ | 17,906,132 | |||||
Other income | 119,902 | 92,610 | 248,297 | 309,655 | |||||||||
11,141,426 | 9,589,218 | 21,753,922 | 18,215,787 | ||||||||||
Operating cost and expenses: | |||||||||||||
Cost of medical services | 6,724,869 | 5,738,179 | 13,267,470 | 10,900,401 | |||||||||
Selling, general and administrative expenses | 3,454,250 | 2,901,470 | 6,698,011 | 5,696,940 | |||||||||
Provision for doubtful accounts | 204,649 | 200,042 | 452,643 | 348,337 | |||||||||
10,383,768 | 8,839,691 | 20,418,124 | 16,945,678 | ||||||||||
Operating income | 757,658 | 749,527 | 1,335,798 | 1,270,109 | |||||||||
Other income (expense): | |||||||||||||
Interest income on officer/director note | 1,421 | 960 | 2,713 | 1,921 | |||||||||
Interest expense to parent | (54,875 | ) | (7,758 | ) | (89,811 | ) | (10,776 | ) | |||||
Other income, net | 44,538 | 21,806 | 76,393 | 44,100 | |||||||||
(8,916 | ) | 15,008 | (10,705 | ) | 35,245 | ||||||||
Income before income taxes, minority interest | |||||||||||||
and equity in affiliate earnings | 748,742 | 764,535 | 1,325,093 | 1,305,354 | |||||||||
Income tax provision | 310,105 | 277,665 | 618,908 | 493,773 | |||||||||
Income before minority interest and equity in | |||||||||||||
affiliate earnings | 438,637 | 486,870 | 706,185 | 811,581 | |||||||||
Minority interest in income | |||||||||||||
of consolidated subsidiaries | (89,131 | ) | (130,610 | ) | (152,401 | ) | (186,442 | ) | |||||
Equity in affiliate earnings | 94,689 | 31,362 | 214,798 | 50,395 | |||||||||
Net income | $ | 444,195 | $ | 387,622 | $ | 768,582 | $ | 675,534 | |||||
Earnings per share: | |||||||||||||
Basic | $ | .05 | $ | .05 | $ | .09 | $ | .08 | |||||
Diluted | $ | .05 | $ | .04 | $ | .08 | $ | .08 |
See notes to consolidated financial statements.
DIALYSIS CORPORATION OF AMERICA AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
June 30, | December 31, | ||||||
2005 | 2004(A) | ||||||
(Unaudited) | |||||||
ASSETS | |||||||
Current assets: | |||||||
Cash and cash equivalents | $ | 892,197 | $ | 601,603 | |||
Accounts receivable, less allowance | |||||||
of $1,896,000 at June 30, 2005; | |||||||
$1,636,000 at December 31, 2004 | 8,598,589 | 8,592,476 | |||||
Inventories | 1,222,856 | 1,297,782 | |||||
Deferred income tax asset | 849,000 | 720,000 | |||||
Officer loan and interest receivable | 114,410 | 111,696 | |||||
Prepaid expenses and other current assets | 1,798,578 | 1,223,023 | |||||
Total current assets | 13,475,630 | 12,546,580 | |||||
Property and equipment: | |||||||
Land | 519,716 | 376,211 | |||||
Buildings and improvements | 2,619,400 | 2,352,191 | |||||
Machinery and equipment | 8,294,637 | 8,087,349 | |||||
Leasehold improvements | 5,240,159 | 4,674,704 | |||||
16,673,912 | 15,490,455 | ||||||
Less accumulated depreciation and amortization | 7,248,180 | 6,496,571 | |||||
9,425,732 | 8,993,884 | ||||||
Goodwill | 3,649,014 | 3,649,014 | |||||
Other assets | 1,340,768 | 1,300,236 | |||||
Total other assets | 4,989,782 | 4,949,250 | |||||
$ | 27,891,144 | $ | 26,489,714 | ||||
LIABILITIES AND STOCKHOLDERS’ EQUITY | |||||||
Current liabilities: | |||||||
Accounts payable | $ | 1,339,051 | $ | 1,625,930 | |||
Accrued expenses | 4,361,205 | 4,921,769 | |||||
Note payable and accrued interest payable to parent | 3,001,389 | 1,461,647 | |||||
Current portion of long-term debt | 1,075,000 | 513,000 | |||||
Acquisition liabilities - current portion | 380,298 | 380,298 | |||||
Total current liabilities | 10,156,943 | 8,902,644 | |||||
Advances from parent | 554,279 | 449,117 | |||||
Long-term debt, less current portion | 750,783 | 1,585,936 | |||||
Acquisition liabilities, net of current portion | 380,297 | 380,297 | |||||
Deferred income tax liability | 633,000 | 559,000 | |||||
Total liabilities | 12,475,302 | 11,876,994 | |||||
Minority interest in subsidiaries | 1,182,689 | 1,282,924 | |||||
Commitments and Contingencies | |||||||
Stockholders' equity: | |||||||
Common stock, $.01 par value, authorized 20,000,000 shares: 8,662,815 shares issued and outstanding at June 30, 2005; 8,485,815 shares issued and outstanding at December 31, 2004 | 86,628 | 84,858 | |||||
Additional paid-in capital | 5,090,151 | 4,957,146 | |||||
Retained earnings | 9,056,374 | 8,287,792 | |||||
Total stockholders' equity | 14,233,153 | 13,329,796 | |||||
$ | 27,891,144 | $ | 26,489,714 |
(A) | Reference is made to the company’s Annual Report on Form 10-K for the year ended December 31, 2004 filed with the Securities and Exchange Commission in March, 2005, and amended on Form 10-K/A1 dated August 9, 2005. |
See notes to consolidated financial statements.
DIALYSIS CORPORATION OF AMERICA AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
Six Months Ended | |||||||
June 30, | |||||||
2005 | 2004 | ||||||
Operating activities: | |||||||
Net income | $ | 768,582 | $ | 675,534 | |||
Adjustments to reconcile net income to net cash | |||||||
provided by (used in) operating activities: | |||||||
Depreciation | 814,193 | 713,067 | |||||
Amortization | 7,050 | 1,157 | |||||
Bad debt expense | 452,643 | 348,337 | |||||
Deferred income tax benefit | (65,217 | ) | (70,000 | ) | |||
Minority interest | 152,401 | 186,442 | |||||
Equity in affiliate earnings | (214,798 | ) | (50,395 | ) | |||
Increase (decrease) relating to operating activities from: | |||||||
Accounts receivable | (458,756 | ) | (1,765,345 | ) | |||
Inventories | 74,926 | (225,269 | ) | ||||
Interest receivable on officer loan | (2,714 | ) | (1,921 | ) | |||
Prepaid expenses and other current assets | (575,555 | ) | 5,868 | ||||
Accounts payable | (286,879 | ) | 14,096 | ||||
Accrued interest on note payable to parent | 24,742 | 8,856 | |||||
Accrued expenses | (560,564 | ) | 1,315,747 | ||||
Income taxes payable | --- | 115,783 | |||||
Net cash provided by operating activities | 130,054 | 1,271,957 | |||||
Investing activities: | |||||||
Purchase of minority interest in subsidiaries | --- | (670,000 | ) | ||||
Additions to property and equipment, net of minor disposals | (1,246,041 | ) | (1,960,456 | ) | |||
Payments received on physician affiliate loans | 7,667 | --- | |||||
Distributions from affiliate | 208,622 | 20,400 | |||||
Other assets | (45,740 | ) | (9,324 | ) | |||
Net cash used in investing activities | (1,075,492 | ) | (2,619,380 | ) | |||
Financing activities: | |||||||
Advances from parent | 105,162 | 106,977 | |||||
Note payable to parent | 1,515,000 | 885,008 | |||||
Payments on long-term debt | (273,153 | ) | (276,475 | ) | |||
Exercise of stock options | 134,775 | 5,400 | |||||
Capital contributions by subsidiaries’ minority members | 10,000 | --- | |||||
Distribution to subsidiary minority members | (255,752 | ) | (115,843 | ) | |||
Net cash provided by financing activities | 1,236,032 | 605,067 | |||||
Increase (decrease) in cash and cash equivalents | 290,594 | (742,356 | ) | ||||
Cash and cash equivalents at beginning of periods | 601,603 | 1,515,202 | |||||
Cash and cash equivalents at end of periods | $ | 892,197 | $ | 772,846 |
See notes to consolidated financial statements.
DIALYSIS CORPORATION OF AMERICA AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2005
(Unaudited)
NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Business
The company is in one business segment, kidney dialysis operations, providing outpatient hemodialysis services, home dialysis services, inpatient dialysis services and ancillary services associated with dialysis treatments. The company owns 21 operating dialysis centers located in Georgia, Maryland, New Jersey, Ohio, Pennsylvania, South Carolina and Virginia; manages two other dialysis facilities, one a 40% owned Ohio affiliate and the other an unaffiliated Georgia center, has six dialysis facilities under development; and has agreements to provide inpatient dialysis treatments to nine hospitals. See “Consolidation.”
Medical Service Revenue
Revenues by payor are:
Three Months Ended June 30, | Six Months Ended June 30, | ||||||||||||
2005 | 2004 | 2005 | 2004 | ||||||||||
Medicare | 51 | % | 48 | % | 51 | % | 49 | % | |||||
Medicaid and comparable programs | 9 | 8 | 9 | 8 | |||||||||
Hospital inpatient dialysis services | 4 | 5 | 5 | 6 | |||||||||
Commercial insurers and other private payors | 36 | 39 | 35 | 37 | |||||||||
100 | % | 100 | % | 100 | % | 100 | % |
Sources of revenue (in thousands):
Three Months Ended June 30, | Six Months Ended June 30, | ||||||||||||||||||||||||
2005 | 2004 | 2005 | 2004 | ||||||||||||||||||||||
Outpatient hemodialysis services | $ | 5,764 | 52 | % | $ | 4,362 | 46 | % | $ | 11,134 | 52 | % | $ | 8,168 | 46 | % | |||||||||
Home peritoneal dialysis services | 761 | 7 | 654 | 7 | 1,541 | 7 | 1,077 | 6 | |||||||||||||||||
Inpatient hemodialysis services | 482 | 4 | 521 | 5 | 1,110 | 5 | 1,110 | 6 | |||||||||||||||||
Ancillary services | 4,015 | 37 | 3,960 | 42 | 7,721 | 36 | 7,551 | 42 | |||||||||||||||||
$ | 11,022 | 100 | % | $ | 9,497 | 100 | % | $ | 21,506 | 100 | % | $ | 17,906 | 100 | % |
Consolidation
The consolidated financial statements include the accounts of Dialysis Corporation of America and its subsidiaries, collectively referred to as the “company.” All material intercompany accounts and transactions have been eliminated in consolidation. The company is a 55.6% owned subsidiary of Medicore, Inc., its parent. The company has a 40% interest in an Ohio dialysis center which it manages, which is accounted for on the equity method and not consolidated for financial reporting purposes.
