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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
--------------------------
FORM 10-K
(MARK ONE)
[X]ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 1996
OR
[_]TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
COMMISSION FILE NUMBER 1-4034
TOTAL RENAL CARE HOLDINGS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
Delaware 51-0354549
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER IDENTIFICATION NO.)
INCORPORATION OR ORGANIZATION)
21250 Hawthorne Boulevard, Suite 800, Torrance, California 90503-5517
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
Registrant's telephone number, including area code: (310) 792-2600
Securities registered pursuant to Section 12(b) of the Act: Common Stock, par
value $.01 per share
Name of each exchange on which registered: New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.
YES X NO
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Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]
The aggregate market value of the Common Stock of the Registrant held by
non-affiliates of the Registrant on March 1, 1997, based on the price at which
the Common Stock was sold as of March 1, 1997, was $22,490,695.
The number of shares of the Registrant's Common Stock outstanding as of
March 1, 1997 was 26,593,432 shares.
DOCUMENTS INCORPORATED BY REFERENCE
None.
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PART I
ITEM 1. BUSINESS.
The following should be read in conjunction with the Registrant's
Consolidated Financial Statements and the related notes thereto contained
elsewhere in this Form 10-K. This Form 10-K contains forward-looking
statements which involve risks and uncertainties. The Registrant's actual
results may differ significantly from the results discussed in the forward-
looking statements. Unless the context otherwise requires, the term "Company"
refers to Total Renal Care Holdings, Inc. and its Subsidiaries.
Total Renal Care Holdings, Inc. is the third largest and fastest growing
provider of high-quality dialysis and related services for patients suffering
from chronic kidney failure, also known as end stage renal disease ("ESRD").
As of December 31, 1996, the Company provides dialysis and ancillary services
to more than 10,200 patients through a network of 134 outpatient dialysis
facilities in 16 states, Washington, D.C. and Guam. In addition, the Company
provides inpatient dialysis services at 87 hospitals.
The Company has implemented an aggressive growth strategy since the August
1994 Transaction (as defined below). From August 1994 through December 31,
1996, the Company has added 97 outpatient dialysis facilities to its network
as well as 59 hospital inpatient contracts. Sixty-six of these outpatient
dialysis facilities and 39 of these hospital inpatient contracts have been
added during 1996. The Company also has continued to expand its in-house
ancillary services to include vascular access management and transplant
services programs in addition to the ESRD laboratory and pharmacy facilities
established in 1995. The increase in the number of facilities and hospital
contracts, combined with the enhancement of the Company's ancillary businesses
and growth in existing businesses, has resulted in an increase in net
operating revenues of 102% to $272.9 million in the fiscal year ended December
31, 1996 as compared to the prior year and an increase in operating income of
83% to $48.8 million during the same period.
The Company's wholly-owned subsidiary, Total Renal Care, Inc. ("TRC"),
formerly known as Medical Ambulatory Care, Inc., was organized in 1979 by
Tenet Healthcare Corporation ("Tenet"), formerly known as National Medical
Enterprises, Inc., to own and operate Tenet's hospital-based dialysis services
as freestanding dialysis facilities and to acquire and develop additional
dialysis facilities in Tenet's markets. The Company was organized to
facilitate the sale by Tenet of approximately 75% of its ownership interest
(the "August 1994 Transaction") to management of the Company, DLJ Merchant
Banking Partners, L.P. and certain of its affiliates ("DLJMB"), and certain
holders of debt securities of the Company. In connection with the August 1994
Transaction, the Company, NME Properties Corporation, a wholly owned
subsidiary of Tenet, Tenet and DLJMB entered into a number of agreements
relating to, among other things, corporate governance, the provision of
certain services to the Company by Tenet, and restrictions on stock transfers.
THE DIALYSIS INDUSTRY
End-Stage Renal Disease
ESRD is the state of advanced renal impairment that is irreversible and
requires routine dialysis treatments or kidney transplantation to sustain
life. Qualified patients with ESRD have been entitled, since 1972, to Medicare
benefits regardless of age or financial circumstances. According to figures
published by the Health Care Financing Administration ("HCFA"), the number of
patients requiring chronic dialysis services in the U.S. has increased at a 9%
compounded annual growth rate to 200,000 patients in 1995 from 66,000 in 1982.
The Company estimates that the U.S. market for outpatient and inpatient
services to ESRD patients in 1995 exceeded $13 billion.
The Company attributes the continuing growth in the number of ESRD patients
principally to the aging of the general population and to better treatment and
longer survival of patients with hypertension, diabetes and other illnesses
that lead to ESRD. Management also believes improved medical and dialysis
technology has enabled older patients and those who previously could not
tolerate dialysis due to other illnesses to benefit from this life-prolonging
treatment.
2
The Company estimates there were approximately 3,000 dialysis facilities in
the United States at the end of 1996, of which approximately 27% were owned by
independent physicians (down from 37% in 1992), 28% were hospital-based
facilities (down from 33% in 1992), and 45% were owned by seven major multi-
facility dialysis providers (up from 30% in 1992), including the Company. The
dialysis services industry has been undergoing rapid consolidation. The
Company believes that many physician owners are selling their facilities to
obtain relief from changing government regulation and administrative
constraints, to enable them to focus on patient care and to realize a return
on their investment. Hospitals are also motivated to sell or outsource
management of their facilities as they refocus their resources on their core
business due to increasing competitive pressures within the hospital industry.
The Company believes that these changes in the health care environment will
continue to drive consolidation within the dialysis services industry.
Treatment Options for End-Stage Renal Disease
Treatment options for ESRD include hemodialysis, peritoneal dialysis and
kidney transplantation. ESRD patients are treated predominantly in outpatient
treatment facilities. HCFA estimates that as of December 31, 1995, 83% of the
ESRD patients in the United States were receiving hemodialysis treatment in
outpatient facilities, with the remaining patients being treated in the home
either through peritoneal dialysis (16%) or home hemodialysis (1%).
Hemodialysis. Hemodialysis, the most common form of ESRD treatment, is
generally performed either in a freestanding facility or in a hospital-based
facility. Hemodialysis uses an artificial kidney, called a dialyzer, to remove
certain toxins, fluids and salt from the patient's blood combined with a
machine to control external blood flow and to monitor certain vital signs of
the patient. The dialysis process occurs across a semi-permeable membrane that
divides the dialyzer into two distinct chambers. While blood is circulated
through one chamber, a pre-mixed dialyzer fluid is circulated through the
other chamber. The toxins and excess fluid from the blood selectively cross
the membrane into the dialysis fluid. A hemodialysis treatment usually lasts
approximately three hours and is performed three times per week per patient.
Peritoneal Dialysis. Peritoneal dialysis is generally performed by the
patient at home. There are several variations of peritoneal dialysis. The most
common are continuous ambulatory peritoneal dialysis ("CAPD") and continuous
cycling peritoneal dialysis ("CCPD") or automated peritoneal dialysis ("APD").
All forms of peritoneal dialysis use the patient's peritoneal (abdominal)
cavity to eliminate fluid and toxins from the patient. CAPD utilizes a
sterile, pharmaceutical-grade dialysis solution which is introduced into the
patient's peritoneal cavity through a surgically placed catheter. Toxins in
the blood continuously cross the peritoneal membrane into the dialysis
solution. After several hours, the patient drains the used dialysis solution
and replaces it with fresh solution. CCPD and APD are performed in a manner
similar to CAPD, but use a mechanical device to cycle dialysis solution while
the patient is sleeping or at rest.
Other Treatment Options. An alternative treatment not provided by the
Company is kidney transplantation. However, the Company does provide both pre
and post transplant nursing services and the provision of transplant
pharmaceuticals in selected markets. While transplantation, when successful,
is generally the most desirable form of therapeutic intervention, the shortage
of suitable donors limits the availability of this treatment option.
BUSINESS STRATEGY
The Company has implemented an aggressive growth strategy since the August
1994 Transaction adding 97 outpatient dialysis facilities to its network as
well as 59 hospital inpatient contracts through December 31, 1996. Sixty-six
of these outpatient dialysis facilities and 39 of these hospital inpatient
contracts have been added during 1996. The Company also has expanded its in-
house ancillary services to include ESRD laboratory and pharmacy facilities,
as well as vascular access management and transplant services programs. The
strong growth in the number of facilities and hospital contracts, combined
with the enhancement of the Company's ancillary businesses and growth in the
existing businesses, has resulted in an increase in net operating revenues of
102% to $272.9 million in the year ended December 31, 1996 as compared to the
prior year and an increase in operating income of 83% to $48.8 million during
the same period. As part of its growth strategy, the Company continually
reviews and evaluates potential acquisition candidates and seeks to identify
locations for de novo developments. The Company is currently developing 15 new
facilities scheduled for completion during 1997.
3
The Company's growth strategy is focused on establishing strong regional
networks of clustered facilities that provide comprehensive care for ESRD
patients. The Company believes that this approach enhances its operating
efficiency and positions the Company to be a leader in a health care
environment increasingly influenced by managed care. The Company strives to
continue its growth and margin improvement by (i) expanding its existing
networks and by creating new regional facility networks through acquisitions,
de novo developments and the formation of hospital alliances, (ii) forming
strategic alliances with managed care organizations and physicians, (iii)
expanding the range of ancillary services it provides to patients,
(iv) continuously improving the quality of care provided through the Company's
Quality Management Program and (v) maximizing operating efficiencies and
utilization.
Creation and Expansion of the Facility Networks
Acquisitions. The Company's acquisition strategy is to leverage its
operating infrastructure in existing regions by acquiring centers where the
Company already has a strong market presence and to establish a strong
presence in new markets by acquiring clusters of facilities that can support
new regional operating infrastructures. In reviewing a potential acquisition,
the Company's evaluation includes analyzing financial pro formas, reviewing
the local competitive market and assessing the target facility's reputation
for providing quality care. From August 1994 through December 31, 1996 the
Company acquired 84 new facilities of which 57 were acquired during 1996. The
new facilities acquired during 1996 have expanded the Company's existing
facility networks in Southern and Northern California, Florida, the Greater
Washington, D.C. area and El Paso while providing significant entries into new
markets including the Minneapolis/St. Paul region, Houston and Guam.
De Novo Developments. The Company develops new facilities to further enhance
its regional clusters, to better serve the managed care market, to accommodate
the growing number of ESRD patients and to satisfy demand by local
nephrologists. The Company has established an expertise in the design and
construction of dialysis facilities, having developed 13 facilities from
August 1994 through December 31, 1996 nine of which were developed during
1996. During 1996, de novo developments enhanced existing regional clusters in
Southern California, New Orleans, Florida, El Paso, Washington D.C. and
Minnesota. In addition, the Company is currently developing 15 new facilities
scheduled for completion by the end of 1997.
Hospital Alliances. Management believes alliances with hospital-based
facilities represent a growth opportunity for the Company as hospitals refocus
on their core business due to the changing competitive environment in the
hospital industry. These alliances allow the Company to be a value-added
partner for hospitals through application of the Company's industry-specific
expertise to hospital-based dialysis facilities. Accordingly, the Company is
actively pursuing alliances with academic medical centers, as well as
community and county hospitals. The Company currently has alliances to work
with the following academic institutions to provide the highest quality care
for their ESRD patients: University of Southern California, Louisiana State
University, Georgetown University, Harbor-UCLA Medical Center (alliance to be
finalized in the second quarter of 1997) and Hennepin County Medical
Center/University of Minnesota. These academic affiliations help the Company
remain on the leading edge of academic advances in the caring for ESRD
patients. The Company has an Academic Advisory Board which meets semi-annually
to review leading programs and to discuss ways in which the Company and its
community physicians can work together on critical research to improve the
well being of the growing ESRD patient population.
Alliances with Managed Care and Physicians
Alliances with Managed Care. The Company is committed to forming innovative
alliances directly with managed care organizations by providing comprehensive,
integrated ESRD services that deliver high-quality care and reduce overall
health care costs. In July 1995, the Company was awarded the first long-term
ESRD contract to develop and manage a dialysis center for Kaiser Permanente
("Kaiser") in San Diego, California and in March 1996 the 25 station facility
was opened. The facility currently cares for approximately 100 Kaiser patients
through its innovative integrated ESRD program. This contract is also the
first "partnership" of its type for Kaiser. Kaiser contracts services for one
of the largest dialysis and kidney transplant populations (approximately 3,000
patients in California) in the country.
4
The Company has also developed innovative programs with payors throughout
the country, including Aetna-New Orleans and Maxicare-New Orleans. These
payors have selected the Company to be its integrated provider of renal
services and have transitioned most of their ESRD patients to the Company's
facilities in New Orleans and El Paso. These payors elected to partner with
the Company due to its Quality Management Program, Outcomes Programs and
geographic coverage of the regions. As a result of its managed care programs,
the Company has signed approximately 138 contracts with managed care payors.
Alliances With Physicians. The Company seeks to organize and manage networks
of nephrologists which further enhance the ability of these nephrologists and
the Company to provide integrated ESRD services. The Company entered into a
long-term management contract with Total Nephrology Care Network Medical
Associates, a Professional Corporation (the "Physician Network"), a network of
over 35 leading nephrologists in Southern California that works in partnership
with the Company to provide high-quality, integrated ESRD services while
reducing total costs. The Physician Network markets the services of
participating nephrologists to preferred provider organizations, insurance
companies, health maintenance organizations and other third-party payors for
ESRD services both on a discounted fee-for-service basis and on a prepaid or
capitated basis. Through a long-term management services agreement the Company
is responsible for providing billing, information systems and other services
to the Physician Network. The Company is paid a management fee for all the
services provided by the Company to the Physician Network. The Company is
actively developing Physician Networks in most of its major markets including
Chicago, South Florida and Minneapolis.
Comprehensive Renal Services
The Company is committed to broadening the range of services it provides to
its ESRD patients while adding additional sources of revenue and profits. The
Company owns two laboratories, in Florida and Minnesota, that provide both
routine (including those in the Medicare composite rate) and non-routine
(those for which an additional fee is charged) laboratory tests for its own
and other ESRD patients throughout the United States.