Stock Split
On January 28, 2004, the company effected a two-for-one stock split. All share and per share data in the consolidated financial statements and notes have been adjusted to reflect the two-for-one split.
Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.
DIALYSIS CORPORATION OF AMERICA AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2005
(Unaudited)
NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--Continued
The company’s principal estimates are for estimated uncollectible accounts receivable as provided for in its allowance for doubtful accounts, estimated useful lives of depreciable assets, estimates for patient revenues from non-contracted payors, and the valuation allowance for deferred tax assets based on the estimated realizability of deferred tax assets. The company’s estimates are based on historical experience and assumptions believed to be reasonable given the available evidence at the time of the estimates. Actual results could differ from those estimates.
Vendor Volume Discounts
The company has contractual arrangements with certain vendors pursuant to which it receives discounts based on volume of purchases. These discounts are recorded in accordance with paragraph 4 of EITF 02-16 as a reduction in inventory costs resulting in reduced costs of sales as the related inventory is utilized.
Government Regulation
A substantial portion of the company’s revenues are attributable to payments received under Medicare, which is supplemented by Medicaid or comparable benefits in the states in which the company operates. Reimbursement rates under these programs are subject to regulatory changes and governmental funding restrictions. Laws and regulations governing the Medicare and Medicaid programs are complex and subject to interpretation. The company believes that it is in compliance with 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 such laws and regulations can be subject to future government review and interpretation as well as significant regulatory action including fines, penalties, and exclusions from the Medicare and Medicaid programs.
Cash and Cash Equivalents
The company considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents. The carrying amounts reported in the balance sheet for cash and cash equivalents approximate their fair values. Although cash and cash equivalents are largely not federally insured, the credit risk associated with these deposits that typically may be redeemed upon demand is considered low due to the high quality of the financial institutions in which they are invested.
Credit Risk
The company’s primary concentration of credit risk is with accounts receivable, which consist of amounts owed by governmental agencies, insurance companies and private patients. Receivables from Medicare and Medicaid comprised 48% of receivables at June 30, 2005 and 52% at December 31, 2004.
Inventories
Inventories, which consist primarily of supplies used in dialysis treatments, are valued at the lower of cost (first-in, first-out method) or market value.
DIALYSIS CORPORATION OF AMERICA AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2005
(Unaudited)
NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--Continued
Prepaid Expenses and Other Current Assets
Prepaid expenses and other current assets is comprised as follows:
June 30, | December 31, | ||||||
2005 | 2004 | ||||||
Vendor volume discounts receivable | $ | 242,520 | $ | 382,757 | |||
Prepaid expenses | 770,822 | 607,398 | |||||
Prepaid income taxes | 687,115 | 58,913 | |||||
Other | 98,121 | 173,955 | |||||
$ | 1,798,578 | $ | 1,223,023 |
Accrued Expenses
Accrued expenses is comprised as follows:
June 30, | December 31, | ||||||
2005 | 2004 | ||||||
Accrued compensation | $ | 969,445 | $ | 1,306,892 | |||
Due to insurance companies | 2,963,860 | 2,926,711 | |||||
Other | 427,900 | 688,166 | |||||
$ | 4,361,205 | $ | 4,921,769 |
Due to insurance companies represents amounts paid by insurance companies in excess of anticipated revenues from the insurers. The company communicates with the payors regarding these amounts, which can result from duplicate payments, payments in excess of contractual agreements, payments as primary when payor is secondary, and underbillings by the company based on estimated fee schedules. These amounts remain in due to insurance companies until resolution.
Vendor Concentration
The company purchases erythropoietin (EPO) from one supplier which comprised 34% and 33% of the company’s cost of sales for the three months and six months ended June 30, 2005, and 35% and 36% for the same periods of the preceding year. There is only one supplier of EPO in the United States, and this supplier has received FDA approval for an alternative product available for dialysis patients; but there are no other suppliers of any similar drug available to dialysis treatment providers. Revenues from the administration of EPO, which amounted to approximately $3,055,000 and $5,842,000 for the three months and six months ended June 30, 2005 and $2,571,000 and $5,001,000 for the same periods of the preceding year, comprised 28% and 27% and 27% and 28% of medical service revenue for these periods, respectively.
Revenue Recognition
Net revenue is recognized as services are rendered at the net realizable amount from Medicare, Medicaid, commercial insurers and other third party payors. Currently, there are no approvals pending from third party payors. The company occasionally provides dialysis treatments on a charity basis to patients who cannot afford to pay. The amount is not significant.
DIALYSIS CORPORATION OF AMERICA AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2005
(Unaudited)
NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--Continued
Goodwill
Goodwill represents cost in excess of net assets acquired. The company adopted Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets” (FAS 142) effective January 1, 2002. Under FAS 142, goodwill and intangible assets with indefinite lives are no longer amortized but are reviewed annually (or more frequently if impairment indicators are present) for impairment. Pursuant to the provisions of FAS 142, the goodwill resulting from the company's acquisition of minority interests in August, 2001 and June, 2003, the acquisition of Georgia dialysis centers in April, 2002 and April, 2003, and the acquisition of a Pennsylvania dialysis business at the close of business on August 31, 2004, are not being amortized for book purposes and are subject to the annual impairment testing provisions of FAS 142, which testing indicated no impairment for goodwill.
Deferred Expenses
Deferred expenses, except for deferred loan costs, are amortized on the straight-line method over their estimated benefit period with deferred loan costs amortized over the lives of the respective loans. Deferred expenses of approximately $73,000 at June 30, 2005 and $80,000 at December 31, 2004 are included in other assets. Amortization expense was $3,525 and $7,050 for the three months and six months ended June 30, 2005 and $578 and $1,157 for the same periods of the preceding year.
Income Taxes
Deferred income taxes are determined by applying enacted tax rates applicable to future periods in which the taxes are expected to be paid or recovered to differences between financial accounting and tax basis of assets and liabilities.
Stock-Based Compensation
The company follows the intrinsic method of Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (APB 25) and related Interpretations in accounting for its employee stock options because, as discussed below, Financial Accounting Standards Board Statement No. 123, “Accounting for Stock-
Based Compensation” (FAS 123) requires use of option valuation models that were not developed for use in valuing employee stock options. FAS 123 permits a company to elect to follow the intrinsic method of APB 25 rather than the alternative fair value accounting provided under FAS 123, but requires pro forma net income and earnings per share disclosures as well as various other disclosures not required under APB 25 for companies following APB 25. The company has adopted the disclosure provisions required under Financial Accounting Standards Board Statement No. 148, “Accounting for Stock-Based Compensation - Transition and Disclosure” (FAS 148). Under APB 25, because the exercise price of the company’s stock options equals the market price of the underlying stock on the date of grant, no compensation expense was recognized. See “New Pronouncements.”
Pro forma information regarding net income and earnings per share is required by FAS 123 and FAS 148, and has been determined as if the company had accounted for its employee stock options under the fair value method of those statements. The fair value for these options was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted-average assumptions for options granted during 2004, 2003, 2002 and 2001, respectively: risk-free interest rate of 3.83%, 1.44%, 3.73%, and 5.40%; no dividend yield; volatility factor of the expected market price of the company’s common stock of 1.31, 1.07, 1.15, and 1.14, and a weighted-average expected life of 5 years, 4.7 years, 5 years, and 4 years.
DIALYSIS CORPORATION OF AMERICA AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2005
(Unaudited)
NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--Continued
The Black-Scholes option valuation model was developed for use in 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 input 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 measure of the fair value of its employee stock options.
For purposes of pro forma disclosures, the estimated fair value of options is amortized to expense over the options’ vesting period. The company’s pro forma information follows:
Three Months Ended June 30, | Six Months Ended June 30, | ||||||||||||
2005 | 2004 | 2005 | 2004 | ||||||||||
Net income, as reported | $ | 444,195 | $ | 387,622 | $ | 768,582 | $ | 675,534 | |||||
Stock-based employee compensation expense under fair value method, net of related tax effects | (46,299 | ) | (42,136 | ) | (93,567 | ) | (59,148 | ) | |||||
Pro forma net income | $ | 397,896 | $ | 345,486 | $ | 675,015 | $ | 616,386 | |||||
Earnings per share: | |||||||||||||
Basic, as reported | $ | .05 | $ | .05 | $ | .09 | $ | .08 | |||||
Basic, pro forma | $ | .05 | $ | .04 | $ | .08 | $ | .07 | |||||
Diluted, as reported | $ | .05 | $ | .04 | $ | .08 | $ | .08 | |||||
Diluted, pro forma | $ | .04 | $ | .04 | $ | .07 | $ | .07 |
Earnings per Share
Diluted earnings per share gives effect to potential common shares that were dilutive and outstanding during the period, such as stock options, calculated using the treasury stock method and average market price.
Three Months Ended June 30, | Six Months Ended June 30, | ||||||||||||
2005 | 2004 | 2005 | 2004 | ||||||||||
Net income | $ | 444,195 | $ | 387,622 | $ | 768,582 | $ | 675,534 | |||||
Weighted average shares-denominator basic computation | 8,661,859 | 8,322,959 | 8,599,837 | 8,315,943 | |||||||||
Effect of dilutive stock options | 577,409 | 385,031 | 544,592 | 571,179 | |||||||||
Weighted average shares, as adjusted-denominator diluted computation | 9,239,268 | 8,707,990 | 9,144,429 | 8,887,122 | |||||||||
Earnings per share: | |||||||||||||
Basic | $ | .05 | $ | .05 | $ | .09 | $ | .08 | |||||
Diluted | $ | .05 | $ | .04 | $ | .08 | $ | .08 |
The company had various potentially dilutive securities during the periods presented, including stock options. See Note 7.
DIALYSIS CORPORATION OF AMERICA AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2005
(Unaudited)
NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES—Continued
Other Income
Operating:
Other operating income is comprised as follows:
Three Months Ended June 30, | Six Months Ended June 30, | ||||||||||||
2005 | 2004 | 2005 | 2004 | ||||||||||
Management fee income | $ | 119,902 | $ | 92,610 | $ | 248,297 | $ | 175,472 | |||||
Litigation settlement | --- | --- | --- | 134,183 | |||||||||
$ | 119,902 | $ | 92,610 | $ | 248,297 | $ | 309,655 |
Non-operating:
Other non-operating income (expense) is comprised as follows:
Three Months Ended June 30, | Six Months Ended June 30, | ||||||||||||
2005 | 2004 | 2005 | 2004 | ||||||||||
Rental income | $ | 49,364 | $ | 47,033 | $ | 98,391 | $ | 93,696 | |||||
Interest income | 18,596 | 5,417 | 34,859 | 14,006 | |||||||||
Interest expense | (31,773 | ) | (40,754 | ) | (66,475 | ) | (83,351 | ) | |||||
Other | 8,351 | 10,110 | 9,618 | 19,749 | |||||||||
Other income, net | $ | 44,538 | $ | 21,806 | $ | 76,393 | $ | 44,100 |
Estimated Fair Value of Financial Instruments
The carrying value of cash, accounts receivable and debt in the accompanying financial statements approximate their fair value because of the short-term maturity of these instruments, and in the case of debt because such instruments either bear variable interest rates which approximate market or have interest rates approximating those currently available to the company for loans with similar terms and maturities.
Reclassification
Certain prior year amounts have been reclassified to conform with the current year’s presentation.
New Pronouncements
On November 24, 2004, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 151, “Inventory Costs” an amendment of ARB No. 43, Chapter 4 (“FAS 151”). FAS 151 requires companies to recognize as current period changes abnormal amounts of idle facility expense, freight, handling costs and wasted materials (spoilage). FAS 151 also requires manufacturers to allocate fixed production overheads to inventory based on normal capacity of their production facilities. FAS 151 is effective for inventory costs incurred during fiscal years beginning after June 15, 2005. The company does not expect FAS 151 to have a significant effect on its consolidated financial statements.
DIALYSIS CORPORATION OF AMERICA AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2005
(Unaudited)
NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES—Continued
On December 16, 2004, the FASB issued Statement of Financial Accounting Standards No. 153, “Exchange of Nonmonetary Assets,” an amendment of APB Opinion No. 29 (“FAS 153”). The amendments made by FAS 153 are based on the principle that exchanges of nonmonetary assets should be measured based on the fair value of the assets exchanged. The amendments eliminate the narrow exception for nonmonetary exchanges of similar productive assets and replace it with an exception for exchanges of nonmonetary assets that do not have commercial substance. Previous to FAS 153 some nonmonetary exchanges, although commercially substantive, were recorded on a carryover basis rather than being based on the fair value of the assets exchanged. FAS 153 is effective for nonmonetary assets exchanges occurring in fiscal periods beginning after June 15, 2005. The company does not expect FAS 153 to have a significant effect on its financial statements.
On December 16, 2004, the FASB issued Statement of Financial Accounting Standards No. 123 (revised), “Share-Based Payment” (“FAS 123(R)”). FAS 123(R) requires companies to recognize the fair value of stock option grants as a compensation costs in their financial statements. Public entities, other than small business issuers, on a calendar year need not comply with FAS 123(R) until the interim financial statements for the first quarter of 2006 are filed with the SEC. In addition to stock options granted after the effective date, companies will be required to recognize a compensation cost with respect to any unvested stock options outstanding as of the effective date equal to the grant date fair value of those options (as previously disclosed in the notes to the financial statements) with the cost related to the unvested options to be recognized over the vesting period of the options. The company is in the process of determining the impact that FAS 123(R) will have on its consolidated financial statements.
NOTE 2--INTERIM ADJUSTMENTS
The financial summaries for the three months and six months ended June 30, 2005 and June 30, 2004 are unaudited and include, in the opinion of management of the company, all adjustments (consisting of normal recurring accruals) necessary to present fairly the earnings for such periods. Operating results for the three months and six months ended June 30, 2005 are not necessarily indicative of the results that may be expected for the entire year ending December 31, 2005.
While the company believes that the disclosures presented are adequate to make the information not misleading, it is suggested that these consolidated financial statements be read in conjunction with the financial statements and notes included in the company’s audited financial statements for the year ended December 31, 2004, as amended on Form 10-K/A1 dated August 9, 2005.
NOTE 3--LONG-TERM DEBT
The company through its subsidiary, DCA of Vineland, LLC, pursuant to a December 3, 1999 loan agreement obtained a $700,000 development loan with interest at 8.75% through December 2, 2001, 1½% over the prime rate thereafter through December 15, 2002, and 1% over prime thereafter secured by a mortgage on the company’s real property in Easton, Maryland. Outstanding borrowings were subject to monthly payments of interest only through December 2, 2001, with monthly payments thereafter of $2,917 principal plus interest through December 2, 2002, and monthly payments thereafter of $2,217 plus interest with any remaining balance due December 2, 2007. This loan had an outstanding principal balance of approximately $596,000 at June 30, 2005 and $610,000 December 31, 2004.
In April 2001, the company obtained a $788,000 five-year mortgage through April, 2006, on its building in Valdosta, Georgia with interest at 8.29% until March, 2002, 7.59% thereafter until December 16, 2002, and prime plus ½% with a minimum of 6.0% effective December 16, 2002. Payments are $6,800 including principal and interest commencing May, 2001, with a final payment consisting of a balloon payment and any unpaid interest due April, 2006. The remaining principal balance under this mortgage amounted to approximately $654,000 at June 30, 2005 and $675,000 at December 31, 2004.
NOTE 3--LONG-TERM DEBT
The equipment financing agreement is for financing for some of the kidney dialysis machines for the company’s dialysis facilities. Payments under the agreement are pursuant to various schedules extending through August, 2007. Financing under the equipment purchase agreement is a non-cash financing activity, which is a supplemental disclosure required by Financial Accounting Standards Board Statement No. 95, “Statement of Cash Flows.” There was no financing under this agreement during the first half of 2005 or the same period of the preceding year. The remaining principal balance under this financing amounted to approximately $575,000 at June 30, 2005 and $814,000 at December 31, 2004.
The prime rate was 6.25% as of June 30, 2005 and 5.25% as of December 31, 2004. For interest payments, see Note 11.
The company’s two mortgage agreements contain certain restrictive covenants that, among other things, restrict the payment of dividends above 25% of the company’s net worth, require lenders’ approval for a merger, sale of substantially all the assets, or other business combination of the company, and require maintenance of certain financial ratios. The company was in compliance with the debt covenants at June 30, 2005 and December 31, 2004.
NOTE 4--INCOME TAXES
Deferred income taxes reflect the net tax effect of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. For financial reporting purposes, a valuation allowance has been recognized to offset a portion of the deferred tax assets.
For income tax payments, see Note 11.
NOTE 5--TRANSACTIONS WITH PARENT
The company’s parent, Medicore, Inc., provides certain financial and administrative services for the company. Central operating costs are charged on the basis of time spent. In the opinion of management, this method of allocation is reasonable. The amount of expenses allocated by the parent totaled approximately $50,000 and $100,000 for the three months and six months ended June 30, 2005 and for the same period of the preceding year, which is included in selling, general and administrative expenses in the Consolidated Statements of Income.
The company had an intercompany advance payable to its parent of approximately $554,000 as of June 30, 2005 and $449,000 as of December 31, 2004, which bears interest at the short-term Treasury Bill rate. Interest expense on intercompany advances payable was approximately $2,000 and $5,000 for the three months and six months ended June 30, 2005 and $1,000 and $2,000 for the same periods of the preceding year. Interest is included in the intercompany advance balance. The company’s parent has agreed not to require repayment of the intercompany advance balance prior to July 1, 2006; therefore, the advance has been classified as long-term at June 30, 2005.
On March 17, 2004, the company issued a demand promissory note to its parent for up to $1,500,000 of financing for equipment purchases with annual interest of 1.25% over the prime rate. The note was subsequently modified by increasing the maximum amount of advances that can be made to $5,000,000, and by adding to the purposes of the financing, working capital and other corporate needs. This note had an outstanding balance of approximately $2,950,000 and an interest rate of 7.5% at June 30, 2005 and an outstanding balance of approximately $1,435,000 and an interest rate of 6.50% at December 31, 2004. The weighted average interest rate on the note was
DIALYSIS CORPORATION OF AMERICA AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2005
(Unaudited)
NOTE 5--TRANSACTIONS WITH PARENT--Continued
7.17% and 6.98% during the three months and six months ended June 30, 2005, and 5.25% for the same periods of the preceding year. Interest expense on the note amounted to approximately $51,000 and $85,000 for the three months and six months ended June 30, 2005 and $7,000 and $9,000 for the same periods of the preceding year. Accrued interest payable on the note amounted to approximately $51,000 as of June 30, 2005 and $27,000 as of December 31, 2004.
NOTE 6--OTHER RELATED PARTY TRANSACTIONS
The 20% minority interest in DCA of Vineland, LLC was held by a company owned by the medical director of that facility, who became a director of Dialysis Corporation of America in 2001, and whose directorship ceased in June, 2003. This physician was provided with the right to acquire up to 49% of DCA of Vineland. In April, 2000, another company owned by this physician acquired an interest in DCA of Vineland, resulting in Dialysis Corporation of America holding a 51% ownership interest in DCA of Vineland and this physician’s companies holding a combined 49% ownership interest of DCA of Vineland.