The Company opened a pharmacy in February 1995 that provides a comprehensive
prescription oral drug program to patients receiving treatments at the
Company's facilities. The pharmacy recently began a transplant program that
provides immunosuppressive medications that are required to maintain the
viability of a transplant patient's new kidney. The pharmacy also provides
intradialytic parenteral nutrition ("IDPN") to patients who require the
therapy. The Company's dialysis facilities administer erythropoietin ("EPO")
and other injectable drugs to patients upon a physician's prescription.
The Company is also part of a joint venture to provide vascular access
management services to ESRD patients. Clotting of the hemodialysis vascular
access, the physical entry point to the circulatory system for the dialysis
procedure, is one of the most common causes of hospitalization for ESRD
patients. The Company's vascular access management program uses diagnostic and
preventive procedures to help keep the access point functioning.
The Company has a pre- and post-kidney transplant services program in which
our transplant nurses and coordinators train and counsel patients and their
families while also assisting in the continuous outcomes monitoring required
for this population.
The Company is committed to expanding its home dialysis program. During the
year ended December 31, 1996, the Company increased the percentage of its
patients receiving peritoneal dialysis to approximately 13% from 12% for the
comparable period in the prior year. Management believes that it can increase
the proportion of its patients receiving peritoneal dialysis services, as an
estimated 16% of all patients in the federal ESRD program at December 31, 1996
received such services.
Quality Management Program
The Company believes its reputation for quality care is a significant
competitive advantage in attracting patients and physicians and in pursuing
growth in the managed care environment. The Company engages in organized and
systematic efforts to measure, maintain and improve the quality of services it
delivers through its
5
Quality Management Program. In response to current payor demands for cost-
effective health care treatments with measurable outcomes, the Company has
developed a proprietary PC-based, networked clinical information system that
provides managed care organizations with detailed patient outcome reports and
critical on-line clinical information. See "Operations--Quality Assurance."
Maximizing Operating Efficiencies
The Company believes it has adequate capacity within its existing facilities
network to accommodate greater patient volume and expects such operating
leverage to contribute to increasing margins. In addition, at certain of its
facilities, the Company is able to add dialysis stations to meet growing
demand. The Company will continue to focus on enhancing operating
efficiencies, including staffing, purchasing and financial reporting systems
and controls.
The Company recently implemented a Best Demonstrated Practices Program that
creates value by identifying ways to improve quality of care and to reduce
overall cost at each dialysis facility. Once a facility has demonstrated
proficiency with a certain practice, information and operational systems are
developed and disseminated throughout the organization by the Regional Quality
Management Coordinator and Regional Operations Directors. This program has
been focused on improvements in staffing level efficiency, rationalization of
drug and ancillary usage, revenue capture and medical supply utilization.
RECENT FACILITY NETWORK EXPANSION
The Company has implemented an aggressive growth strategy since the closing
of the August 1994 Transaction and has added, through December 31, 1996, 97
new centers (comprised of 84 acquisitions and management contracts, and 13 de
novo developments) representing, at the time of acquisition or commencement of
operations, 1,402 dialysis stations and more than 7,200 patients. Sixty-six of
these new centers (comprised of 57 acquisitions and management contracts and 9
de novo developments) have been added during 1996 and represent, at the time
of acquisition or commencement of operations, 960 dialysis stations and more
than 4,800 patients.
The Company has obtained 59 additional hospital inpatient contracts from the
closing of the August 1994 Transaction through December 31, 1996, of which 39
were added during 1996. Furthermore the Company has expanded its in-house
ancillary services to include ESRD laboratory and pharmacy facilities, as well
as vascular access management and transplant services programs. As part of its
growth strategy, the Company continually reviews and evaluates potential
acquisition candidates and seeks to identify locations for de novo
developments. The Company is currently developing 15 new facilities scheduled
for completion by the end of 1997.
6
Network Expansion Since January 1, 1996
The following chart lists the 57 centers acquired (or managed) and the nine
de novo facilities developed by the Company during fiscal 1996:
CAREMARK ACQUISITION (MARCH 1996)
Chabot Dialysis Clinic, Dublin CA
Chabot Dialysis Clinic, Hayward CA
Chabot Dialysis Clinic, San Leandro CA
Chabot Dialysis Clinic, Union City CA
East Bay Peritoneal Dialysis CA
Alexandria Dialysis Unit MN
Anoka-Good Samaritan Dialysis Unit MN
Arden Hills Dialysis Unit MN
Burnsville Dialysis Unit MN
Cass Lake Dialysis Unit MN
Coon Rapids Dialysis Unit MN
Edina Dialysis Unit MN
Fairmont Dialysis Unit MN
Faribault Dialysis Unit MN
Maplewood Dialysis Unit MN
Marshall Dialysis Unit MN
Minneapolis Dialysis Unit MN
Minnetonka Dialysis Unit MN
Montevideo Dialysis Unit MN
Morris Dialysis Unit MN
Pine City Dialysis Unit MN
Red Lake Dialysis Unit MN
Red Wing Dialysis Unit MN
Redwood Falls Dialysis Unit MN
Special Needs Dialysis Unit MN
St. Paul Dialysis Unit MN
West St. Paul Dialysis Unit MN
Mitchell Dialysis Unit SD
Pine Ridge Dialysis Unit SD
Rosebud Dialysis Unit SD
Sioux Falls Dialysis Unit SD
St. Croix Falls Dialysis Unit WI
OTHER ACQUISITIONS
Burbank Regional Dialysis Center CA January
Pacific Peritoneal Dialysis Center Guam January
Greer Kidney Center SC March
Upstate Dialysis Center SC March
Downtown Dialysis Center MD April
Eaton Canyon Dialysis Center CA June
Georgetown Dialysis Center (1) DC June
St. Mary Medical Center PA June
Piedmont Dialysis CA July
Peralta Dialysis CA July
Bertha Sirk Dialysis MD July
Greenspring Dialysis MD July
Houston Kidney Center TX August
Houston Kidney Center Southeast TX August
North Houston Kidney Center TX August
Northwest Kidney Center TX August
Port Charlotte Artificial Kidney FL August
Gulf Coast Peritoneal FL August
Paramount Dialysis CA September
Doctors Dialysis East L.A. (2) CA October
Doctors Dialysis Montebello (2) CA October
Complete Dialysis Care CA October
Astro Dialysis Center TX November
Hobby Dialysis Center TX November
West Mount Dialysis Center TX November
DE NOVO FACILITIES
Kenner Dialysis Center LA February
Potrero Hill Dialysis Center CA February
Mission Dialysis Center CA March
Guam Renal Center Guam May
Loma Vista TX August
Pine Island FL October
USC CA November
Forest Lake MN November
Union Plaza DC December
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(1) Management Contract
(2) In October 1996 the Company entered into a definitive agreement to
purchase Doctors Dialysis Center of East Los Angeles and Doctors Dialysis
Center of Montebello and expects to complete the acquisition during the
second quarter of 1997.
7
OPERATIONS
Location, Capacity and Use of Facilities
As of December 31, 1996 the Company operated 134 outpatient dialysis centers
with 2,045 dialysis stations. The Company owns or operates, directly or
through wholly-owned subsidiary corporations, 107 of these facilities. The
remaining 27 centers are partially-owned by physicians. The Company's
facilities range in size from four to 52 dialysis stations. The facilities are
located in the following states in the following numbers: California (34);
Minnesota (23); Florida (17); Texas (11); Arizona (7); Illinois (7); Louisiana
(6); Virginia (6); Georgia (5); South Dakota (4); Maryland (3); Guam (2); New
Mexico (2); South Carolina (2); Washington, D.C. (2); Pennsylvania (1);
Washington (1); Wisconsin (1). The Company also provides acute inpatient
dialysis services to 87 hospitals. System-wide, the Company provides training,
supplies and on-call support services to all of its CAPD and CCPD patients.
Operation of Facilities
The Company's dialysis facilities are designed specifically for outpatient
hemodialysis and generally contain, in addition to space for dialysis
treatments, a nurses' station, a patient weigh-in area, a supply room, a water
treatment space used to purify the water used in hemodialysis treatments, a
dialyzer reprocessing room (where, with both the patient's and physician's
consent, the patient's dialyzer is sterilized for reuse), staff work areas,
offices and a staff lounge and kitchen. Many of the Company's facilities also
have a designated area for training patients in home dialysis. Each facility
also offers amenities for the patients, such as a color television with
headsets at each dialysis station.
In accordance with conditions for participation in the Medicare ESRD
program, each facility has a qualified Medical Director. See "Physician
Relationships" below. Each facility also has an Administrator, typically a
registered nurse, who supervises the day-to-day operations of each facility
and the staff. The staff of each facility typically consists of registered
nurses, licensed practical or vocational nurses, patient care technicians, a
social worker, a registered dietician, a unit clerk and bio-medical
technicians.
All of the Company's facilities offer high-flux and high-efficiency
hemodialysis, which most physicians practicing at the Company's facilities
deem suitable for most of their patients. High-flux and high-efficiency
hemodialysis utilize machinery that allow patients to dialyze in a shorter
period of time per treatment because such methods cleanse the blood at a
faster rate than conventional hemodialysis. Many of the Company's facilities
also offer conventional hemodialysis. The Company considers the equipment
installed in its facilities to be among the most technologically advanced
equipment presently available to the dialysis industry.
Many of the Company's facilities also offer various forms of home dialysis,
primarily CAPD. Home dialysis services consist of providing equipment and
supplies, training, patient monitoring and follow-up assistance to patients
who prefer and are able to receive dialysis treatments in their homes.
Patients and their families or other patient assistants are trained by a
registered nurse to perform either CAPD or CCPD at home. Company training
programs for CAPD or CCPD generally encompass two to three weeks.
Inpatient Dialysis Services
The Company provides inpatient dialysis services (excluding physician
professional services) to 87 hospitals. These services are required in
connection with the hospital's inpatient services for a per treatment fee
individually negotiated with the hospital. In most instances, the Company
transports the dialysis equipment and supplies to the hospital when requested
and administers the dialysis treatment. Examples of cases in which such
inpatient services are required include patients with acute kidney failure
resulting from trauma or similar causes, patients in the early stages of ESRD
and ESRD patients who require hospitalization for other reasons.
Ancillary Services
Dialysis facilities provide a comprehensive range of ancillary services to
ESRD patients, the most significant of which is the administration of EPO upon
a physician's prescription. EPO is a bio-engineered protein which
8
stimulates the production of red blood cells and is used in connection with
all forms of dialysis to treat anemia, a medical complication frequently
experienced by ESRD patients. The Company also has a licensed pharmacy which
provides ESRD patients with oral medications and IDPN services upon a
physician's prescription. Other ancillary services include studies to test the
degree of bone deterioration, electrocardiograms ("EKGs"), nerve conduction
studies to test the degree of deterioration of nerves, doppler flow testing to
test the effectiveness of the patient's vascular access for dialysis and blood
transfusions.
The Company owns two licensed clinical laboratories, located in Florida and
Minnesota, specializing in ESRD patient testing. These ESRD laboratories
provide various forms of laboratory tests, a large majority of which are
performed for the Company's outpatient dialysis facilities. The types of
laboratory tests performed at the ESRD laboratories consist of (i) blood tests
to manage the ESRD condition, some of the costs which are reimbursed as part
of the dialysis composite rate; (ii) blood tests ordered for co-morbid ESRD
conditions (i.e., diseases that are the result of or cause of ESRD) and (iii)
general symptom testing. In addition, the Minnesota laboratory provides
certain highly-specialized tests, including therapeutic drug monitoring, bone
deterioration and renal stone disease monitoring and certain pre- and post-
kidney transplant testing.
The Company is also part of a joint venture to provide vascular access
management services to ESRD patients. Clotting of the hemodialysis vascular
access, the physical entry point to the circulatory system for the dialysis
procedure, is one of the most common causes of hospitalization for ESRD
patients. The Company's vascular access management program uses diagnostic and
preventive procedures to help keep the access point functioning.
The Company has a pre- and post-kidney transplant services program in which
our transplant nurses and coordinators train and counsel patients and their
families while also assisting in the continuous outcomes monitoring required
for this population.
Physician Relationships
A key factor in the success of a dialysis facility is its relationship with
local nephrologists. An ESRD patient generally seeks treatment at a facility
near such patient's home and where such patient's nephrologist has practice
privileges. Consequently, the Company relies on its ability to meet the needs
of referring physicians in order to continue to receive physician referrals of
ESRD patients.
The conditions of participation in the Medicare ESRD program mandate that
treatment at a dialysis facility be "under the general supervision of a
Director who is a physician." The Company has engaged qualified physicians or
groups of qualified physicians to serve as Medical Directors for each of its
facilities. Generally, the Medical Director must be board eligible or board
certified in internal medicine or nephrology and have had at least 12 months
of experience or training in the care of patients at ESRD facilities. At some
facilities, the Company also contracts with one or more physicians to serve as
Assistant or Associate Medical Directors or to direct specific programs, such
as CAPD training.
Medical Directors, Associate Medical Directors and Assistant Medical
Directors enter into written contracts with the Company which specify their
duties and establish their compensation (which is fixed for periods of one
year or more). Such agreements are terminable by either party with advance
written notice. The Company believes that this allows the Company to evaluate
frequently the quality of the Medical Director's performance; however, the
lack of long-term contracts with physicians could result in the loss of
certain key physicians at particular facilities, which could have a material
adverse effect on the operations of such facilities. The compensation of the
Medical Directors and other physicians under contract is separately negotiated
for each facility and generally depends upon competitive factors in the local
market, the physician's professional qualifications and responsibilities and
the size and utilization of the facility or relevant program.
As is often true in the dialysis industry, one or a few physicians account
for all or a significant portion of a dialysis facility's patient referral
base. Therefore the Company's selection of a location for a dialysis facility
is determined in part by the physician or nephrologist selected (in advance)
to serve as the Company's Medical Director. The loss of an important referring
physician at a particular facility could have a material adverse effect on the
operations of that facility.