In July 2000, one of the companies owned by this physician acquired a 20% interest in DCA of Manahawkin, Inc. Under agreements with DCA of Vineland and DCA of Manahawkin, this physician serves as medical director for each of those dialysis facilities.
In May 2001, the company loaned its President $95,000 to be repaid with accrued interest at prime minus 1% (floating prime) on or before maturity on May 11, 2006. This demand loan is collateralized by all of the President’s stock options in the company, as well as common stock from exercise of the options and proceeds from sale of such stock. Interest income on the loan amounted to approximately $1,000 and $3,000 for the three months and six months ended June 30, 2005, and $1,000 and $2,000 for the same periods of the preceding year.
Minority members in subsidiaries in certain situations may fund a portion of required capital contributions by issuance of an interest bearing note payable to the company which minority members may repay directly or through their portion of distributions of the subsidiary. The minority members funded in the aggregate approximately $15,000 in capital contributions during the first half of 2005 and $42,000 during the same period of the preceding year, under notes accruing interest at prime plus 2%, with an aggregate of approximately $22,000 of distributions applied against the notes and accrued interest during the first half of 2005, and $46,000 during the same period of the preceding year. Interest income on the notes totaled approximately $7,000 and $14,000 for the three months and six months ended June 30, 2005 and $3,000 and $6,000 for the same periods of the preceding year. These represent non-cash investing activities, which is a supplemental disclosure required by Financial Accounts Standards Board Statement No. 95, “Statement of Cash Flows.” See Notes 10 and 11.
NOTE 7--STOCK OPTIONS
In April, 1999, the company adopted a stock option plan pursuant to which the board of directors granted 1,600,000 options exercisable at $.63 per share to certain of its officers, directors, employees and consultants with 680,000 options exercisable through April 20, 2000 and 920,000 options exercisable through April 20, 2004. 1,480,000 options have been exercised. 120,000 options have been cancelled. 680,000 options were exercised in part with promissory notes with the interest at 6.2% and repaid with 91,800 shares of common stock in February, 2004. The balance of the 800,000 options were exercised in 2003 and 2004 with the exercise prices paid in part with director bonuses and in part by the payment with company stock. The exercises and share payments to the company represent non-cash investing activity, which is a supplemental disclosure required by Financial Accounting Standards Board Statement No. 95, “Statement of Cash Flows.” See Note 11.
DIALYSIS CORPORATION OF AMERICA AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2005
(Unaudited)
NOTE 7--STOCK OPTIONS--Continued
In January 2001, the board of directors granted to the company’s Chief Executive Officer and President a five-year option for 330,000 shares exercisable at $.63 per share all of which options having vested on January 1, 2005. In January 2004, 56,384 of these options were exercised for $35,240 with the exercise price satisfied by a director bonus. In March 2005, 150,000 of these options were exercised with the company receiving a $93,750 cash payment for the exercise price, leaving 123,616 of these options outstanding.
In September 2001, the board of directors granted five-year options for an aggregate of 150,000 shares exercisable at $.75 per share through September 5, 2006, to certain officers, directors and key employees. 30,000 of the options vested immediately. In 2003 and 2004, 8,146 of these options were exercised with the exercise prices satisfied by director bonuses. These exercises represent non-cash investing activity, which is a supplemental disclosure required by Financial Accounting Standards Board Statement No. 95, “Statement of Cash Flows.” See Note 11. In January 2004, 7,200 options were exercised and in February 2005, 15,000 options were exercised for cash. 14,654 options have been cancelled due to the resignation of a director in June 2004, and 105,000 options remain outstanding, of which 75,000 vested as of June 30 2005.
In May 2002, the board of directors granted five-year options for an aggregate of 21,000 shares to certain of the company’s employees. Options for 14,000 shares have been cancelled as a result of the termination of several employee option holders. During the first half of 2005, 7,000 of these options were exercised.
In June 2003, the board of directors granted to an officer a five-year option for 50,000 shares exercisable at $1.80 per share through June 3, 2008. The option vests annually in increments of 12,500 shares on each June 4 from 2004 to 2007, with 25,000 of such options vested at June 30, 2005.
In August 2003, the board of directors granted a three-year option to a director, for 10,000 shares exercisable at $2.25 per share through August 18, 2006. The option vests in two annual increments of 5,000 shares commencing on August 19, 2004, with 5,000 of these options vested as of June 30, 2005.
In January 2004, the board of directors granted a five year option to an employee for 20,000 shares exercisable at $3.09 per share through January 12, 2009. The option vests in annual increments of 5,000 shares on each January 13 from 2005 through 2008. In February 2005, a portion of this option was exercised for 5,000 shares with the company receiving a cash payment of $15,425, leaving 15,000 of these options (non-vested) outstanding.
In June 2004, the board of directors granted 160,000 stock options to officers, directors and a key employee exercisable at $4.02 per share through June 6, 2009. 51,500 options vested of which 3,750 were exercised in July 2005, and 108,750 options vest 25% annually from June 7, 2006 to June 7, 2008.
DIALYSIS CORPORATION OF AMERICA AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2005
(Unaudited)
NOTE 7--STOCK OPTIONS--Continued
In August 2004, the board of directors granted 50,000 incentive stock options to an officer exercisable at $4.02 per share through August 15, 2009. The options vest 25% annually commencing August 16, 2005.
On January 28, 2004, the company affected a two-for-one stock split of its outstanding common stock. All option amounts and exercise prices have been adjusted to reflect the stock split. See Note 1. Split-adjusted option exercise prices resulting in a fraction of a cent have been rounded up to the nearest cent for purposes of these Notes.
NOTE 8--COMMITMENTS
The company and its parent established a 401(k) plan effective January 2003, with an eligibility requirement of one year of service and 21 year old age requirement, which allows employees, in addition to regular employee contributions, to elect to have a portion of bonus payments contributed. As an incentive to save for retirement, the company will match 10% of an employee’s contribution resulting from any bonus paid during the year and may make a discretionary contribution with the percentage of any discretionary contribution to be determined each year with only employee contributions up to 6% of annual compensation considered when determining employer matching. To date, employer matching expense has been minimal.
The company has given the non-affiliated owner of the facility in Georgia that is managed by the company a put option to sell to a subsidiary of the company all the assets of that Georgia dialysis facility. The company’s subsidiary holds a call option to purchase the assets of the Georgia facility. Each of the put and call options are exercisable through September 2005. The put option is not exercisable unless that Georgia dialysis facility has recorded $100,000 in pre-tax profits. Upon exercise of either the put or call option the owner would receive a 20% interest in the company’s subsidiary which would own and operate the Georgia facility, and the remainder of the purchase price would be paid in cash, determined on a formula based upon a multiple of EBITDA.
NOTE 9--ACQUISITIONS
The company has made various acquisitions commencing in 2001, as further described below. These acquisition were made either on the basis of existing profitability or expectation of future profitability for the interest acquired based on the company’s analysis of the potential for each acquisition, and the value of the relationship with the physician affiliated with the selling entity. Each acquisition was intended to either strengthen our market share within a geographic area or provide us with the opportunity to enter a new geographic area and market.
In addition to potential future profitability, market share, physician relationships and geographic considerations, the company reviews the purchase price and any resulting goodwill based on established current per patient valuations for dialysis centers. The company also considers the synergistic effects of a potential acquisition, including potential costs integration and the effect of the acquisition on the overall valuation of the company.
Effective as of the close of business on August 31, 2004, the company acquired a Pennsylvania dialysis company for an estimated net purchase price of $1,521,000. Of that amount, $761,000 is currently in escrow, with the balance of approximately $760,000 to be paid in equal installments, each on the first and second anniversary of the effective date of the purchase agreement. This transaction resulted in $1,358,000 of goodwill representing the
DIALYSIS CORPORATION OF AMERICA AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2005
(Unaudited)
NOTE 9--ACQUISITIONS--Continued
excess of the net purchase price over the estimated $164,000 fair value of net assets acquired, including an $83,000 valuation of an eight year non-competition agreement that will be amortized over the life of the agreement. The goodwill is not amortizable for tax purposes, since the transaction was a stock acquisition. The initial allocation of purchase cost at fair value was based upon available information and will be finalized as any contingent purchase amounts are resolved and estimated fair values of assets are finalized. The company began recording the results of operations for the acquired company as of the effective date of the acquisition. The company’s decision to make this investment was based on its expectation of future profitability resulting from its review of the acquired company’s operations prior to making the acquisition. See Note 1.
The following table summarizes the estimated fair values of the assets acquired and liabilities assumed at the date of acquisition for the August 2004 Pennsylvania acquisition:
Accounts receivable, net | $ | 215,825 | ||
Inventory and other current assets | 79,383 | |||
Property, plant and equipment, net | 88,231 | |||
Intangible assets | 82,500 | |||
Goodwill | 1,357,681 | |||
Total assets acquired | 1,823,620 | |||
Total liabilities assumed | 302,429 | |||
Net assets acquired | $ | 1,521,191 |
NOTE 10--LOAN TRANSACTIONS
The company has and may continue to provide funds in excess of capital contributions to meet working capital requirements of its dialysis facility subsidiaries, usually until they become self-sufficient. The operating agreements for the subsidiaries provide for cash flow and other proceeds to first pay any such financing, exclusive of any tax payment distributions. See Notes 6 and 11.
NOTE 11--SUPPLEMENTAL CASH FLOW INFORMATION
The following amounts represent (rounded to the nearest thousand) non-cash financing and investing activities and other cash flow information in addition to information disclosed in Notes 3 and 6:
Six Months Ended | |||||||
June 30, | |||||||
2005 | 2004 | ||||||
Interest paid (see Notes 3 and 5) | $ | 152,000 | $ | 80,000 | |||
Income taxes paid (see Note 4) | $ | 1,311,000 | $ | 453,000 | |||
Options exercise bonus (191,238 shares) (see Note 7) | --- | $ | 120,000 | ||||
Subsidiary minority member capital contributions funded by notes (see Note 6) | $ | 15,000 | $ | 42,000 | |||
Subsidiary minority member distributions applied against notes and accrued interest (see Note 6) | $ | 22,000 | $ | 46,000 | |||
Share payment (514,008 options exercised; 72,375 shares paid) | |||||||
for stock option exercises (see Note 7) | --- | $ | 321,000 | ||||
Payment on notes receivable with 91,800 shares | |||||||
of common stock (see Note 7) | --- | $ | 521,000 |
DIALYSIS CORPORATION OF AMERICA AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2005
(Unaudited)
NOTE 12--STOCKHOLDERS’ EQUITY
The changes in stockholders’ equity for the six months ended June 30, 2005 are summarized as follows:
Common Stock | Additional Paid-in Capital | Retained Earnings | Total | ||||||||||
Balance at December 31, 2004 | $ | 84,858 | $ | 4,957,146 | $ | 8,287,792 | $ | 13,329,796 | |||||
Exercise of stock options | 1,770 | 133,005 | --- | 134,775 | |||||||||
Net income | --- | --- | 768,582 | 768,582 | |||||||||
Balance June 30, 2005 | $ | 86,618 | $ | 5,090,151 | $ | 9,056,374 | $ | 14,233,153 |
NOTE 13--AFFILIATE FINANCIAL INFORMATION
The following amounts represent certain operating data of the company’s 40% owned Ohio affiliate that is accounted for in the equity method and not consolidated for financial reporting purposes (see Note 1):
Three Months Ended | Six Months Ended | ||||||||||||
June 30, | June 30, | ||||||||||||
2005 | 2004 | 2005 | 2004 | ||||||||||
Revenues | $ | 709,000 | $ | 479,000 | $ | 1,475,000 | $ | 885,000 | |||||
Gross profit | $ | 405,000 | $ | 211,000 | $ | 881,000 | $ | 378,000 | |||||
Net income | $ | 237,000 | $ | 78,000 | $ | 537,000 | $ | 126,000 |
The following amounts are from the balance sheet of the company’s 40% owned Ohio affiliate:
June 30, | December 31, | ||||||
2005 | 2004 | ||||||
Current assets | $ | 969,939 | $ | 945,321 | |||
Non-current assets | 142,501 | 160,504 | |||||
Total assets | $ | 1,112,440 | $ | 1,105,825 | |||
Current liabilities | $ | 235,751 | $ | 244,570 | |||
Non-current liabilities | --- | --- | |||||
Capital | 876,689 | 861,255 | |||||
Total liabilities and capital | $ | 1,112,440 | $ | 1,105,825 |
NOTE 14--ACQUISITION OF PARENT COMAPNY
On March 15, 2005, the company and its parent, Medicore, Inc., jointly announced they have agreed to terms whereby Medicore, which owns approximately 56% of the company, will merge into the company for a total consideration of approximately 5,273,000 shares of the company’s common stock. On June 2, 2005, the company and Medicore entered into an Agreement and Plan of Merger. Upon completion of the merger, each Medicore shareholder will receive .68 shares of the company’s common stock for each share of Medicore common stock, and Medicore’s ownership in the company of approximately 4,821,000 of the company’s common stock will be retired resulting in approximately 9,118,000 shares of the company to remain outstanding. Tax and fairness opinions have been obtained regarding the transaction. Completion of the transaction is subject to shareholder approval of each company.
DIALYSIS CORPORATION OF AMERICA AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2005
(Unaudited)
NOTE 14--ACQUISITION OF PARENT COMPANY--Continued
The merger is intended to simplify the corporate structure and enable the ownership of the control interest in the company to be in the hands of the public shareholders. The merger will provide the company with additional capital resources to continue to build its dialysis business. Several litigations have recently been initiated against the company’s directors and its parent relating to the proposed merger.
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
Cautionary Notice Regarding Forward-Looking Information
The statements contained in this quarterly report on Form 10-Q for the quarter ended June 30, 2005, that are not historical are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934 (the “Exchange Act”). In addition, from time to time, we or our representatives have made or may make forward looking statements, orally or in writing, and in press releases. The Private Securities Litigation Reform Act of 1995 contains certain safe harbors for forward-looking statements. Certain of the forward-looking statements include management’s expectations, intentions, beliefs and strategies regarding the growth of our company and our future operations, the proposed acquisition of our parent public company, Medicore, Inc. pursuant to a stock for stock merger transaction (see Note 14 to the “Notes to Consolidated Financial Statements”), the character and development of the dialysis industry, anticipated revenues, our need for and sources of funding for expansion opportunities and construction, expenditures, costs and income, our business strategies and plans for future operations, and similar expressions concerning matters that are not considered historical facts. Forward-looking statements also include our statements regarding liquidity, anticipated cash needs and availability, and anticipated expense levels in this Item 2, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” commonly known as MD&A. Words such as “anticipate,”“estimate,”“expects,”“projects,”“intends,”“plans” and “believes,” and words and terms of similar substance used in connection with any discussions of future operating or financial performance identify forward-looking statements. Such forward-looking statements, like all statements about expected future events, are based on assumptions and are subject to substantial risks and uncertainties that could cause actual results to materially differ from those expressed in the statements, including the general economic, market and business conditions, opportunities pursued or not pursued, competition, changes in federal and state laws or regulations affecting the company and our operations, and other factors discussed periodically in our filings. Many of the foregoing factors are beyond our control. Among the factors that could cause actual results to differ materially are the factors detailed in the risks discussed in the “Risk Factors” section beginning on page 21 of our annual report on Form 10-K for the year ended December 31, 2004, as amended on Form 10-K/A1 dated August 9, 2005. If any of such events occur or circumstances arise that we have not assessed, they could have a material adverse effect upon our revenues, earnings, financial condition and business, as well as the trading price of our common stock, which could adversely affect your investment in our company. Accordingly, readers are cautioned not to place too much reliance on such forward-looking statements. All subsequent written and oral forward-looking statements attributable to us or persons acting on our behalf, are expressly qualified in their entirety by the cautionary statements contained in this quarterly report. You should read this quarterly report, with any of the exhibits attached and the documents incorporated by reference, completely and with the understanding that the company’s actual results may be materially different from what we expect.
The forward-looking statements speak only as of the date of this quarterly report, and except as required by law, we undertake no obligation to rewrite or update such statements to reflect subsequent events.
MD&A is our attempt to provide a narrative explanation of our financial statements, and to provide our shareholders and investors with the dynamics of our business as seen through our eyes as management. Generally, MD&A is intended to cover expected effects of known or reasonably expected uncertainties, expected effects of known trends on future operations, and prospective effects of events that have had a material effect on past operating results.
Overview
Dialysis Corporation of America provides dialysis services, primarily kidney dialysis treatments through 23 outpatient dialysis centers, including a 40% owned Ohio affiliate and one unaffiliated dialysis center which it manages, to patients with chronic kidney failure, also know as end-stage renal disease or ESRD. We provide dialysis treatments to dialysis patients of nine hospitals and medical centers through acute inpatient dialysis services agreements with those entities. We provide homecare services, including home peritoneal dialysis.
The following table shows the number of in-center, home peritoneal and acute inpatient treatments performed by us through the dialysis centers we operate, including the two centers we manage, one in which we have a 40% ownership interest, and those hospitals and medical centers with which we have inpatient acute service agreements for the periods presented:
Three Months Ended June 30, | Six Months Ended June 30, | ||||||||||||
2005 | 2004 | 2005 | 2004 | ||||||||||
In center | 38,176 | 30,034 | 74,120 | 57,783 | |||||||||
Home peritoneal | 4,031 | 3,480 | 7,981 | 5,860 | |||||||||
Acute | 1,724 | 1,982 | 4,079 | 4,161 | |||||||||
43,931 | 35,496(1 | ) | 86,180 | 67,804(1 | ) |
(1) Treatments by the two managed centers included: in-center treatments of 3,836 and 7,439 respectively, for the three months and six months ended June 30, 2005, and 3,205 and 6,088 for the three months and six months ended June 30, 2004; no home peritoneal treatments; and acute treatments of 61 and 126, for the three months and six months ended June 30, 2005, and 35 and 47 for the three months and six months ended June 30, 2004.
We also provide ancillary services associated with dialysis treatments, including the administration of EPO for the treatment of anemia in our dialysis patients. EPO is currently available from only one manufacturer, and no alternative drug has been available to us for the treatment of anemia in our dialysis patients. If our available supply of EPO were reduced either by the manufacturer or due to excessive demand, our revenues and net income would be adversely affected. The manufacturer of EPO increased its price in early 2003, and could implement further price increases which would adversely affect our net income. This manufacturer has developed another anemia drug that could possibly substantially reduce our revenues and profit from the treatment of anemia in our patients.
ESRD patients must either obtain a kidney transplant or obtain regular dialysis treatments for the rest of their lives. Due to a lack of suitable donors and the possibility of transplanted organ rejection, the most prevalent form of treatment for ESRD patients is hemodialysis through a kidney dialysis machine. Hemodialysis patients usually receive three treatments each week with each treatment lasting between three and five hours on an outpatient basis. Although not as common as hemodialysis in an outpatient facility, home peritoneal dialysis is an available treatment option, representing the third most common type of ESRD treatment after outpatient hemodialysis and kidney transplantation.
Approximately 60% of our medical service revenues are derived from Medicare and Medicaid reimbursement for the three months and six months ended June 30, 2005 compared to 56% and 57% for the same period of the preceding year, with rates established by the Center for Medicare and Medicaid Services, or CMS, and which rates are subject to legislative changes. Over the last two years, Medicare reimbursement rates have not increased. Congress has approved a 1.6% composite rate increase for 2005. Also for 2005, Medicare has modified the way it reimburses dialysis providers, which includes revision of pricing for separately billable drugs and biologics, with an add-on component to make the change budget-neutral. Effective April 1, 2005, CMS also implemented a case-mix adjustment payment methodology which is designed to pay differential composite service rates based upon a variety of patient characteristics. If the case-mix adjustment is not properly implemented it could adversely affect the Medicare reimbursement rates. This change is designed to be budget neutral. Dialysis is typically reimbursed at higher rates from private payors, such as a patient’s insurance carrier, as well as higher payments received under negotiated contracts with hospitals for acute inpatient dialysis services.