9
Generally, the Company has non-competition agreements with its Medical
Directors or referring physicians. In all cases in which the Company acquired
a facility from one or more physicians, or where one or more physicians own
interests in facilities as partners, members of a limited liability
corporation or co-shareholders with the Company, such physicians have agreed
to refrain from owning interests in competing facilities within a defined
geographic area for various periods. In other cases, physicians who provide
Medical Director services have executed non-competition agreements. While not
frequent, the Company has from time to time experienced competition from a
dialysis facility established by a former Medical Director following the
termination of his or her relationship with the Company.
Quality Assurance
Quality Management Program. The Company engages in organized and systematic
efforts to measure, maintain and improve the quality of services it delivers
and believes that it has earned a favorable reputation for quality in the
dialysis community. The Company has recently implemented a Quality Management
Program designed to measure outcomes and improve the quality of its services.
The Company also has developed and is rolling-out a proprietary PC-based
Clinical Information System to support its Quality Management, Outcomes
Monitoring, Measurement and Management and Managed Care Programs. The
Company's Quality Management Program and Clinical Information Systems have
been developed under the direction of the Company's Vice President, Quality
Management and Integrated Programs, who is a Clinical Professor of Medicine at
the University of California Medical Center in San Francisco. The
implementation of the Quality Management Program is being coordinated by the
Company's Corporate Director of Quality Management and 12 regional Quality
Management Coordinators. This corporate quality management team works with
each facility's multi-disciplinary quality management team (including the
Medical Director) at each facility to implement the Program. The Quality
Management Program involves all areas of the Company's services, monitoring
and evaluating all of the Company's activities with a focus on continuous
improvement. These objectives are accomplished through measurable trend
analysis based on specific statistical tools for analysis and communication,
and through continuing employee and patient education.
Clinical Information Systems. To support the Quality Management Program and
in response to current payor demands for cost-effective health care treatments
with measurable outcomes, the Company has developed a proprietary PC-based,
networked clinical information system that will provide the facilities and
managed care organizations with detailed patient outcome reports and critical
clinical information. The clinical information system has been rolled-out to
most all of the Company's facilities. Furthermore, the Company has implemented
connectivity between Kaiser's mainframe and the Company's Clinical Information
System at the new Mission Dialysis Center in San Diego.
Best Demonstrated Practices. The Company recently implemented a Best
Demonstrated Practices Program that creates value by identifying ways to
improve quality of care and to reduce overall cost at each dialysis facility.
Once a facility has demonstrated proficiency with a certain practice,
information and operational systems are developed and disseminated throughout
the organization by the Regional Quality Management Coordinator and Regional
Operations Directors. This program has been focused on improvements in
staffing level efficiency, rationalization of drug and ancillary usage,
revenue capture and medical supply utilization.
Physician Advisory Board. The Company has a Physicians Advisory Board
consisting of certain Medical Directors of facilities from different regions
of the country who advise management on the Company's Quality Management
Program. Members of the Physicians Advisory Board respond to specific
questions on quality issues and the Physicians Advisory Board meets semi-
annually to discuss Company quality and related operational issues. The
Company believes its reputation for quality care is a competitive advantage in
attracting new patients and new referring physicians.
Patient Satisfaction. Since 1991, the Company has retained an independent
consulting firm to conduct patient satisfaction surveys. These surveys track
and identify trends in resulting patient satisfaction indicators that are in
turn shared with management, Medical Directors and patients for discussion. In
conjunction with the patient satisfaction surveys, the Company is currently
developing a pilot program in cooperation with its laboratory to analyze
specific laboratory test data and related patient treatment outcome data to
evaluate patient
10
treatment quality. The Company also compiles patient hospitalization and
related patient treatment outcomes data and is developing standards to
evaluate such data as part of the Company's national Quality Management
Program.
Sources of Revenue Reimbursement
The following table provides information for the periods indicated regarding
the percentage of Company net operating revenues provided by (i) the Medicare
ESRD program, (ii) Medicaid, (iii) private/alternative payors, such as private
insurance and private funds, and (iv) hospital inpatient dialysis services.
SEVEN MONTHS
ENDED YEAR ENDED
YEARS ENDED MAY 31, DECEMBER 31, DECEMBER 31,
---------------------- -------------- --------------
1993 1994 1995 1994 1995 1995 1996
Medicare................ 66.5% 65.6% 62.0% 59.4% 60.2% 61.8% 61.1%
Medicaid................ 8.4 9.0 8.1 9.3 6.7 6.7 6.1
Private/alternative
payors................. 19.0 19.7 24.3 26.3 27.9 25.9 27.3
Hospital inpatient dial-
ysis services.......... 6.1 5.7 5.6 5.0 5.2 5.6 5.5
------ ------ ------ ------ ------ ------ ------
Total................. 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
====== ====== ====== ====== ====== ====== ======
Under the Medicare ESRD program, Medicare reimburses dialysis providers for
the treatment of individuals who are diagnosed to have ESRD and are eligible
for participation in the Medicare program, regardless of age or financial
circumstances. For each treatment, Medicare pays 80% of the amount set by the
Medicare prospective reimbursement system, and a secondary payor (usually
Medicare supplemental insurance or the state Medicaid program) pays
approximately 20% of the amount set by the Medicare prospective reimbursement
system. From time to time the Company pays Medicare supplemental insurance
premiums for patients with financial need. All of the states in which the
Company operates dialysis facilities provide Medicaid benefits to qualified
recipients to supplement their Medicare entitlement. The Medicare and Medicaid
programs are subject to statutory and regulatory changes, administrative
rulings, interpretations of policy and governmental funding restrictions, some
of which may have the effect of decreasing program payments, increasing costs
or modifying the way the Company operates its dialysis business. See "--
Medicare Reimbursement."
Assuming a patient is eligible for participation in the Medicare program,
the commencement date of Medicare benefits for ESRD patients electing
hemodialysis is dependent on several factors. For ESRD patients 65 years of
age or older who are not covered by an employer group health plan, Medicare
coverage commences immediately. For ESRD patients 65 years of age or older who
are covered by an employer group health plan, Medicare coverage commences
after an 18-month coordination period. ESRD patients under 65 years of age who
are not covered by an employer group health plan (for example, the uninsured,
those covered by Medicaid and those covered by an individual health insurance
policy) must wait 90 days after commencing dialysis treatments to be eligible
for Medicare benefits. During the first 90 days of treatment, the patient,
Medicaid or the private insurer is responsible for payment (and, in the case
of the individual covered by private insurance, such responsibility is limited
to the terms of the policy, with the patient being responsible for the
balance). ESRD patients under 65 years of age who are covered by an employer
group health plan must wait 21 months after commencing dialysis treatments
before Medicare becomes the primary payor. During the first 21 months of
treatments, the employer group health plan is responsible for payment at its
negotiated rate or, in the absence of such a rate, at the Company's usual and
customary rates, and the patient is responsible for deductibles and co-
payments, if applicable, under the terms of the employer group health plan.
If an ESRD patient with an employer group health plan elects home dialysis
training during the first 90 days of dialysis, Medicare becomes the primary
payor after 18 months. If an ESRD patient without an employer group health
plan begins home dialysis training during the first three months of dialysis,
Medicare immediately becomes the primary payor.
11
On August 10, 1993, the provisions of the Omnibus Budget Reconciliation Act
of 1993 ("OBRA 93") became effective. The OBRA 93 provisions were originally
interpreted by HCFA to require employer group health sponsored insurance plans
("EGHP") to be the primary payor for ESRD patients for the first 18 months of
service regardless of whether such patients were otherwise Medicare eligible.
In April 1995, HCFA issued instructions of clarification to the fiscal
intermediaries that Medicare would continue as the primary payor during such
period if such patients were originally Medicare eligible but not yet
suffering from ESRD. In June 1995, a preliminary injunction was issued by a
federal court preventing HCFA from retroactively applying its reinterpretation
of the OBRA 93 regulations as unlawful retroactive rule-making. Accordingly,
the Company has recognized as revenue payments from private payors in excess
of the revenue previously recognized at lower rates which are attributable to
such patients. The Company intends to continue to recognize revenues as cash
is received in the future. The Company cannot estimate, at the present time,
the potential impact that any final ruling or interpretation or the timing of
the same may have upon earnings.
Certain Payor Arrangements
The Company has entered into contracts with third-party payors, including
many leading health maintenance organizations in the Company's service areas,
to provide dialysis services to their beneficiaries. The Company is a party to
non-exclusive agreements with certain of such third-party payors and
termination of such third-party agreements could have an adverse effect on the
Company. The Company has a contract with the Department of Health and Human
Services Navajo Area Indian Health Service to provide (i) chronic dialysis
services to Native Americans at the Company's facilities in Farmington and
Shiprock, New Mexico as well as at the Company's facilities in Chinle,
Kayenta, Tuba City and Ganado, Arizona and (ii) acute dialysis in Indian
Health Service Hospitals in Chinle and Tuba City (the "Indian Health Service
Contract"). The Company is providing dialysis services to a substantial number
of chronic dialysis patients pursuant to the Indian Health Service Contract.
Medicare Reimbursement
The Company is reimbursed by Medicare under a prospective reimbursement
system for chronic dialysis services provided to ESRD patients. Under this
system, the reimbursement rates are fixed in advance and have been adjusted
from time to time by Congress. Although this form of reimbursement limits the
allowable charge per treatment, it provides the Company with predictable and
recurring per treatment revenues and allows the Company to retain any profit
earned. Medicare has established a composite rate set by HCFA that governs the
Medicare reimbursement available for a designated group of dialysis services,
including the dialysis treatment, supplies used for such treatment, certain
laboratory tests and certain medications. The Medicare composite rate is
subject to regional differences based upon certain factors, including regional
differences in wage earnings. Certain other services and items are eligible
for separate reimbursement under Medicare and are not part of the composite
rate, including certain drugs (including EPO), blood (for amounts in excess of
three units per patient per year), and certain physician-ordered tests
provided to dialysis patients. Claims for Medicare reimbursement must
generally be presented within 15 to 27 months of treatment depending on the
month in which the service was rendered and for Medicaid secondary
reimbursement, if applicable, within 60 to 90 days after payment of the
Medicare claim. The Company generally submits claims monthly and is usually
paid by Medicare within 30 days of the submission. If in the future Medicare
were to include in its composite reimbursement rate any of the ancillary
services presently reimbursed separately, the Company would not be able to
seek separate reimbursement for these services and this would adversely affect
the Company's results of operations to the extent a corresponding increase
were not provided in the Medicare composite rate.
The Company receives reimbursement for outpatient dialysis services provided
to Medicare-eligible patients at rates that are currently between $118 and
$138 per treatment, depending upon regional wage variations. The Medicare
reimbursement rate is subject to change by legislation and recommendations by
the Prospective Payment Assessment Commission ("PROPAC"). The Medicare ESRD
reimbursement rate was unchanged from commencement of the program in 1972
until 1983. From 1983 through December 1990 numerous Congressional actions
resulted in net reduction of the average reimbursement rate from a fixed fee
of $138 per treatment in 1983 to approximately $125 per treatment in 1990.
Congress increased the ESRD reimbursement rate, effective
12
January 1, 1991, resulting in an average ESRD reimbursement rate of $126 per
treatment. In 1990, Congress required that the Department of Health and Human
Services ("HHS") and PROPAC study dialysis costs and reimbursement and make
findings as to the appropriateness of ESRD reimbursement rates. In January
1997, PROPAC recommended a 2.8% increase be made in the reimbursement rate.
However, Congress is not required to implement this recommendation and could
either raise or lower the reimbursement rate. The Company is unable to predict
what, if any, future changes may occur in the rate of reimbursement, or, if
made, whether any such changes will have a material effect on the Company's
revenues and net earnings.
On June 1, 1989, the FDA approved the production and sale of EPO, and HCFA
approved Medicare reimbursement for EPO's use by dialysis patients. EPO
stimulates the production of red blood cells and is beneficial in the
treatment of anemia, with the effect of reducing or eliminating the need for
blood transfusions for dialysis patients. Physicians began prescribing EPO for
their patients in the Company's dialysis facilities in August 1989.
From June 1, 1989 through December 31, 1990, the Medicare ESRD program
reimbursed for EPO at the fixed rate of $40 per administration of EPO in
addition to the dialysis facility's allowable composite rate for dosages of up
to 9,999 units per administration. For higher dosages, an additional $30 per
EPO administration was allowed. Effective January 1, 1991, the Medicare
allowable prescribed rate for EPO was changed to $11 per 1,000 units, rounded
to the nearest 100 units. Subsequently, legislation was enacted to reduce the
Medicare prescribed rate for EPO by $1 per 1,000 units after December 31,
1993. There can be no assurance that the Company can maintain current
operating margins in the future for EPO administrations due to potential
reimbursement decreases, or to potential increases in product costs from its
sole manufacturer.
The Company provides certain of its patients with IDPN, a nutritional
supplement administered during dialysis to patients suffering from nutritional
deficiencies. The Company has historically been reimbursed by the Medicare
program for the administration of IDPN therapy. Beginning in 1993, HCFA
designated four durable medical equipment regional carriers ("DMERCs") to
process reimbursement claims for IDPN therapy. The DMERCs recently established
new, more stringent medical policies for reimbursement of IDPN therapy, and
many dialysis providers' claims have subsequently been denied or delayed.
Where appropriate, the Company has appealed and continues to appeal such
denials. In addition, the DMERCs are reportedly reviewing the existing IDPN
medical policies. The final outcome of appeals and the anticipated review is
uncertain and may ultimately reduce the number of patients eligible to receive
reimbursement for IDPN therapy. The Company has continued to provide IDPN
therapy to its patients pending clarification of this policy. A significant
reduction in the number of patients eligible to receive reimbursement for IDPN
therapy or the amount of Medicare reimbursement therefor would have an adverse
effect on the Company's future net operating revenues and net income.