The following table shows the breakdown of our revenues by type of payor for the periods presented:
Three Months Ended June 30, | Six Months Ended June 30, | ||||||||||||
2005 | 2004 | 2005 | 2004 | ||||||||||
Medicare | 51 | % | 48 | % | 51 | % | 49 | % | |||||
Medicaid and comparable programs | 9 | 8 | 9 | 8 | |||||||||
Hospital inpatient dialysis services | 4 | 5 | 5 | 6 | |||||||||
Commercial insurers and other private payors | 36 | 39 | 35 | 37 | |||||||||
100 | % | 100 | % | 100 | % | 100 | % |
Our medical service revenues are derived primarily from four sources: outpatient hemodialysis services, home peritoneal dialysis services, inpatient hemodialysis services and ancillary services. The following table shows the breakdown of our medical service revenues (in thousands) derived from our primary revenue sources and the percentage of total medical service revenue represented by each source for the periods presented:
Three Months Ended June 30, | Six Months Ended June 30, | ||||||||||||||||||||||||
2005 | 2004 | 2005 | 2004 | ||||||||||||||||||||||
Outpatient hemodialysis services | $ | 5,764 | 52 | % | $ | 4,362 | 46 | % | $ | 11,134 | 52 | % | $ | 8,168 | 46 | % | |||||||||
Home peritoneal dialysis services | 761 | 7 | 654 | 7 | 1,541 | 7 | 1,077 | 6 | |||||||||||||||||
Inpatient hemodialysis services | 482 | 4 | 521 | 5 | 1,110 | 5 | 1,110 | 6 | |||||||||||||||||
Ancillary services | 4,015 | 37 | 3,960 | 42 | 7,721 | 36 | 7,551 | 42 | |||||||||||||||||
$ | 11,022 | 100 | % | $ | 9,497 | 100 | % | $ | 21,506 | 100 | % | $ | 17,906 | 100 | % |
The healthcare industry is subject to extensive regulation by federal and state authorities. There are a variety of fraud and abuse measures to combat waste, including anti-kickback regulations and extensive prohibitions relating to self-referrals, violations of which are punishable by criminal or civil penalties, including exclusion from Medicare and other governmental programs. Unanticipated changes in healthcare programs or laws could require us to restructure our business practices which, in turn, could materially adversely affect our business, operations and financial condition. We have developed a Corporate Integrity Program to assure that we provide the highest level of patient care and services in a professional and ethical manner consistent with applicable federal and state laws and regulations. Among the different programs is our Compliance Program, which has been implemented to assure our compliance with fraud and abuse laws and to supplement our existing policies relating to claims submission, cost report preparation, initial audit and human resources, all geared towards a cost-efficient operation beneficial to patients and shareholders.
Dialysis Corporation of America’s future growth depends primarily on the availability of suitable dialysis centers for development or acquisition in appropriate and acceptable areas, and our ability to manage the development costs for these potential dialysis centers while competing with larger companies, some of which are public companies or divisions of public companies with greater numbers of personnel and financial resources available for acquiring and/or developing dialysis centers in areas targeted by us. Additionally, there is intense competition for qualified nephrologists who would serve as medical directors of dialysis facilities, and be responsible for the supervision of those dialysis centers. There is no assurance as to when any new dialysis centers or inpatient service contracts with hospitals will be implemented, or the number of stations, or patient treatments such center or service contract may involve, or if such center or service contract will ultimately be profitable. It has been our experience that newly established dialysis centers, although contributing to increased revenues, have adversely affected our results of operations in the short term due to start-up costs and expenses and a smaller patient base.
Results of Operations
The following table shows our results of operations (in thousands) and the percentage of medical service revenue represented by each line item for the periods presented:
Three Months Ended | Six Months Ended | ||||||||||||||||||||||||
June 30 | June 30, | ||||||||||||||||||||||||
2005 | 2004 | 2005 | 2004 | ||||||||||||||||||||||
Medical service revenue | $ | 11,022 | 100.0 | % | $ | 9,497 | 100.0 | % | $ | 21,506 | 100.0 | % | $ | 17,906 | 100.0 | % | |||||||||
Other income | 120 | 1.1 | 92 | .9 | 248 | 1.2 | 310 | 1.7 | |||||||||||||||||
Total operating revenues | 11,142 | 101.1 | 9,589 | 100.9 | 21,754 | 101.2 | 18,216 | 101.7 | |||||||||||||||||
Cost of medical services | 6,725 | 61.0 | 5,738 | 60.4 | 13,267 | 61.7 | 10,901 | 60.9 | |||||||||||||||||
Selling, general and administrative expenses | 3,454 | 31.3 | 2,901 | 30.5 | 6,698 | 31.1 | 5,697 | 31.8 | |||||||||||||||||
Provision for doubtful accounts | 205 | 1.9 | 200 | 2.1 | 453 | 2.1 | 348 | 1.9 | |||||||||||||||||
Total operating costs and expenses | 10,384 | 94.2 | 8,839 | 93.0 | 20,418 | 94.9 | 16,946 | 94.6 | |||||||||||||||||
Operating income | 758 | 6.9 | 750 | 7.9 | 1,336 | 6.2 | 1,270 | 7.1 | |||||||||||||||||
Other, net | (9 | ) | (.1 | ) | 15 | .2 | (11 | ) | (.1 | ) | 35 | .2 | |||||||||||||
Income before income taxes, minority | |||||||||||||||||||||||||
interest and equity in affiliate earnings | 749 | 6.8 | 765 | 8.1 | 1,325 | 6.2 | 1,305 | 7.3 | |||||||||||||||||
Income tax provision | 310 | 2.8 | 278 | 2.9 | 619 | 2.9 | 494 | 2.8 | |||||||||||||||||
Income before minority interest and | |||||||||||||||||||||||||
equity in affiliate earnings | 439 | 4.0 | 487 | 5.2 | 706 | 3.3 | 811 | 4.5 | |||||||||||||||||
Minority interest in income of | |||||||||||||||||||||||||
consolidated subsidiaries | (89 | ) | (.8 | ) | (131 | ) | (1.4 | ) | (152 | ) | (.7 | ) | (186 | ) | (1.0 | ) | |||||||||
Equity in affiliate earnings | 94 | .9 | 31 | .3 | 215 | 1.0 | 50 | .3 | |||||||||||||||||
Net income | $ | 444 | 4.0 | % | $ | 388 | 4.1 | % | $ | 769 | 3.6 | % | $ | 675 | 3.8 | % |
Operating income increased approximately $8,000 (1%) and $66,000 (5%) for the three months and six months ended June 30, 2005, compared to the same periods of the preceding year. For these same periods net income increased $56,000 (15%) and $93,000 (14%).
Medical service revenues increased approximately $1,525,000 (16%) and $3,599,000 (20%) for the three months and six months ended June 30, 2005, compared to the same periods of the preceding year with the increase largely attributable to a 24% increase in total dialysis treatments performed by the company from 32,256 during the second quarter of 2004 to 40,034 during the second quarter of 2005, and a 27% increase in total dialysis treatments performed by the company from 61,669 during the first half of 2004 to 78,615 during the first half of 2005. The increase in treatments resulted in increases of approximately $1,470,000 (27%) and $3,430,000 (33%) in treatment revenues with related increases of approximately $55,000 (1%) and $170,000 (2%) in ancillary service revenues for the three months and six months ended June 30, 2005 compared to the same periods of the preceding year. The increase in treatments includes the five new centers we opened during 2004 and two Pennsylvania centers acquired in 2004.
This increase in medical services revenues reflects increased revenues for the three months and six months ended June 30, 2005 compared to the same periods of the preceding year of approximately $226,000 and $637,000 for our Pennsylvania dialysis centers, including revenues of $600,000 and $1,193,000 for the two centers included in our acquisition of Keystone Kidney Care; decreased revenues of approximately $171,000 and $187,000 for our New Jersey centers; increased revenues of approximately $88,000 and $195,000 for our Georgia centers; increased revenues of approximately $630,000 and $1,026,000 for our Maryland centers; decreased revenues of approximately $42,000 for the three months and increased revenues of $27,000 for our Ohio center for the six months; increased revenues of approximately $465,000 and $873,000 for our Virginia centers; and increased revenues of approximately $329,000 and $1,028,000 for our South Carolina center. Some of our patients carry commercial insurance which may require an out of pocket co-pay by the patient, which is often uncollectible by us. This co-pay is typically limited, and therefore may lead to our under-recognition of revenue at the time of service. We routinely recognize these revenues as we become aware that these limits have been met.
We record contractual adjustments based on fee schedules for a patient’s insurance plan except in limited circumstances where the schedules are not readily determinable, in which case rates are estimated based on similar insurance plans and subsequently adjusted when actual rates are determined. Out-of-network providers generally do not provide fee schedules and coinsurance information and, consequently, represent the largest portion of contractual adjustment changes.
Other operating income increased by approximately $27,000 for the three months ended June 30, 2005, and decreased by approximately $61,000 for the six months ended June 30, 2005, compared to the same periods of the preceding year. There was an increase in management fee income of $27,000 and $73,000 for the three months and six months ended June 30, 2005 compared to the same periods of the preceding year pursuant to management services agreements with our 40% owned Toledo, Ohio affiliate and an unaffiliated Georgia center. There was a gain on litigation settlement of $134,000 during the first quarter of 2004.
Cost of medical services sales as a percentage of sales amounted to 61% and 62% for the three months and six months ended June 30, 2005, compared to 60 and 61% for the same periods of the preceding year, reflecting an increase in payroll and medical director costs as a percentage of medical service sales.
Approximately 28% and 27% of our medical services revenues for the three months and six months ended June 30, 2005, and 27% and 28% for the same periods of the preceding year was derived from the administration of EPO to our dialysis patients. This drug is only available from one manufacturer in the United States. Price increases for this product without our ability to increase our charges would increase our costs and thereby adversely impact our earnings. We cannot predict the timing, if any, or extent of any future price increases by the manufacturer, or our ability to offset any such increases. Beginning this year, Medicare is reimbursing dialysis providers for the ten most utilized ESRD drugs at an amount equal to the cost of such drugs as determined by the Inspector General of HHS, with complimentary increases in the composite rate. Management believes these changes have little impact on the company’s average Medicare revenue per treatment.