Medicaid Reimbursement
Medicaid programs are state administered programs partially funded by the
federal government. These programs are intended to provide coverage for
patients whose income and assets fall below state defined levels and who are
otherwise uninsured. The programs also serve as supplemental insurance
programs for the Medicare co-insurance portion and provide certain coverages
(e.g., oral medications) that are not covered by Medicare. State regulations
generally follow Medicare reimbursement levels and coverages without any co-
insurance amounts. Certain states, however, require beneficiaries to pay a
monthly share of the cost based upon levels of income or assets. Further, the
State of Florida does not provide Medicaid benefits on a primary insurance
basis, but does provide benefits as a secondary insurer to Medicare. Within
the State of Florida, various governmental subdivision agencies provide
insurance coverage for the indigent who are otherwise uninsured. The Company
is a licensed ESRD Medicaid provider in all states in which it does business.
13
GOVERNMENT REGULATION
General
The Company's dialysis operations are subject to extensive governmental
regulations at the federal, state and local levels. These regulations require
the Company to meet various standards relating to, among other things, the
management of facilities, personnel, maintenance of proper records, equipment
and quality assurance programs. The dialysis facilities are subject to
periodic inspection by state agencies and other governmental authorities to
determine if the premises, equipment, personnel and patient care meet
applicable standards. To receive Medicare reimbursement, the Company's
dialysis facilities must be certified by HCFA. All of the Company's dialysis
facilities are so certified.
Any loss by the Company of its various federal certifications, its
authorization to participate in the Medicare or Medicaid programs or its
licenses under the laws of any state or other governmental authority from
which a substantial portion of its revenues is derived or a change resulting
from healthcare reform reducing dialysis reimbursement or reducing or
eliminating coverage for dialysis services would have a material adverse
effect on the Company's business. To date, the Company has not had any
difficulty in maintaining its licenses or its Medicare and Medicaid
authorizations. The healthcare services industry will continue to be subject
to intense regulation at the federal and state levels, the scope and effect of
which cannot be predicted. No assurance can be given that the activities of
the Company will not be reviewed and challenged or that healthcare reform will
not result in a material adverse change to the Company.
Fraud and Abuse
The Company's dialysis operations are subject to the illegal remuneration
provisions of the Social Security Act (sometimes referred to as the "anti-
kickback" statute) and similar state laws that impose criminal and civil
sanctions on persons who solicit, offer, receive or pay any remuneration,
whether directly or indirectly, in return for inducing the referral of a
patient for treatment or the ordering or purchasing of items or services that
are paid for in whole or in part by Medicare, Medicaid or similar state
programs. Violations of the federal anti-kickback statute are punishable by
criminal penalties, including imprisonment, fines or exclusion of the provider
from future participation in the Medicare and Medicaid programs, and civil
penalties, including assessments of $2,000 per improper claim for payment plus
twice the amount of such claim and suspension from future participation in
Medicare and Medicaid. Some state statutes also include criminal penalties.
While the federal statute expressly prohibits transactions that have
traditionally had criminal implications, such as kickbacks, rebates or bribes
for patient referrals, its language has not been limited to such obviously
wrongful transactions. Court decisions state that, under certain
circumstances, the statute is also violated when one purpose (as opposed to
the "primary" or a "material" purpose) of a payment is to induce referrals.
Proposed federal legislation would expand the federal illegal remuneration
laws to include referrals of any patients regardless of payor source.
In July 1991 and in November 1992, the Secretary of HHS published
regulations that create exceptions or "safe harbors" for certain business
transactions. Transactions that are structured within the safe harbors will be
deemed not to violate the federal illegal remuneration statute. For a business
arrangement to receive the protection of a relevant safe harbor, each and
every element of the safe harbor must be satisfied. Transactions that do not
satisfy all elements of a relevant safe harbor do not necessarily violate the
illegal remuneration statute, but may be subject to greater scrutiny by
enforcement agencies. The Company believes its arrangements with referring
physicians are in material compliance with applicable laws. The Company seeks
wherever practicable to structure its various business arrangements to satisfy
as many safe harbor elements as possible under the circumstances. Except with
respect to the Company's lease arrangements with referring physicians, which
the Company believes materially satisfy all the relevant safe harbor
requirements, none of the Company's arrangements satisfy all elements of a
relevant safe harbor. Although the Company has never been challenged under
these statutes and believes it complies in all material respects with these
and all other applicable laws and regulations, there can be no assurance that
the Company will not be required to change its practices or experience a
material adverse effect as a result of any such challenge.
14
The conditions of participation in the Medicare ESRD program mandate that
treatment at a dialysis facility be "under the general supervision of a
Director who is a physician." Generally, the Medical Director must be board
eligible or board certified in internal medicine or pediatrics and have had at
least 12 months of experience or training in the care of patients at ESRD
facilities. The Company has by written agreement engaged qualified physicians
or groups of qualified physicians to serve as Medical Directors for its
facilities. At some facilities the Company also contracts with one or more
physicians to serve as Assistant or Associate Medical Directors, or to direct
specific programs, such as CAPD training, or to provide Medical Director
services for acute dialysis services provided to hospitals. The compensation
of the Medical Directors and other physicians under contract is separately
negotiated for each facility and generally depends upon competitive factors in
the local market, the physician's professional qualifications and
responsibilities and the size and utilization of the facility or relevant
program. The aggregate compensation of the Medical Directors and other
physicians under contract is fixed for periods of one year or more by written
agreement. Because in all cases the Company's Medical Directors and the other
physicians under contract refer patients to the Company's facilities, the
federal anti-kickback statute may apply. The Company believes it is in
material compliance with the anti-kickback statute with respect to its
arrangements with these physicians under contract. Among the safe harbors
promulgated by the Secretary of HHS is one relevant to the Company's
arrangements with its Medical Directors and the other physicians under
contract. That safe harbor, generally applicable to personal services and
management contracts, sets forth six requirements. None of the Company's
agreements with its Medical Directors or other physicians under contract
satisfy all of these elements. However, the Company believes that, except in
cases where a facility is in transition from one Medical Director to another,
or where the term of an agreement with a physician has expired and a new
agreement is in negotiation, the Company's agreements with its Medical
Directors and other physicians under contract satisfy five of the six safe
harbor requirements.
Certain of the Company's dialysis facilities are owned by partnerships in
which physicians who refer patients to the facilities hold interests. Because
these physicians refer patients to these facilities, the anti-kickback statute
may apply. The Company believes these business arrangements are in material
compliance with the anti-kickback statute. With regard to the anti-kickback
statute, there is a relevant safe harbor (the "small entity investment
interests" safe harbor) which, although none of these arrangements satisfies
all elements of that safe harbor, the Company believes that each of the above-
mentioned partnerships satisfies a majority of the safe harbor's elements.
While the Company believes there are good arguments to the contrary, a
majority of these elements may not be satisfied with respect to the above-
mentioned subsidiary corporations.
Certain of the Company's dialysis facilities are leased from entities in
which physicians who refer patients to the centers hold interests. In
addition, a medical facility at which the Company provides ESRD ancillary
services is leased from physicians who refer patients for the provision of
such ancillary services. Because of the referral of patients to the facilities
by these physicians, the anti-kickback statute may apply. The Secretary of HHS
has promulgated a safe harbor relevant to such arrangements, generally
applicable to space rentals. The Company believes that these leases are in
material compliance with the anti-kickback statute and that the leases satisfy
in all material respects each of the elements of the space rental safe harbor.
On July 21, 1994, the Secretary of HHS proposed a rule that the Secretary
said "would modify the original set of safe harbor provisions to give greater
clarity to the rulemaking's original intent." The proposed rule would, among
other things, make changes to the safe harbors on personal services and
management contracts, small entity investment interests and space rentals. The
Company does not believe that its conclusions with respect to the application
of these safe harbors to its current arrangements as set forth above would
change if the proposed rule were adopted in the form proposed. However, the
Company cannot predict the outcome of the rulemaking process or whether
changes in the safe harbors rule will affect the Company's position with
respect to the anti-kickback statute.
Several states in which the Company operates dialysis facilities, including
California, Virginia, Georgia, Florida, Illinois, Minnesota and Maryland, have
enacted statutes prohibiting physicians from holding financial interests in
various types of medical facilities to which they refer patients. In certain
of these states, the Company
15
has joint ownership relationships with referring physicians. The Company
believes its joint ownership relationships with these physicians are within
the exceptions stated in these various state laws.
A California statute makes it unlawful for a physician who has, or a member
of whose immediate family has, a financial interest with or in an entity to
refer a person to that entity for laboratory, diagnostic nuclear medicine,
radiation oncology, physical therapy, physical rehabilitation, psychometric
testing, home infusion therapy, or diagnostic imaging goods or services. Under
the statute, "financial interest" includes, among other things, any type of
ownership interest, debt, loan, lease, compensation, remuneration, discount,
rebate, refund, dividend, distribution, subsidy or other form of direct or
indirect payment, whether in money or otherwise, between a physician and the
entity to which the physician makes a referral for the items described above.
The statute also prohibits the entity to which the referral was made from
presenting a claim for payment to any payor for a service furnished pursuant
to a prohibited referral and prohibits a payor from paying for such a service.
Violation of the statute by a physician is a misdemeanor and subjects the
physician to civil fines. Violation of the prohibition on submitting a claim
in violation of the statute is a public offense, subjecting the offender to a
fine of up to $15,000 for each violation and possible action against
licensure. Some of the Company's facilities perform laboratory services
incidental to dialysis services pursuant to the orders of referring
physicians; certain laboratory services, which are performed by laboratories
independent of the Company for all outpatient dialysis patients, are
identified as included among the services for which the Company is financially
responsible under the composite rate under Medicare and under other payment
arrangements. Therefore, although the Company does not believe that the
statute is intended to apply to laboratory services that are provided incident
to dialysis services, it is possible that the statute could be interpreted to
apply to such laboratory services. The statute includes certain exemptions
from its prohibitions. However, the California statute includes no explicit
exemption for Medical Director services or other services for which the
Company contracts with and compensates referring physicians in California or
for partnership interests of the type held by the referring physicians in
eight of the Company's facilities in California. Thus, if the California
statute is interpreted to apply to referring physicians with whom the Company
contracts, by law, for Medical Director and similar services and with the
referring physicians with whom it is in partnership, the Company would be
required to restructure some or all of its relationships with such referring
physicians. The consequences of such restructuring, if any, cannot be
predicted.
A Virginia statute (the "Virginia Statute") generally prohibits a physician
from referring a patient for health services to an entity outside the
physician's office if the physician or any of the physician's immediate family
members is an investor in such entity unless the physician directly provides
health services within the entity and will be personally involved with the
provision of care to the referred patient or has been granted an exception by
the Virginia Board of Health Professions (the "Virginia Board"). Violation of
the Virginia Statute by the physician constitutes grounds for disciplinary
action as unprofessional conduct and subjects the entity to which a prohibited
referral is made to a monetary penalty of not more than $20,000 per referral,
bill or claim if the entity knows or has reason to know that the referral is
prohibited by the Virginia Statute. With respect to investment interests
acquired prior to February 1, 1993, compliance with the Virginia Statute was
required by July 1, 1996. Investment interests of the physicians holding
minority interests in the Company's Virginia facilities were acquired prior to
February 1, 1993. The Company believes it is reasonable to argue that
physicians who refer patients to dialysis facilities directly provide health
care within such facilities and are personally involved with the provision of
care to such referred patients within the meaning of the Virginia Statute.
However, the Company is unaware of any official interpretation of the Virginia
Statute by any agency charged with its enforcement that either supports or
rejects this interpretation of the Virginia Statute. The Company also believes
that, as a public policy matter, it would be reasonable to argue that the
Virginia Board should grant an exception to a physician who is an investor in
a dialysis facility to which such physician refers his or her patients for
care. However the Company is not aware of the grant of any exception by the
Board with respect to ownership interests in dialysis facilities by physicians
who refer patients to such facilities. The Company believes that, if
necessary, the ownership of its Virginia facilities could be restructured to
conform to the requirements of the Virginia Statute.
A Georgia statute (the "Georgia Statute"), prohibits a health care provider
(defined to include physicians) from referring a patient for the provision of
designated health services to an entity in which the health care
16
provider has an investment interest, unless the provider satisfies certain
disclosure requirements. An "investment interest" is defined as an equity or
debt security issued by an entity, including shares of stock in a corporation,
units or other interests in a partnership, bonds, debentures, notes or other
equity interest or debt instruments, but excludes investments in a publicly
held corporation with total assets over $50 million whose shares are traded on
a national exchange or over-the-counter market if the investment interest
constitutes ownership of less than one percent of the corporation, there are
no special stock classes for health care provider investors, and no income
from the investment interest is tied to the volume of referrals. The term
"entity" is defined as any individual, partnership, firm, corporation or other
business entity. A "designated health service" is defined as clinical
laboratory services, physical therapy services, rehabilitation services,
diagnostic imaging services, pharmaceutical services and outpatient surgical
services. While dialysis is not itself a designated health service, a dialysis
supplier could be subject to the Georgia Statute to the extent that the
dialysis service involves the provision of clinical laboratory services,
pharmaceutical services or outpatient surgical services. To comply with the
Georgia Statute, the health care provider must furnish the patient with a
written disclosure form approved by the health care provider's respective
board of licensure, informing the patient of (i) the existence of the
investment interest, (ii) the name and address of each applicable entity in
which the referring health care provider is an investor, and (iii) the
patient's right to obtain the items or services at the location or from the
health care provider or supplier of the patient's choice. In addition, the
provider must post a copy of the disclosure form in a conspicuous public place
in the provider's office. The Georgia Statute applies to any consideration
paid as compensation or in any manner which is a product of, or incident to,
or in any way related to any membership, proprietary interest or co-ownership
with an individual, group or organization to whom patients, clients or
customers are referred or to any employer-employee or independent contractor
relationship including those that may occur in a limited partnership, profit-
sharing arrangement, or other similar arrangement with any licensed person to
whom these patients are referred. The health care provider or an entity may
not present a claim for payment to any individual, third-party payor, or other
entity for services provided pursuant to a prohibited referral. If the health
care provider or entity improperly collects any amount, the provider or entity
must refund such amount to the payor or individual. Any health care provider
or other entity that enters into an arrangement or scheme which the health
care provider or entity knows or should know has a principal purpose of
assuring referrals by the health care provider to a particular entity is
subject to a civil penalty of not more than $50,000 for each such
circumvention, arrangement or scheme. Furthermore, any person who presents or
causes to be presented a bill for a claim for services that such person knows
or should know is for a service for which payment may not be made under the
Georgia Statute is subject to a civil penalty of up to $15,000 for each such
service. The Company believes that all physicians who have an investment
interest in the Company and who also refer patients to the Company's dialysis
facilities are in compliance with the disclosure requirements of the Georgia
statute and will be exempt from such statute.
A Florida statute (the "Florida Statute") prohibits health care providers
(defined to include physicians) from referring a patient for the provision of
designated health services to an entity in which the health care provider is
an investor or has an investment interest. The term "designated health
services" means clinical laboratory services, physical therapy services,
comprehensive rehabilitative services, diagnostic imagining services and
radiation therapy services. "Comprehensive rehabilitative services" includes
speech, occupational or physical therapy services on an outpatient or
ambulatory basis. The term "referral" includes any referral of a patient by a
physician for infusion therapy services to a patient of that physician or a
member of that physician's group practice. Further, a health care provider may
not refer a patient for the provision of any other health care item or service
(i.e., an item or service that is not a "designated health service") to an
entity in which the health care provider is an investor unless the entity is a
publicly traded corporation whose shares are traded on a national exchange or
on the over-the-counter market with total assets over $50 million, or certain
disclosure requirements are met and (i) no more than 50 percent of the value
of the investment interests are held by investors who are in a position to
make referrals to the entity, (ii) the terms under which an investment
interest is offered to an investor who is in a position to make referrals to
the entity are no different from the terms offered to investors who are not in a
position to make such referrals, (iii) the terms offered to an investor in a
position to make referrals are not related to the previous or expected volume of
referrals from that investor to the entity, and (iv) there is no requirement
that an investor make referrals or be in a position to make referrals to the
entity as a
17
condition for becoming or remaining an investor. The Florida Statute carries
with it penalties of up to $15,000 for each service for any person who
presents or causes to be presented a bill or claim for services that such
person knows or should know is prohibited. Furthermore, any health care
provider or other entity that enters into an arrangement or scheme which the
physician or entity knows or should know has a principal purpose of assuring
referrals by the physician to a particular entity may be subject to a civil
penalty of up to $100,000 for each such arrangement. With respect to
disclosure requirements for permissible referrals, a health care provider who
makes a permitted referral must provide the patient with a written disclosure
form informing the patient of extensive information, including the existence
of the investment interest, the names and addresses of at least two
alternative sources of such services and the name and address of each
applicable entity in which the referring provider is an investor. A violation
of the disclosure requirements constitutes a misdemeanor and may be grounds
for disciplinary action. The Company believes that all physicians with an
investment interest in the Company who also refer patients to the Company's
dialysis facilities are in compliance with the disclosure requirements of the
Florida statute and continue to be exempt from such statute.
An Illinois Statute (the "Illinois Statute") provides that a health care
provider (defined to include physicians) may not refer a patient for health
services to an entity outside the health care provider's office or group
practice in which the health care provider's office or group practice in which
the health care provider is an investor unless the health care provider
directly provides health services within the entity and will be personally
involved with the provision of care to the referred patient. The term "health
services" means health care procedures and services provided by or through a
health care provider. The term "investment interest" means an equity or debt
security issued by an entity including shares of stock in a corporation. The
Illinois Statute applies to referrals for health services made on or after
January 1, 1993; however, if a health care provider acquired an investment
interest before July 1, 1992, the Illinois Statute does not apply to referrals
made for health services before January 1, 1996. The Illinois Statute includes
two potential exceptions. First, it is not a violation for a health care
provider to refer a patient for health services to a publicly-traded entity in
which he or she has an investment interest provided that certain conditions
are met. Under the second exception, assuming that the Illinois Health
Facilities Planning Board determines that this exception is applicable, a
health care provider may invest in and refer to an entity if there is
demonstrated need in the community for the entity and alternative financing is
not available. The Illinois Statute may prohibit physicians who own stock in
the Company from referring patients to the Company, and may prohibit the
Company from billing for services rendered pursuant to such impermissible
referrals. The Company believes that it is reasonable to argue that physicians
who refer patients to dialysis facilities are directly providing health care
within such facilities and are personally involved with the provision of care
to such referred patients within the meaning of the Illinois Statute. The
Company is unaware, however, of any official interpretation of the Illinois
Statute by any agency charged with its enforcement that either supports or
rejects this interpretation of the Illinois Statute. The Company believes that
all physicians who have an investment interest in the Company and who also
refer patients to the Company's dialysis facilities are in compliance with the
disclosure requirements of the Illinois statute and may be exempt from such
statute.
A Minnesota statute (the "Minnesota Statute") prohibits physicians from
referring a patient to any health care provider in which the referring
physician has a significant financial interest unless the physician has
disclosed the physician's own financial interest. Violation of the Minnesota
Statute by the physician constitutes grounds for disciplinary action against
the physician. The term "health care provider" is defined to include certain
licensed individuals such as physicians, dentists and the like, physician
assistants and mental health practitioners and nursing homes. The term
"significant financial interest" is not defined by the Statute. It could be
construed to include compensation received by physicians as medical directors
or consultants. However, the Statute does not on its face appear to apply to
the Company's facilities. The Company believes that it will be exempt from
such Statute.
A Maryland statute (the "Maryland Statute") prohibits health care
practitioners from referring patients to a health care entity in which the
health care practitioner or the health care practitioner's immediate family owns
a beneficial interest or has a compensation arrangement. The term "compensation
arrangement" does not include an arrangement between a health care entity and a
health care practitioner or the immediate family member of a
18
health care practitioner for the provision of any services, as an independent
contractor, if the arrangement is for identifiable services, the amount of the
remuneration under the arrangement is consistent with the fair market value of
the service and is not determined in a manner that takes into account,
directly or indirectly, the volume or value of any referrals by the referring
health care practitioner; and the compensation is provided in accordance with
an agreement that would be commercially reasonable even if no referrals were
made to the health care provider. The Company believes that it will be exempt
from such statute.
The Company believes it is in material compliance with current applicable
laws and regulations. No assurance can be made that in the future the
Company's business arrangements, past or present, will not be the subject of
an investigation or prosecution by a federal or state governmental authority.
Such an investigation or prosecution could result in any, or any combination,
of the penalties discussed above depending upon the agency involved in such
investigation and prosecution. None of the Company's business arrangements
with physicians, vendors, patients or others have been the subject of
investigation by any governmental authority. No assurance can be given that
the Company's activities will not be reviewed or challenged by regulatory
authorities. The Company monitors legislative developments and would seek to
restructure a business arrangement if the Company determined that one or more
of its business relationships placed it in material noncompliance with such a
statute.
Stark I
Stark I restricts physician referrals for clinical laboratory services to
entities with which a physician or an immediate family member has a "financial
relationship." The entity is precluded from claiming payment for such services
under the Medicare or Medicaid programs, is liable for the refund of amounts
received pursuant to prohibited claims, can receive civil penalties of up to
$15,000 per service and can be excluded from participation in the Medicare and
Medicaid programs. Because of its broad language, Stark I may be interpreted
by HCFA to apply to the Company's operations. However, regulations
interpreting Stark I have created an exception to its applicability for
services furnished in a dialysis facility if payment for those services is
included in the ESRD composite rate. The Company believes that its
compensation arrangements with medical directors and other physicians under
contract are in material compliance with the provisions of Stark I.
Stark II
Stark II restricts physician referrals for certain "designated health
services" to entities with which a physician or an immediate family member has
a "financial relationship." The entity is prohibited from claiming payment for
such services under the Medicare or Medicaid programs, is liable for the
refund of amounts received pursuant to prohibited claims, can receive civil
penalties of up to $15,000 per service and can be excluded from participation
in the Medicare and Medicaid programs. Comparable provisions applicable to
clinical laboratory services became effective in 1992. Stark II provisions
which may be relevant to the Company became effective on January 1, 1995.
Because of its broad language, Stark II may be interpreted by HCFA to apply
to the Company's operations. Consequently, Stark II may require the Company to
restructure certain existing compensation agreements with its Medical
Directors and to repurchase or to request the sale of ownership interests in
subsidiaries and partnerships held by referring physicians or, in the
alternative, to refuse to accept referrals for designated health services from
such physicians. The Company believes, but cannot assure, that if Stark II is
interpreted to apply to the Company's operations, the Company will be able to
bring its financial relationships with referring physicians into material
compliance with the provisions of Stark II, including relevant exceptions. If
the Company cannot achieve such material compliance, and Stark II is broadly
interpreted by HCFA to apply to the Company, such application of Stark II
could have a material adverse effect on the Company. A broad interpretation of
Stark II to include dialysis services and items provided incident to dialysis
services would apply to the Company's competitors as well.
19
A "financial relationship" under Stark II is defined as an ownership or
investment interest in, or a compensation arrangement between, the physician
and the entity. The Company has entered into compensation agreements with its
Medical Directors and other referring physicians; some Medical Directors
either own stock in a Company subsidiary which operates a particular dialysis
facility or a partnership interest in a Company dialysis facility; and certain
of the Company's dialysis facilities are leased from entities in which
physicians who refer patients to the facilities hold interests. Certain of the
Medical Directors, as part of their compensation, and certain of the
physicians from whom the Company has acquired dialysis facilities, as part of
the consideration for such acquisitions, have acquired stock or stock options
in the Company. The Company believes that the granting of the stock and stock
options is in material compliance with the anti-kickback statute, Stark II and
the various state statutes.
Stark II includes certain exceptions. A personal services compensation
arrangement is excepted from Stark II prohibitions if (i) the arrangement is
set out in writing, signed by the parties, and specifies the services covered
by the arrangement, (ii) the arrangement covers all of the services to be
provided by the physician (or an immediate family member of such physician) to
the entity, (iii) the aggregate services contracted for do not exceed those
that are reasonable and necessary for the legitimate business purposes of the
arrangement, (iv) the term of the arrangement is for at least one year, (v)
the compensation to be paid over the term of the arrangement is set in
advance, does not exceed fair market value, and is not determined in a manner
that takes into account the volume or value of any referrals or other business
generated between the parties, (vi) the services to be performed do not
involve the counseling or promotion or a business arrangement or other
activity that violates any state or federal law and (vii) the arrangement
meets such other requirements that may be imposed pursuant to regulations
promulgated by HCFA. The Company believes that its compensation arrangements
with Medical Directors and other physicians under contract materially satisfy
the personal services exception to the Stark II prohibitions.
Payments made by a lessor to a lessee for the use of premises are excepted
from Stark II prohibitions if (i) the lease is set out in writing, signed by
the parties, and specifies the premises covered by the lease, (ii) the space
rented or leased does not exceed that which is reasonable and necessary for
the legitimate business purposes of the lease or rental and is used
exclusively by the lessee when being used by the lessee, subject to certain
permitted payments for common areas, (iii) the lease provides for a term of
rental or lease for at least one year, (iv) the rental charges over the term
of the lease are set in advance, are consistent with fair market value, and
are not determined in a manner that takes into account the volume or value of
any referrals or other business generated between the parties, (v) the lease
would be commercially reasonable even if no referrals were made between the
parties, and (vi) the lease meets such other requirements that may be imposed
pursuant to regulations promulgated by HCFA. The Company believes that its
leases with referring physicians materially satisfy the lease of premises
exception to the Stark II prohibitions. The Stark II exception provisions that
are applicable to physician ownership interests in entities to which they make
referrals do not encompass the kinds of ownership arrangements that referring
physicians own in Company subsidiaries that operate particular dialysis
facilities.
For purposes of Stark II, "designated health services" includes: clinical
laboratory services, radiology and other diagnostic services, durable medical
equipment, parenteral and enteral nutrients, equipment and supplies,
prosthetics and prosthetic devices, home health services, outpatient
prescription drugs, and inpatient and outpatient hospital services. The
Company believes that the language and legislative history of Stark II
indicate that Congress did not intend to include dialysis services and the
services and items provided incident to dialysis services within the Stark II
prohibitions. However, the Company's provision of, or arrangement and
assumption of financial responsibility for, outpatient prescription drugs,
including EPO and IDPN, clinical laboratory services, facility dialysis
services and supplies, home dialysis supplies and equipment, and services to
hospital inpatients and outpatients under its dialysis services agreements
with hospitals, include services and items which could be construed as
designated health services within the meaning of Stark II. Although the
Company does not bill Medicare or Medicaid for hospital inpatient and
outpatient services, the Company's Medical Directors may request or establish
a plan of care that includes dialysis services for hospital inpatients and
outpatients that may be considered a referral to the Company within the
meaning of Stark II.
20
Medicare
Because the Medicare program represents a substantial portion of the federal
budget, Congress takes action in almost every legislative session to modify
the Medicare program for the purpose of reducing the amounts otherwise payable
from the program to health care providers. Legislation or regulations may be
enacted in the future that may significantly modify the ESRD program or
substantially reduce the amount paid for Company services. Further, statutes
or regulations may be adopted which impose additional requirements in order
for the Company to be eligible to participate in the federal and state payment
programs. Such new legislation or regulations may adversely affect the
Company's business operations.