Selling, general and administrative expenses, those corporate and facility costs not directly related to the care of patients, including, among others, administration, accounting and billing, increased by approximately $553,000 (19%) and $1,001,000 (18%) for the three months and six months ended June 30, 2005, compared to the same periods of the preceding year. This increase reflects operations of our new dialysis centers in Pennsylvania, South Carolina, Virginia, and Maryland, pre-operating costs of centers under development, and increased support activities resulting from expanded operations and approximately $100,000 of costs during the second quarter of 2005 related to our pending merger with Medicore, Inc. See Note 14 to "Notes to Consolidated Financial Statements." Selling, general and administrative expenses as a percentage of medical services revenues amounted to approximately 31% for the three months and six months ended June 30, 2005, compared to 31% and 32% for the same periods of the preceding year.
Provision for doubtful accounts increased approximately $4,000 and $104,000 for the three months and six months ended June 30, 2005, compared to the same periods of the preceding year. Medicare bad debt recoveries of $168,000 were recorded during the six months ended June 30, 2005, with no such recoveries recorded during the first half of the preceding year. Without the effect of the Medicare bad debt recoveries, the provision would have amounted to 2% and 3% of sales for the three months and six months ended June 30, 2005 compared to 2% for the same periods of the preceding year. The provision for doubtful accounts reflects our collection experience with the impact of that experience included in accounts receivable presently reserved, plus recovery of accounts previously considered uncollectible from our Medicare cost report filings. The provision for doubtful accounts is determined under a variety of criteria, primarily aging of the receivables and payor mix. Accounts receivable are estimated to be uncollectible based upon various criteria including the age of the receivable, historical collection trends and our understanding of the nature and collectibility of the receivables, and are reserved for in the allowance for doubtful accounts until they are written off.
After a patient’s insurer has paid the applicable coverage for the patient, the patient is billed for the applicable co-payment or balance due. If payment is not received from the patient for its applicable portion, collection letters and billings are sent to that patient until such time as the patients’ account is determined to be uncollectible, at which time the account will be charged against the allowance for doubtful accounts. Patient accounts that remain outstanding four months after initial collection efforts are generally considered uncollectible.
Other non-operating income (expense) increased approximately $23,000 and $32,000 for the three months and six months ended June 30, 2005, compared to the same periods of the preceding year. This includes an increase in interest income of $13,000 and $21,000, an increase in rental income of $2,000 and $4,000, a decrease in miscellaneous other income of $1,000 and $10,000, and a decrease in interest expense to unrelated parties of $9,000 and $17,000 with the effect of decreased average non-inter-company borrowings more than offsetting an increase in average interest rates. Interest expense to our parent, Medicore, Inc., increased $47,000 and $79,000 for the three months and six months ended June 30, 2005 compared to the same periods of the preceding year as a result of an increase in the intercompany advance payable to our parent and borrowings under a demand promissory note payable to our parent and increases in the average interest rates on these borrowings. The prime rate was 6.25% at June 30, 2005, and 5.25% at December 31, 2004. See Notes 1, 3 and 5 of “Notes to the Consolidated Financial Statements.”
Although operations of additional centers have resulted in additional revenues, certain of these centers are still in the developmental stage and, accordingly, their operating results will adversely impact our overall results of operations until they achieve a patient count sufficient to sustain profitable operations.
Minority interest represents the proportionate equity interests of minority owners of our subsidiaries whose financial results are included in our consolidated results. Equity in affiliate earnings represents our proportionate interest in the earnings of our 40% owned Ohio affiliate. See Notes 1 and 13 to “Notes to Consolidated Financial Statements.”
Liquidity and Capital Resources
Working capital totaled approximately $3,319,000 at June 30, 2005, which reflected a decrease of $325,000 (9%) during the six months ended June 30, 2005. Included in the changes in components of working capital was an increase in cash and cash equivalents of $291,000, which included net cash provided by operating activities of $130,000; net cash used in investing activities of $1,076,000 (including additions to property and equipment of $1,246,000, and distributions of $209,000 received from our 40% owned Ohio affiliate; and net cash provided by financing activities of $1,236,000 (including an increase in advances payable to our parent of $105,000, an increase in notes payable to our parent of $1,515,000, debt repayments of $273,000, receipts of $135,000 from the exercise of stock options, capital contributions of $10,000 by a subsidiary minority member and distribution of $256,000 to subsidiary minority members). See Notes 1 and 11 to “Notes to Consolidated Financial Statements.”
Net cash provided by operating activities consists of net income before non-cash items, consisting of depreciation and amortization of $821,000 bad debt expense of $453,000 deferred income tax benefits of $65,000, income applicable to minority interest $152,000, and equity in affiliate earnings of $215,000, as adjusted for changes in components of working capital, primarily an increase in accounts receivable of $459,000, an increase in prepaid expenses of $576,000 (including income tax prepayments of $687,000), a decrease in accounts payable of $287,000, and a decrease in accrued expenses of $561,000. The major uses of cash in operating activities are supply costs, payroll, independent contractor costs, and costs for our leased facilities.
Our Easton, Maryland building has a mortgage to secure a development loan for our Vineland, New Jersey subsidiary, which loan is guaranteed by us. This loan had a remaining principal balance of $596,000 at June 30, 2005 and $610,000 at December 31, 2004. In April 2001, we obtained a $788,000 five-year mortgage on our building in Valdosta, Georgia, which had an outstanding principal balance of approximately $654,000 at June 30, 2005 and $675,000 at December 31, 2004. See Note 3 to “Notes to Consolidated Financial Statements.”
We have an equipment financing agreement for kidney dialysis machines for some of our facilities, which had an outstanding balance of approximately $575,000 at June 30, 2005, and $814,000 at December 31, 2004. There was no additional equipment financing under this agreement during the first quarter of 2005 or the first quarter of the preceding year. See Note 3 to “Notes to Consolidated Financial Statements.”
During the first half of 2005, we borrowed approximately $1,515,000 under a demand promissory note to our parent with $2,950,000 outstanding at June 30, 2005 and $1,435,000 at December 31, 2004. See Note 5 to “Notes to Consolidated Financial Statements.”
We opened centers in Ashland, Virginia; Warsaw, Virginia; Aiken, South Carolina; Pottstown, Pennsylvania; and Rockville, Maryland during 2004, and acquired Keystone Kidney Care with two dialysis facilities in Pennsylvania effective as of the close of business on August 31, 2004. We are in the process of developing a new dialysis center in each of Maryland, Ohio, and Pennsylvania and three new dialysis centers in South Carolina.
On March 15, 2005, the company and its parent, Medicore, Inc., issued a joint press release announcing their agreement to terms for a merger of Medicore into the company and on June 2, 2005 executed an Agreement and Plan of Merger. The merger is subject to the approval of shareholders of each of Medicore and our company. This transaction will enable the control interest in the company to be in the hands of the public stockholders and provide the company with additional capital resources to expand. See Note 14 to “Notes to Consolidated Financial Statements.” See Item 1, “Legal Proceedings” under Part II - “Other Information” of this quarterly report.
Capital is needed primarily for the development of outpatient dialysis centers. The construction of a 15 station facility, typically the size of our dialysis facilities, costs in the range of $750,000 to $1,000,000, depending on location, size and related services to be provided, which includes equipment and initial working capital requirements. Acquisition of an existing dialysis facility is more expensive than construction, although acquisition would provide us with an immediate ongoing operation, which most likely would be generating income. Although our expansion strategy focuses primarily on construction of new centers, we have expanded through acquisition of dialysis facilities and continue to review potential acquisitions. Development of a dialysis facility to initiate operations takes four to six months and usually up to 12 months or longer to generate income. We consider some of our centers to be in the developmental stage since they have not developed a patient base sufficient to generate and sustain earnings.
We are seeking to expand our outpatient dialysis treatment facilities and inpatient dialysis care and are presently in different phases of negotiations with physicians for the development of additional outpatient centers. Such expansion requires capital. We have been funding our expansion through internally generated cash flow and financing from our parent, Medicore, Inc. See Note 5 to “Notes to Consolidated Financial Statements.” Our future expansion may require us to seek outside financing. While we anticipate that financing will be available either from a financial institution or our parent company, including the proposed merger of our parent with our company providing us with cash estimated at approximately $1,500,000, no assurance can be given that we will be successful in implementing our growth strategy, that the proposed merger will be completed, or that adequate financing will be available to support our expansion.
New Accounting Pronouncements
In November , 2004, the FASB issued Statement of Financial Accounting Standards No. 151, “Inventory Costs,” an amendment of ARB No. 43, Chapter 4 (“FAS 151”). FAS 151 requires companies to recognize as current-period charges abnormal amounts of idle facility expense, freight, handling costs, and wasted materials (spoilage). FAS 151 is effective for inventory costs incurred during fiscal years beginning after June 15, 2005. The company does not expect FAS 151 to have a significant effect on its consolidated financial statements. See Note 1 to “Notes to Consolidated Financial Statements.”
In December, 2004, the FASB issued Statement of Financial Accounting Standards No. 153, “Exchanges of Non-monetary Assets,” an amendment of APB Opinion No. 29 (“FAS 153”). The amendments made by FAS 153 are intended to assure that non-monetary exchanges of assets that are commercially substantive are based on the fair value of the assets exchanged. FAS 153 is effective for non-monetary assets exchanges occurring in fiscal periods beginning after June 15, 2004. The company does no expect FAS 153 to have a significant effect on its financial statements. See Note 1 to “Notes to Consolidated Financial Statements.”
In December 16, 2004, the FASB issued Statement of Financial Accounting Standards No. 123 (revised), “Share-Based Payment” (“FAS 123(R)”). FAS 123(R) requires companies to recognize the fair value of stock option grants as a compensation costs in their financial statements. The company will be required to comply with the provisions of FAS 123(R) effective with its interim financial statements for the first quarter of 2006. The company is in the process of determining the impact that FAS 123 will have on its consolidated financial statements. See Note 1 to “Notes to Consolidated Financial Statements.”