Other Regulations
The Company's operations are subject to various state hazardous waste
disposal laws. Those laws as currently in effect do not classify most of the
waste produced during the provision of dialysis services to be hazardous,
although disposal of non-hazardous medical waste is also subject to
regulation. Occupational Safety and Health Administration regulations require
employers of workers who are occupationally subject to blood or other
potentially infectious materials to provide those workers with certain
prescribed protections against bloodborne pathogens. The regulatory
requirements apply to all health care facilities, including dialysis
facilities, and require employers to make a determination as to which
employees may be exposed to blood or other potentially infectious materials
and to have in effect a written exposure control plan. In addition, employers
are required to provide or employ hepatitis B vaccinations, personal
protective equipment, infection control training, post-exposure evaluation and
follow-up, waste disposal techniques and procedures, and engineering and work
practice controls. Employers are also required to comply with certain record-
keeping requirements. The Company believes it is in material compliance with
the foregoing laws and regulations.
Some states have established certificate of need ("CON") programs regulating
the establishment or expansion of health care facilities, including dialysis
facilities. The Company believes it is in material compliance with all state
CON Laws, as applicable, in which it does business.
Although the Company believes it complies in all material respects with
current applicable laws and regulations, the health care service industry will
continue to be subject to substantial regulation at the federal and state
levels, the scope and effect of which cannot be predicted by the Company. No
assurance can be given that the Company's activities will not be reviewed or
challenged by regulatory authorities.
COMPETITION
The dialysis industry is fragmented and highly competitive, particularly in
terms of acquisition of existing dialysis facilities and developing
relationships with referring physicians. Competition for qualified physicians
to act as Medical Directors is also high. The Company estimates that there
were approximately 3,000 dialysis facilities in the United States at the end
of 1996, of which approximately 27% were owned by independent physicians (down
from 37% in 1992), 28% were hospital-based facilities (down from 33% in 1992)
and 45% were owned by seven major multi-facility dialysis providers (up from
30% in 1992). There are also a number of health care providers that have
entered or may decide to enter the dialysis business. Certain of the Company's
competitors have substantially greater financial resources than the Company
and may compete with the Company for acquisitions and development of
facilities in markets targeted by the Company. Competition for acquisitions
has increased the cost of acquiring existing dialysis facilities. While it
occurs infrequently, the Company has experienced competition from the
establishment of a facility by a former Medical Director or referring
physician.
INSURANCE
The Company carries property and general liability insurance, professional
liability insurance and other insurance coverage in amounts deemed adequate by
management. However, there can be no assurance that any future claims will not
exceed applicable insurance coverage. Furthermore, no assurance can be given
that malpractice and other liability insurance will be available at a
reasonable cost or that the Company will be able
21
to maintain adequate levels of malpractice insurance and other liability
insurance in the future. Physicians practicing at the Company's facilities are
required to maintain their own malpractice insurance. However, the Company
maintains coverage for the activities of its Medical Directors (but not for
their individual private medical practices).
EMPLOYEES
As of December 31, 1996, the Company had over 3,125 employees, including a
professional staff of approximately 2,250 registered nurses and technicians, a
corporate and regional staff of approximately 355 employees and a facilities
support and maintenance staff of approximately 515 employees. Of the Company's
employees, approximately 2,130 are full time employees. With the exception of
Stan Lindenfeld, M.D., an officer of the Company, Medical Directors of the
Company's dialysis facilities are not employees of the Company.
RISK FACTORS
In evaluating the Company, its business and its financial position the
following risk factors should be carefully considered in addition to the other
information contained herein. The following factors could affect the Company's
actual future results and could cause them to differ from any forward-looking
statements made by or on behalf of the Company.
Dependence on Medicare, Medicaid and Other Sources of Reimbursement
The Company is reimbursed for dialysis services primarily at fixed rates
established in advance under the Medicare End Stage Renal Disease program.
Under this program, once a patient becomes eligible for Medicare
reimbursement, Medicare is responsible for payment of 80% of the composite
rates determined by the Health Care Financing Administration ("HCFA") for
dialysis treatments. Since 1972, qualified patients suffering from chronic
kidney failure, also known as ESRD, have been entitled to Medicare benefits
regardless of age or financial circumstances. The Company estimates that
approximately 61% of its net patient revenues during its fiscal year ended
December 31, 1996, approximately 60% during the seven months ended December
31, 1995 and 62% during the year ended May 31, 1995 were funded by Medicare.
Since 1983, numerous Congressional actions have resulted in changes in the
Medicare composite reimbursement rate from a national average of $138 per
treatment in 1983 to a low of $125 per treatment on average in 1986 and to
approximately $126 per treatment on average at present. The Company is not
able to predict whether future rate changes will be made. Reductions in
composite rates could have a material adverse effect on the Company's revenues
and net earnings. Furthermore, increases in operating costs that are subject
to inflation, such as labor and supply costs, without a compensating increase
in prescribed rates, may adversely affect the Company's earnings in the
future. The Company is also unable to predict whether certain services, as to
which the Company is currently separately reimbursed, may in the future be
included in the Medicare composite rate.
Since June 1, 1989, the Medicare ESRD program has provided reimbursement for
the administration to dialysis patients of erythropoietin ("EPO"). EPO is
beneficial in the treatment of anemia, a medical complication frequently
experienced by dialysis patients. Many of the Company's dialysis patients
receive EPO. Revenues from EPO (the substantial majority of which are
reimbursed through Medicare and Medicaid programs) were approximately $55.1
million, or 20% of net patient revenues, in its fiscal year ended December 31,
1996 and were $18.0 million, or 20% of net patient revenues, during the seven
months ended December 31, 1995 and $18.2 million, or 18% of net patient
revenues during the year ended May 31, 1995. EPO reimbursement significantly
affects the Company's net income. Medicare reimbursement for EPO was reduced
from $11 to $10 per 1,000 units for services rendered after December 31, 1993.
EPO is produced by a single manufacturer, and any interruption of supply or
product cost increases could adversely affect the Company's operations.
The Company provides certain of its patients with intradialytic parenteral
nutrition ("IDPN"), a nutritional supplement administered during dialysis to
patients suffering from nutritional deficiencies. The Company has
22
historically been reimbursed by the Medicare program for the administration of
IDPN therapy. Beginning in 1993, HCFA designated four durable medical
equipment regional carriers ("DMERCs") to process reimbursement claims for
IDPN therapy. The DMERCs established new, more stringent medical policies for
reimbursement of IDPN therapy which were adopted by HCFA in April 1996, and
many dialysis providers' claims have been denied or delayed. Where
appropriate, the Company has appealed and continues to appeal such denials.
The final outcome of some appeals and the anticipated review is uncertain. The
Company's allowance for doubtful accounts reflects a reserve that the Company
believes is adequate against the possibility of an adverse outcome. The
Company has continued to provide IDPN therapy only to a select number of its
patients whom the Company believes meet the most stringent guidelines.
Although the Company fully expects to be paid on outstanding claims, there can
be no certainty to that effect.
All of the states in which the Company currently operates dialysis
facilities provide Medicaid (or comparable) benefits to qualified recipients
to supplement their Medicare entitlement. The Company estimates that
approximately 6% of its net patient revenues during the year ended December
31, 1996, 7% of its net operating revenues during the seven months ended
December 31, 1995 and 8% of its net operating revenues during the year ended
May 31, 1995 were funded by Medicaid or comparable state programs. The
Medicaid programs are subject to statutory and regulatory changes,
administrative rulings, interpretations of policy and governmental funding
restrictions, all of which may have the effect of decreasing program payments,
increasing costs or modifying the way the Company operates its dialysis
business. Approximately 33% of the Company's net patient revenues during the
year ended December 31, 1996, 33% during the seven month period ended December
31, 1995 and 30% during the year ended May 31, 1996 were from sources other
than Medicare and Medicaid. These sources include payments from third-party,
non-government payors, at rates that generally exceed the Medicare and
Medicaid rates, and payments from hospitals with which the Company has
contracts for the provision of acute dialysis treatments. Any restriction or
reduction of the Company's ability to charge for such services at rates in
excess of those paid by Medicare would adversely affect the Company's net
operating revenues and net income. The Company is unable to quantify or
predict the degree, if any, of the risk of reductions in payments under these
various payment plans. The Company is a party to non-exclusive agreements with
certain third-party payors and termination of such third-party agreements
could have an adverse effect on the Company.
Operations Subject to Government Regulation
The Company is subject to extensive regulation by both the federal
government and the states in which the Company conducts its business. The
Company is subject to the illegal remuneration provisions of the Social
Security Act and similar state laws, which impose civil and criminal sanctions
on persons who solicit, offer, receive or pay any remuneration, directly or
indirectly, for referring a patient for treatment that is paid for in whole or
in part by Medicare, Medicaid or similar state programs. In July 1991 and
November 1992, the federal government published regulations that provide
exceptions or "safe harbors" for certain business transactions. Transactions
that are structured within the safe harbors are deemed not to violate the
illegal remuneration provisions. Transactions that do not satisfy all elements
of a relevant safe harbor do not necessarily violate the illegal remuneration
statute, but may be subject to greater scrutiny by enforcement agencies.
Neither the arrangements between the Company and the physician directors of
its facilities ("Medical Directors") nor the minority ownership interests of
referring physicians in certain of the Company's dialysis facilities fall
within the protection afforded by these safe harbors. Although the Company has
never been challenged under these statutes and believes it complies in all
material respects with these and all other applicable laws and regulations,
there can be no assurance that the Company will not be required to change its
practices or relationships with its Medical Directors or with referring
physicians holding minority ownership interests or that the Company will not
experience material adverse effects as a result of any such challenge.
The Omnibus Budget Reconciliation Act of 1989 includes certain provisions
("Stark I") that restrict physician referrals for clinical laboratory services
to entities with which a physician or an immediate family member has a
"financial relationship." In August 1995, HCFA published regulations
interpreting Stark I. The regulations specifically provide that services
furnished in an ESRD facility that are included in the composite
23
billing rate are excluded from the coverage of Stark I. The Company believes
that the language and legislative history of Stark I indicate that Congress
did not intend to include laboratory services provided incidental to dialysis
services within the Stark I prohibition; however, laboratory services not
included in the Medicare composite rate could be included within the coverage
of Stark I. Violations of Stark I are punishable by civil penalties which may
include exclusion or suspension of a provider from future participation in
Medicare and Medicaid programs and substantial fines. Due to the breadth of
the statutory provisions, it is possible that the Company's practices might be
challenged under this law. A broad interpretation of Stark I would apply to
the Company's competitors as well.
The Omnibus Budget Reconciliation Act of 1993 includes certain provisions
("Stark II") that restrict physician referrals for certain "designated health
services" to entities with which a physician or an immediate family member has
a "financial relationship." The Company believes that the language and
legislative history of Stark II indicate that Congress did not intend to
include dialysis services and the services and items provided incident to
dialysis services within the Stark II prohibitions; however, certain services,
including the provision of, or arrangement and assumption of financial
responsibility for, outpatient prescription drugs, including EPO, and clinical
laboratory services, could be construed as designated health services within
the meaning of Stark II. Violations of Stark II are punishable by civil
penalties, which may include exclusion or suspension of the provider from
future participation in Medicare and Medicaid programs and substantial fines.
Due to the breadth of the statutory provisions and the absence of regulations
or court decisions addressing the specific arrangements by which the Company
conducts its business, it is possible that the Company's practices might be
challenged under these laws. A broad interpretation of Stark II to include
dialysis services and items provided incident to dialysis services would apply
to the Company's competitors as well.
A California statute that became effective January 1, 1995 makes it unlawful
for a physician who has, or a member of whose immediate family has, a
financial interest with or in an entity to refer a person to that entity for,
among other services, laboratory services. The Company currently operates
centers in California, which accounted for a significant percentage of net
operating revenues for fiscal 1996. Although the Company does not believe that
the statute is intended to apply to laboratory services that are provided
incident to dialysis services, it is possible that the statute could be
interpreted to apply to such laboratory services. If the California statute
were so interpreted, the Company would be required to restructure some or all
of its relationships with referring physicians who serve as Medical Directors
of the Company's facilities and with the physicians who hold minority
interests in certain of the Company's facilities.
From time to time, the Company pays Medicare supplemental insurance premiums
for patients with financial need. The provisions of the Kennedy-Kassebaum
legislation issued January 1, 1997 may limit the Company's ability to pay for
policy premiums for patients even with proven financial hardship. However, the
Company believes that the bill did not intend to limit the Company's ability
to pay premiums for insurance coverage to third-party or governmental payors.
Furthermore, the Company believes that the bill may be amended to include
provisions for the payment of premiums on behalf of ESRD patients or allow the
Company to make grants to a foundation that may provide for such premium
payments on behalf of ESRD patients.
At present, ESRD patients eligible for California's Medicaid program,
MediCal, are reimbursed for their transportation costs relating to ESRD
treatments. If this practice is deemed to violate applicable federal or state
law, the Company may be forced to halt this practice and the Company cannot
predict the effect the foregoing would have on the desire of such patients to
use the Company's services.
The Company's two licensed clinical laboratories are also subject to
extensive federal and state regulation of performance standards, including the
provisions of The Clinical Laboratory Improvement Act of 1967 and The Clinical
Laboratory Improvement Amendments of 1988 Act, as well as the federal and
state regulations described above. See "Government Regulation." The Company's
laboratory subsidiary is presently the subject of a third-party carrier
review. The third party carrier has requested medical and billing records for
certain patients, and the Company has provided the requested records. The
third-party carrier has not informed the Company of the reason for or the
nature or scope of its review.
24
A number of proposals for health care reform have been made in recent years,
some of which have included radical changes in the health care system. Health
care reform could result in material changes in the financing and regulation
of the health care business, and the Company is unable to predict the effect
of such changes on its future operations. It is uncertain what legislation on
health care reform, if any, will ultimately be implemented or whether other
changes in the administration or interpretation of governmental health care
programs will occur. There can be no assurance that future health care
legislation or other changes in the administration or interpretation of
governmental health care programs will not have a material adverse effect on
the results of operations of the Company.
Risks Inherent in Growth Strategy
Following the August 1994 Transaction, the Company began an aggressive
growth strategy. This growth strategy is dependent on the continued
availability of suitable acquisition candidates and subjects the Company to
the risks inherent in assessing the value, strengths and weaknesses of
acquisition candidates, the operations of acquired companies and identifying
suitable locations for additional facilities. The Company's growth is expected
to place significant demands on the Company's financial and management
resources. In recent years, acquisition prices and competition for facilities
has increased. To the extent the Company is unable to acquire or develop
facilities in a cost-effective manner, its ability to expand its business and
enhance results of operations would be adversely affected. In addition,
although the Company believes it has a demonstrable track record of
integrating the operations of acquired companies with its historic operations,
the process for integrating acquired operations, particularly for newly
acquired regional clusters, presents a significant challenge to the Company's
management and may lead to unanticipated costs or a diversion of management's
attention from day-to-day operations. There can be no assurance that the
Company will be able to continue its growth strategy or that this strategy
will ultimately prove successful. A failure to successfully continue its
growth strategy could have an adverse effect on the Company's results of
operations.
Competition
The dialysis industry is fragmented and highly competitive, particularly in
terms of acquisitions of existing dialysis facilities and developing
relationships with referring physicians. Certain of the Company's competitors
have substantially greater financial resources than the Company and may
compete with the Company for acquisitions of facilities in markets targeted by
the Company. Competition for acquisitions has increased the cost of acquiring
existing dialysis facilities. The Company has from time to time experienced
competition from referring physicians who have opened their own dialysis
facilities. A portion of the Company's business consists of monitoring and
providing supplies for ESRD treatments in patients' homes. Certain physicians
also provide similar services and, if the number of such physicians were to
increase, the Company could be adversely affected.
Dependence on Key Personnel
The Company is dependent upon the services and management experience of the
Company's executive officers, and accordingly has entered into employment
agreements with, and provided a variety of equity incentives to, each of these
executives. The Company's continued growth depends upon its ability to attract
and retain skilled employees, in particular highly skilled nurses, for whom
competition is intense. The Company believes that its future success will also
be significantly dependent on its ability to attract and retain qualified
physicians to serve as Medical Directors of its dialysis facilities. The
Company does not carry key-man life insurance on any of its Officers.
Dependence on Physician Referrals
The Company's facilities are dependent upon referrals of ESRD patients for
treatment by physicians specializing in nephrology and practicing in the
communities served by the Company's dialysis facilities. As is generally true
in the dialysis industry, at each facility one or a few physicians account for
all or a significant portion of the patient referral base. The loss of one or
more key referring physicians at a particular facility could
25
have a material adverse effect on the operations of that facility and could
adversely affect the Company's overall operations. Referring physicians own
minority interests in certain of the Company's dialysis facilities. If such
interests are deemed to violate applicable federal or state law, such
physicians may be forced to dispose of their ownership interests. The Company
cannot predict the effect such dispositions would have on its business. See
"Risk Factors--Operations Subject to Government Regulation."
ITEM 2. PROPERTIES.
The Company operates 134 outpatient dialysis facilities, of which 128 are
located in premises leased by the Company or its respective general
partnerships or subsidiary corporations, six of which are located in buildings
owned by the Company. The Company's leases generally cover periods from five
to ten years and typically contain renewal options of five to ten years at the
fair rental value at the time of renewal or at rates subject to consumer price
index increases since the inception of the lease. The Company's facilities
range in size from approximately 2,000 to 10,000 square feet, with an
approximate average size of 4,800 square feet. The Company's headquarters are
located in a 17,000 square foot facility in Torrance, California. The
Company's headquarters lease expires in 2000. The Company's general accounting
office in Tacoma, Washington, is also leased for a term expiring in 2000. The
Company owns one property that it is presently leasing to a third party. The
Company considers its physical properties to be in good operating condition
and suitable for the purposes for which they are being used.
Certain of the Company's facilities are operating at or near capacity.
However, the Company believes it has adequate capacity within most of its
existing facilities to accommodate significantly greater patient volume
through increased hours and/or days of operation, or through the addition of
dialysis stations at a given facility upon obtaining appropriate governmental
approvals. With respect to other facilities, the Company believes that it can
lease space at economically reasonable rates in the area of each of these
facilities. Expansion or relocation of Company facilities would be subject to
review for compliance with conditions relating to participation in the
Medicare ESRD program. In states that require a CON, approval of a Company
application would be necessary for expansion.
ITEM 3. LEGAL PROCEEDINGS.
The Company is subject to claims and suits in the ordinary course of
business for which the Company believes it will be covered by insurance. The
Company does not believe that the ultimate resolution of pending proceedings
will have a material adverse effect on the Company's financial condition,
results of operations or cash flows.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
Not applicable.
26
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS.
The Company's Common Stock is traded on the New York Stock Exchange. The
following table sets forth, for the periods indicated, the high and low
closing prices for the Common Stock as reported by the New York Stock Exchange
since the Initial Public Offering.
HIGH LOW
Transitional Fiscal Year Ended December 31, 1995
4th Quarter (beginning October 31, 1995)................. $29 3/4 $18 3/4
Fiscal Year Ended December 31, 1996
1st Quarter.............................................. $32 $27 3/8
2nd Quarter.............................................. $45 1/8 $32 3/4
3rd Quarter.............................................. $42 1/4 $32 1/2
4th Quarter.............................................. $46 1/8 $32 1/4
Fiscal Year Ending December 31, 1997
1st Quarter (through February 28, 1997).................. $36 5/8 $32
The closing price of the Common Stock on February 28, 1997 was $34 7/8 per
share. As of March 1, 1997 there were approximately 890 holders of the
Company's Common Stock named as holders of record by The Bank of New York, the
Company's registrar and transfer agent. Since the August 1994 Transaction the
Company has not declared or paid cash dividends to its holders of Common Stock
and does not anticipate paying any cash dividends in the foreseeable future.
The Company is subject to certain restrictions on its ability to pay dividends
on its Common Stock under its credit facility (the "TRCH Credit Facility").
Effective July 1, 1996, TRC purchased all of the assets of the Bertha Sirk
Dialysis Center, Inc. and the Greenspring Dialysis Center, Inc. (collectively,
"Bertha Sirk/Greenspring"). As partial consideration for the purchase the
Company issued an aggregate of 25,168 unregistered shares of Common Stock to
the two shareholders of Bertha Sirk/Greenspring. Such unregistered shares were
exempt from registration under the Securities Act pursuant to Rule 505 and
Rule 506 of Regulation D. No underwriter participated in the transaction and
the unregistered shares are not convertible or exchangeable into other equity
securities of the Company.
Effective August 1, 1996, TRC entered into an agreement with Port Charlotte
Artificial Kidney Center, Inc. ("Port Charlotte") to merge Port Charlotte with
and into TRC. As partial consideration for the merger the Company issued an
aggregate of 36,545 unregistered shares of Common Stock to the two
shareholders of Port Charlotte. Such unregistered shares were exempt from
registration under the Securities Act pursuant to Rule 505 and Rule 506 of
Regulation D. No underwriter participated in the transaction and the
unregistered shares are not convertible or exchangeable into other equity
securities of the Company.
27
ITEM 6. SELECTED FINANCIAL DATA.
The following table presents selected consolidated financial and operating
data of the Company for the periods indicated. The consolidated financial data
as of May 31, 1992, 1993, 1994 and 1995 and as of December 31, 1995 and 1996
and for each of the years in the four year period ended May 31, 1995, the
seven month period ended December 31, 1995, and the year ended December 31,
1996 have been derived from the Company's audited consolidated financial
statements. The consolidated financial data for the seven months ended
December 31, 1994 and the year ended December 31, 1995 are unaudited and
include all adjustments consisting solely of normal recurring adjustments
necessary to present fairly the Company's results of operations for the period
indicated. The results of operations for the seven month periods ended
December 31, 1994 and 1995 are not necessarily indicative of the results which
may occur for the full fiscal year. The following financial and operating data
should be read in conjunction with "Item 7: Management's Discussion and
Analysis of Financial Condition and Results of Operations" and the Company's
Consolidated Financial Statements filed as part of this Report.
SEVEN MONTHS
ENDED YEAR ENDED
YEARS ENDED MAY 31, DECEMBER 31,(1) DECEMBER 31,
------------------------------- ------------------ --------------------
1992 1993 1994 1995 1994 1995 1995 1996
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
INCOME STATEMENT DA-
TA:(2)
Net operating
revenues.............. $63,888 $71,576 $80,470 $98,968 $53,593 $89,711 $134,843 $272,947
------- ------- ------- ------- ------- ------- -------- --------
Facility operating
expenses.............. 45,599 49,440 56,828 65,583 36,012 57,406 86,977 183,987
General and
administrative
expenses(3)........... 4,819 5,292 7,457 9,115 4,916 7,645 11,844 19,267
Provision for doubtful
accounts.............. 2,118 2,050 1,550 2,371 1,363 1,811 2,819 5,496
Depreciation and
amortization.......... 3,167 3,434 3,752 4,740 2,586 4,383 6,537 15,368
------- ------- ------- ------- ------- ------- -------- --------
Total operating
expenses.............. 55,703 60,216 69,587 81,809 44,877 71,245 108,177 224,118
------- ------- ------- ------- ------- ------- -------- --------
Operating income....... 8,185 11,360 10,883 17,159 8,716 18,466 26,666 48,829
Interest expense, net.. 110 9 13 7,203 3,300 5,584 9,244 5,175
------- ------- ------- ------- ------- ------- -------- --------
Income before income
taxes, minority
interests and
extraordinary item.... 8,075 11,351 10,870 9,956 5,416 12,882 17,422 43,654
Income taxes........... 2,875 4,129 4,106 3,511 1,933 4,631 6,209 16,351
------- ------- ------- ------- ------- ------- -------- --------
Income before minority
interests and
extraordinary item.... 5,200 7,222 6,764 6,445 3,483 8,251 11,213 27,303
Minority interests in
income of consolidated
subsidiaries.......... 535 775 1,046 1,593 833 1,784 2,544 3,578
------- ------- ------- ------- ------- ------- -------- --------
Income before
extraordinary item.... $ 4,665 $ 6,447 $ 5,718 $ 4,852 $ 2,650 $ 6,467(4) $ 8,669(4) $ 23,725(4)
======= ======= ======= ======= ======= ======= ======== ========
Income per share before
extraordinary item.... $ 0.22(5) $ 0.08(5) $ 0.36(4) $ 0.52(4) $ 0.92(4)
======= ======= ======= ======== ========
SEVEN MONTHS
ENDED YEAR ENDED
YEARS ENDED MAY 31, DECEMBER 31, DECEMBER 31,
-------------------------------- ------------ ------------
1992 1993 1994 1995 1995(1) 1996
OPERATING DATA:
Outpatient facilities (at
period end).................... 35 36 37 57 68 134
Treatments(6)................... 349,736 379,397 423,353 481,537 390,806 1,169,023
Hospitals receiving inpatient
services (at period end)....... 33 32 28 48 55 87
YEARS ENDED MAY 31, DECEMBER 31,
-------------------------------- -------------------------
1992 1993 1994 1995 1995 1996
(DOLLARS IN THOUSANDS)
BALANCE SHEET DATA:(2)
Working capital................. $ 8,508 $14,609 $20,064 $ 14,971 $ 54,691 $ 99,299
Total assets.................... 32,509 36,003 43,621 77,558 163,998 374,080
Long-term debt (including
current portion)............... 437 267 198 88,142 55,894 104,616
Mandatorily redeemable Common
Stock(7)....................... 3,990
Stockholders' equity
(deficit)...................... 22,568 29,015 34,733 (30,879)(8) 82,804 230,966
(See Notes on following page)
28
- --------
(1) In 1995, the Company changed its fiscal year end to December 31 from May
31.
(2) The August 1994 Transaction and subsequent acquisitions had a significant
impact on the Company's capitalization and equity securities and on the
Company's results of operations. Consequently, the Balance Sheet Data as
of May 31, 1995 and as of December 31, 1995 and 1996 and the Income
Statement Data for the fiscal year ended May 31, 1995, for the seven
months ended December 31, 1995, and the year ended December 31, 1996 are
not directly comparable to corresponding information as of prior dates and
for prior periods, respectively.
(3) General and administrative expenses for the fiscal years ended May 31,
1992, 1993 and 1994 include overhead allocations by the Company's former
parent of $662,000, $235,000 and $1,458,000, respectively. The overhead
allocations for the fiscal years ended May 31, 1992 and 1993 were made
using a different methodology than that used in the fiscal year ended May
31, 1994 and the substantial increase in that year reflects this change in
methodology rather than a change in the level of services provided. No
overhead allocation was made for the period from March 1, 1994 through the
closing of the August 1994 Transaction, at which time the Company began to
record general and administrative expenses as incurred on a stand-alone
basis. General and administrative expenses for the fiscal year ended May
31, 1994 reflect $458,000 in expenses relating to a terminated equity
offering.
(4) In December 1995, the Company recorded an extraordinary loss of
$2,555,000, or $0.14 per share, net of tax, on the early extinguishment of
debt. In July and September 1996, the Company recorded a combined
extraordinary loss of $7,700,000 or $0.30 per share net of tax, on the
early retirement of the remaining outstanding Senior Subordinated Discount
Notes. See Note 7 of Notes to Consolidated Financial Statements.
(5) Income per share before extraordinary item for the year ended May 31, 1995
and for the seven months ended December 31, 1994 is presented on a pro
forma basis to give effect to the August 1994 Transaction as if it had
occurred on June 1, 1994. See Note 1 of Notes to Consolidated Financial
Statements.
(6) Represents dialysis treatments provided in outpatient facilities, at home
and in acute care hospitals. Home dialysis treatments are stated in
hemodialysis equivalents. Only treatments rendered by the Company after
the acquisition of a facility are included.
(7) Mandatorily redeemable Common Stock represents shares of Common Stock
issued in certain acquisitions subject to put options that terminated upon
the completion of the Initial Public Offering.
(8) In connection with the August 1994 Transaction, the Company paid a
dividend to Tenet of $75.5 million.