Critical Accounting Policies and Estimates
The SEC has issued cautionary advice to elicit more precise disclosure in this Item 7, MD&A, about accounting policies management believes are most critical in portraying our financial results and in requiring management’s most difficult subjective or complex judgments.
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make judgments and estimates. On an on-going basis, we evaluate our estimates, the most significant of which include establishing allowances for doubtful accounts, a valuation allowance for our deferred tax assets and determining the recoverability of our long-lived assets. The basis for our estimates are historical experience and various assumptions that are believed to be reasonable under the circumstances, given the available information at the time of the estimate, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily available from other sources. Actual results may differ from the amounts estimated and recorded in our financial statements.
We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements.
Revenue Recognition: Revenues are recognized net of contractual provisions at the expected collectable amount. We receive payments through reimbursement from Medicare and Medicaid for our outpatient dialysis treatments coupled with patients’ private payments, individually and through private third-party insurers. A substantial portion of our revenues are derived from the Medicare ERSD program, which outpatient reimbursement rates are fixed under a composite rate structure, which includes the dialysis services and certain supplies, drugs and laboratory tests. Certain of these ancillary services are reimbursable outside of the composite rate. Medicaid reimbursement is similar and supplemental to the Medicare program. Our acute inpatient dialysis operations are paid under contractual arrangements, usually at higher contractually established rates, as are certain of the private pay insurers for outpatient dialysis. We have developed a sophisticated information and computerized coding system, but due to the complexity of the payor mix and regulations, we sometimes receive more or less than the amount expected when the services are provided. We reconcile any differences at least quarterly.
In those situations where a patient’s insurance fee schedule cannot be readily determined, which typically occurs with out of network providers, we estimate fees based on our knowledge base of historical data for patients with similar insurance plans. Our internal controls, including an ongoing review and follow-up on estimated fees, allow us to make necessary changes to estimated fees on a timely basis. When the actual fee schedule is determined, we adjust the amounts originally estimated, and then use the actual fees to estimate fees for similar future situations. We adhere to the guidelines of SAB Topic 13 (SAB 104) in regard to recording reasonable estimates of revenue based on our historical experience and identifying on a timely basis necessary changes to estimates.
Allowance for Doubtful Accounts: We maintain an allowance for doubtful accounts for estimated losses resulting from the inability of our patients or their insurance carriers to make required payments. Based on historical information, we believe that our allowance is adequate. Changes in general economic, business and market conditions could result in an impairment in the ability of our patients and the insurance companies to make their required payments, which would have an adverse effect on cash flows and our results of operations. The allowance for doubtful accounts is reviewed monthly and changes to the allowance are updated based on actual collection experience. We use a combination of percentage of sales and the aging of accounts receivable to establish an allowance for losses on accounts receivable. We adhere to the guidelines of SFAS 5 in determining reasonable estimates of accounts for which uncollectibility is possible.
Valuation Allowance for Deferred Tax Assets: The carrying value of deferred tax assets assumes that we will be able to generate sufficient future taxable income to realize the deferred tax assets based on estimates and assumptions. If these estimates and assumptions change in the future, we may be required to adjust our valuation allowance for deferred tax assets which could result in additional income tax expense.
Long-Lived Assets: We state our property and equipment at acquisition cost and compute depreciation for book purposes by the straight-line method over estimated useful lives of the assets. In accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate the carrying amount of the asset may not be recoverable. Recoverability of assets to be held and used is measured by comparison of the carrying amount of an asset to the future cash flows expected to be generated by the asset. If the carrying amount of the asset exceeds its estimated future cash flows, an impairment charge is recognized to the extent the carrying amount of the asset exceeds the fair value of the asset. These computations are complex and subjective.
Goodwill and Intangible Asset Impairment: In assessing the recoverability of our goodwill and other intangibles we must make assumptions regarding estimated future cash flows and other factors to determine the fair value of the respective assets. This impairment test requires the determination of the fair value of the intangible asset. If the fair value of the intangible asset is less than its carrying value, an impairment loss will be recognized in an amount equal to the difference. If these estimates or their related assumptions change in the future, we may be required to record impairment charges for these assets. We adopted Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets,” (FAS 142) effective January 1, 2002, and are required to analyze goodwill and indefinite lived intangible assets for impairment on at least an annual basis.
Impact of Inflation
Inflationary factors have not had a significant effect on our operations. A substantial portion of our revenue is subject to reimbursement rates established and regulated by the federal government. These rates do not automatically adjust for inflation. Any rate adjustments relate to legislation and executive and Congressional budget demands, and have little to do with the actual cost of doing business. Therefore, dialysis services revenues cannot be voluntarily increased to keep pace with increases in nursing and other patient care costs. Increased operating costs without a corresponding increase in reimbursement rates may adversely affect our earnings in the future.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
We do not consider our exposure to market risks, principally changes in interest rates, to be significant.
Sensitivity of results of operations to interest rate risks on our investments is managed by conservatively investing funds in liquid interest bearing accounts of which we held approximately $848,000 at June 30, 2005.
Interest rate risk on debt is managed by negotiation of appropriate rates for equipment financing and other fixed rate obligations based on current market rates. There is an interest rate risk associated with our variable rate debt obligations, which totaled approximately $4,200,000 at June 30, 2005, including our demand promissory note payable to our parent, Medicore, which amounted to approximately $2,950,000 at June 30, 2005.
We have exposure to both rising and falling interest rates. Assuming a relative 15% decrease in rates on our period-end investments in interest bearing accounts and a relative 15% increase in rates on our period-end variable rate debt would have resulted in a negative impact of approximately $15,000 on our results of operations for the six months ended June 30, 2005.
We do not utilize financial instruments for trading or speculative purposes and do not currently use interest rate derivatives.
Item 4. Controls and Procedures
(a) Disclosure Controls and Procedures.
As of the end of the period of this quarterly report on Form 10-Q for the second quarter ended June 30, 2005, management carried out an evaluation, under the supervision and with the participation of our President and Chief Executive Officer, and the Vice President of Finance and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Rule 13a-15 of the Exchange Act, which disclosure controls and procedures are designed to provide reasonable assurance that, among other things, information is accumulated and communicated to our management, including our Chief Executive Officer and our Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. Based upon such evaluation, our Chief Executive Officer and our Chief Financial Officer have concluded that, as of the end of such period, our disclosure controls and procedures are effective in providing reasonable assurance that information required to be disclosed by our company in the reports that it files under the Exchange Act is recorded, processed, summarized and reported within required time periods specified by the SEC’s rules and forms.
(b) Internal Control Over Financial Reporting.
There were no significant changes in our internal control over financial reporting that occurred during our most recent fiscal quarter or subsequent to the evaluation as described in subparagraph (a) above that materially affected, or are reasonably likely to materially affect, our control over financial reporting.
PART II -- OTHER INFORMATION
Item 1. Legal Proceedings.
Putative class and derivative actions filed in Florida and Maryland with the company named as a nominal defendant, and having named the company’s board members and parent , Medicore Inc., as defendants, regarding the proposed merger of our parent with the company, had been reported in Part II, Item 1, “Legal Proceedings” of the company’s quarterly report for the first quarter ended March 31, 2005.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
Equity Securities Sold by the Company During the Second Quarter Ended June 30, 2005 and Not Registered Under the Securities Act
The only sale of equity securities by the company during the second quarter ended June 30, 2005 that was not registered under the Securities Act was through the issuance of 1,000 shares of common stock pursuant to an option exercise at $2.05 per share for an aggregate of $2,050 by an employee. These securities were included in the company's Form S-8 registration statement filed in February, 2005.
Purchases of Equity Securities By or On Behalf of the Company During the Second Quarter Ended June 30, 2005
The company had a common stock repurchase program announced in September 2000, for the repurchase of up to 600,000 shares at the current market price of approximately $.90 under which 360,000 shares had been purchased. This program has been terminated. The company has not made any repurchases of any equity securities during the second quarter months of April, May and June, 2005.
Item 6. Exhibits
Part I Exhibits
31 | Rule 13a-14(a)/15d-14(a) Certifications |
31.1 | Certifications of the Chief Executive Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934. |
31.2 | Certifications of Chief Financial Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934. |
32 | Section 1350 Certifications |
32.1 | Certifications of the Chief Executive Officer and the Chief Financial Officer pursuant to Rule 13a-14(b) of the Securities Exchange Act of 1934 and U.S.C. Section 1350. |
Part II Exhibits
3 | Articles of Incorporation and Bylaws |
3.1 | Articles of Incorporation (incorporated by reference to the company’s registration statement on Form SB-2 dated December 22, 1995, as amended February 9, 1996, April 15, 1996, registration no. 33-80877-A (“Registration Statement”), Part II, Item 27). |
3.2 | By-laws (incorporated by reference to the company’s Registration Statement, Part II, Item 27). |
4.1 | Form of Common stock Certificate (incorporated by reference to the company’s Registration Statement, Part II, Item 27). |
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
DIALYSIS CORPORATION OF AMERICA | ||
| | |
By: | /s/ DON WAITE | |
DON WAITE, Vice President of Finance and Chief Financial Officer | ||
Dated: August 15, 2005
EXHIBIT INDEX
Exhibit No.
Part I Exhibits
31 | Rule 13a-14(a)/15d-14(a) Certifications |
31.1 | Certifications of the Chief Executive Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934. |
31.2 | Certifications of Chief Financial Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934. |
32 | Section 1350 Certifications |
32.1 | Certifications of the Chief Executive Officer and the Chief Financial Officer pursuant to Rule 13a-14(b) of the Securities Exchange Act of 1934 and U.S.C. Section 1350. |
Part II Exhibits
3 | Articles of Incorporation and Bylaws |
3.1 | Articles of Incorporation (incorporated by reference to the company’s registration statement on Form SB-2 dated December 22, 1995, as amended February 9, 1996, April 15, 1996, registration no. 33-80877-A (“Registration Statement”), Part II, Item 27). |
3.2 | By-laws (incorporated by reference to the company’s Registration Statement, Part II, Item 27). |
4.1 | Form of Common stock Certificate (incorporated by reference to the company’s Registration Statement, Part II, Item 27). |