29
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
The following should be read in conjunction with the Company's Consolidated
Financial Statements and the related notes thereto contained elsewhere in this
Form 10-K.
BACKGROUND
The Company's wholly owned subsidiary Total Renal Care, Inc., formerly
Medical Ambulatory Care, Inc., was organized in 1979 by Tenet Healthcare
Corporation ("Tenet," formerly National Medical Enterprises, Inc.), to own and
operate Tenet's hospital-based dialysis services as freestanding dialysis
facilities and to acquire and develop additional dialysis facilities in
Tenet's markets. The Company was organized to facilitate the sale by Tenet of
approximately 75% of its ownership interest (the "August 1994 Transaction") to
DLJ Merchant Banking Partners, L.P. and certain of its affiliates ("DLJMB"),
management of the Company and certain holders of debt securities of the
Company. In connection with the August 1994 Transaction, the Company, NME
Properties Corporation (a wholly-owned subsidiary of Tenet), Tenet and DLJMB
entered into a number of agreements relating to, among other things, corporate
governance, the provision of certain services to the Company by Tenet, and
restrictions on stock transfers.
In the August 1994 Transaction, the Company paid a dividend of $75.5 million
to NME Properties out of the net proceeds from (i) the issuance of units
consisting of $100 million in principal amount at maturity of 12% Senior
Subordinated Discount Notes due 2004 (the "Discount Notes"), which were issued
at approximately 70% of par, and 600,000 shares of Common Stock and (ii)
borrowing under the Company's revolving credit facility with The Bank of New
York (the "TRC Credit Facility"). The Company raised additional capital to
fund the continuation of its growth strategy through the Initial Public
Offering ("IPO") on October 30, 1995 in which the Company issued and sold
6,900,000 shares of its Common Stock and raised gross proceeds of $107
million. Concurrent with the IPO, the Company listed its Common Stock on the
New York Stock Exchange under the symbol "TRL." Subsequent to the IPO, the
Company changed its fiscal year end from May 31 to December 31.
The Company raised additional capital to further fund its growth strategy
with two secondary stock offerings in April and October of 1996 which raised
gross proceeds to the Company of approximately $135 million. In October of
1996 the Company established its new $400 million TRCH Credit Facility with
The Bank of New York as a replacement to the $130 million TRC Credit Facility.
With the proceeds from the IPO and the secondary offerings the Company was
able to complete the early retirement of the Discount Notes.
Following the August 1994 Transaction, the Company implemented a focused
strategy to increase net operating revenues per treatment and improve
operating income margins. The Company has significantly increased per-
treatment revenues through the addition of in-house clinical laboratory
services, improved pricing, increased utilization of ancillary services and
the addition of in-house pharmacy services. To improve operating income, the
Company began a systematic review of the Company's vendor relations leading to
the renegotiation of a number of supply contracts and insurance arrangements
that reduced operating expenses. In addition the Company has focused on
improving facility operating efficiencies and leveraging corporate and
regional management. These improvements have been offset in part by increased
amortization of goodwill and other intangible assets relating to the Company's
acquisitions (all of which have been accounted for as purchase transactions)
and start-up expenses related to de novo developments.
The Company incurred approximately $70.4 million of indebtedness as a result
of the August 1994 Transaction. The related interest expense had a significant
impact on the Company's results of operations for the fiscal year ended May
31, 1995, the seven months ended December 31, 1995 and the fiscal year ended
December 31, 1996. The Company's results of operations for these periods have
also been materially affected by the implementation of the Company's growth
strategy subsequent to the August 1994 Transaction. Consequently, the results
of operations for the year ended May 31, 1995, the seven months ended December
31, 1995 and the fiscal year ended December 31, 1996 are not directly
comparable to the results of operations for comparable prior periods.
30
NET OPERATING REVENUES
Net operating revenues are derived primarily from four sources: (i)
outpatient facility hemodialysis services, (ii) ancillary services, including
EPO administration, clinical laboratory services and intravenous and oral
pharmaceutical products and services, (iii) home dialysis services and related
products and (iv) inpatient hemodialysis services provided to hospitalized
patients pursuant to arrangements with hospitals. Additional revenues are
derived from the provision of dialysis facility management services to certain
subsidiaries and affiliated and unaffiliated dialysis centers. The Company's
dialysis and ancillary services are reimbursed primarily under the Medicare
ESRD program in accordance with rates established by HCFA. Payments are also
provided by other third party payors, generally at rates higher than those
reimbursed by Medicare for up to the first 21 months of treatment as mandated
by law. Rates paid for services provided to hospitalized patients are
negotiated with individual hospitals. For the year ended May 31, 1995,
approximately 62% and 8% of the Company's net patient revenues were derived
from reimbursement under Medicare and Medicaid, respectively. For the seven
months ended December 31, 1995, approximately 60% and 7% of the Company's net
patient revenues were derived from reimbursement under Medicare and Medicaid,
respectively. For the year ended December 31, 1996, approximately 61% and 6%
of the Company's net patient revenues were derived from reimbursement under
Medicare and Medicaid, respectively. See "Item 1. Business--Operations--
Sources of Revenue Reimbursement."
QUARTERLY RESULTS OF OPERATIONS
The following table sets forth selected unaudited quarterly financial and
operating information for each of the last two calendar years:
QUARTERS ENDED
---------------------------------------------------------------------------------------------
MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31, MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31,
1995 1995 1995 1995 1996 1996 1996 1996
(DOLLARS IN THOUSANDS, EXCEPT PER SHARES AND PER TREATMENT DATA)
Net operating revenues.. $25,469 $30,732 $37,415 $41,335 $50,237 $64,583 $73,333 $84,794
Facility operating
expenses............... 16,922 19,498 23,884 26,673 33,329 43,318 49,474 57,866
General and
administrative
expenses............... 2,423 2,777 3,107 3,537 3,901 4,800 4,943 5,623
Operating income........ 4,286 6,356 7,776 8,356 9,551 11,556 13,126 14,596
Income before
extraordinary item..... 1,001 1,898 2,485 3,285 4,276 5,726 6,536 7,187
Income per share before
extraordinary item..... $ 0.07 $ 0.12 $ 0.16 $ 0.16 $ 0.19 $ 0.22 $ 0.25 $ 0.27
Outpatient facilities... 45 60 62 68 108 116 126 134
Treatments.............. 123,107 136,937 163,633 179,807 217,451 274,256 315,580 361,736
Net operating revenues
per treatment.......... $206.89 $224.42 $228.65 $229.89 $231.03 $235.48 $232.38 $334.41
Operating income
margin................. 16.8% 20.7% 20.8% 20.2% 19.0% 17.9% 17.9% 17.2%
Utilization of the Company's services is generally not subject to material
seasonal fluctuations. The quarterly variations shown above reflect the impact
of increasing labor costs and decreasing margins related to the corresponding
costs of providing services and amortization of intangibles from acquired
facilities.
31
RESULTS OF OPERATIONS
The following table sets forth for the periods indicated selected
information expressed as a percentage of net operating revenues for such
periods:
SEVEN MONTHS
YEARS ENDED ENDED YEARS ENDED
MAY 31, DECEMBER 31, DECEMBER 31,
------------ -------------- --------------
1994 1995 1994 1995 1995 1996
Net operating revenues.......... 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
Facility operating expenses..... 70.6 66.3 67.2 64.0 64.5 67.4
General and administrative ex-
penses......................... 9.3 9.2 9.2 8.5 8.8 7.1
Provision for doubtful ac-
counts......................... 1.9 2.4 2.5 2.0 2.1 2.0
Depreciation and amortization... 4.7 4.8 4.8 4.9 4.8 5.6
Operating income................ 13.5 17.3 16.3 20.6 19.8 17.9
Interest expense, net of inter-
est income..................... -- 7.3 6.2 6.2 6.9 1.9
Income taxes.................... 5.1 3.5 3.6 5.2 4.6 6.0
Minority interests.............. 1.3 1.6 1.6 2.0 1.9 1.3
Income before extraordinary
item........................... 7.1 4.9 4.9 7.2 6.4 8.7
YEAR ENDED DECEMBER 31, 1996 COMPARED TO YEAR ENDED DECEMBER 31, 1995
Net Operating Revenues. Net operating revenues increased $138,104,000 to
$272,947,000 for the year ended December 31, 1996 ("Year End 1996") from
$134,843,000 for the year ended December 31, 1995 ("Year End 1995")
representing a 102.4% increase. Of this increase $119,904,000 was due to
increased treatments from acquisitions, existing facility growth and from de
novo developments. The remainder was due to an increase in net operating
revenues per treatment which was $233.48 in the Year End 1996 compared to
$223.44 in the Year End 1995. The increase in operating revenues per treatment
was due to the addition of TRC's ESRD laboratory in 1995 resulting in a full
year of revenue in 1996, an overall increase in average reimbursement rates,
increased ancillary services utilization primarily in the administration of
EPO, the opening of its oral pharmaceutical and IV therapy program, and an
increase in affiliated and unaffiliated facility management fees.
Facility Operating Expenses. Facility operating expenses consist of costs
and expenses specifically attributable to the operation of dialysis
facilities, including operating and maintenance costs of such facilities,
equipment, direct labor, and supply and service costs relating to patient
care. Facility operating expenses increased $97,010,000 to $183,987,000 in the
Year End 1996 from $86,977,000 in the Year End 1995 and as a percentage of net
operating revenues, facility operating expenses increased to 67.4% in the Year
End 1996 from 64.5% in the Year End 1995. In the Year End 1996 the increase in
facility operating expenses as a percentage of revenue primarily was due to
increased labor and benefits partially incurred as a result of utilizing
existing employees of the acquired facilities during the transition period.
General and Administrative Expenses. General and administrative expenses
include headquarters expense and administrative, legal, quality assurance,
information systems and centralized accounting support functions. General and
administrative expenses increased $7,423,000 to $19,267,000 in the Year End
1996 from $11,844,000 in the Year End 1995, and as a percentage of net
operating revenues, general and administrative expenses declined to 7.1% in
the Year End 1996 from 8.8% in the Year End 1995. This decline as a percentage
of net revenue is a result of revenue growth and economies of scale achieved
through the leveraging of corporate staff across a higher revenue base.
Provision for Doubtful Accounts. The provision for doubtful accounts
increased $2,677,000 to $5,496,000 in the Year End 1996 from $2,819,000 in the
Year End 1995, and as a percentage of net operating revenues, provision for
doubtful accounts decreased to 2.0% in the Year End 1996 from 2.1% in the Year
End 1995. The
32
provision for doubtful accounts is influenced by the amount of net operating
revenues generated from non-governmental payor sources. The decrease for the
Year End 1996 reflects a decline in the older aging categories of accounts
receivable due to increased collection efforts.
Depreciation and Amortization. Depreciation and amortization increased
$8,831,000 to $15,368,000 in the Year End 1996 from $6,537,000 in the Year End
1995, and as a percentage of net operating revenues, depreciation and
amortization increased to 5.6% in the Year End 1996 from 4.8% in the Year End
1995. This increase was attributable to increased amortization due to
acquisition activity and increased depreciation from new center leaseholds and
routine capital expenditures.
Operating Income. Operating income increased $22,163,000 to $48,829,000 in
the Year End 1996 from $26,666,000 in the Year End 1995, and as a percentage
of net operating revenues, operating income decreased to 17.9% in the Year End
1996 from 19.8% in the Year End 1995. This decrease in operating income as a
percent of revenue is primarily due to an increase in facility operating
expenses and depreciation and amortization partially offset by a decrease in
general and administrative expenses as a percentage of net operating revenues.
Interest Expense. Interest expense, net of interest income, decreased
$4,069,000 to $5,175,000 in the Year End 1996 from $9,244,000 in the Year End
1995, and as a percentage of net operating revenues, interest expense, net of
interest income, was 1.9% in the Year End 1996 and 6.9% in the Year End 1995.
Cash interest expense during the Year End 1996 was $2,656,000 and non-cash
interest during the same period was $4,396,000 versus $1,216,000 and
$8,901,000 in the Year End 1995, respectively. The decrease in the Year End
1996 non-cash interest expense was due primarily to the early extinguishment
of a portion of the Discount Notes in December of 1995 and the remainder in
the third quarter of the year ended December 31, 1996 (as discussed in
"Liquidity and Capital Resources" below), and short term investment income
earned on excess proceeds from the public stock offerings in April and
October, 1996.
Provision for Income Taxes. Provision for income taxes increased $10,142,000
to $16,351,000 in the Year End 1996 from $6,209,000 in the Year End 1995, and
the effective income tax rate decreased to 40.6% in the Year End 1996 from
41.3% in the Year End 1995. The overall decrease in the effective tax rate is
due to a reduction in the blended state rates and reducing nondeductible
amortization as a percentage of revenues.
Minority Interests. Minority interests represent the pretax income earned by
physicians who directly or indirectly own minority interests in the Company's
partnership affiliates and the net income in two of the Company's corporate
subsidiaries. Minority interests increased $1,304,000 to $3,578,000 in the
Year End 1996 from $2,544,000 in the Year End 1995, and as a percentage of net
operating revenues, minority interest decreased to 1.3% in the Year End 1996
from 1.9% in the Year End 1995. This decrease in minority interest as a
percentage of net operating revenues is a result of a relative proportionate
decrease in the formation of partnership affiliates and subsidiaries as a
percentage of total new acquisitions.
Extraordinary Loss. In December 1995 the Company redeemed 35% of the
accreted value of the Discount Notes for a total redemption price of
$31,912,000. In connection with this redemption, the Company recorded an
extraordinary loss of $2,555,000 (net of income tax effect). In July and
September 1996, the Company retired all remaining outstanding Notes for a
total redemption price of $68,499,000. In connection with these redemptions,
the Company recorded an extraordinary loss of $7,700,000 (net of income tax
effect).
SEVEN MONTHS ENDED DECEMBER 31, 1995 COMPARED TO SEVEN MONTHS ENDED DECEMBER
31, 1994
Net Operating Revenues. Net operating revenues increased $36,118,000 to
$89,711,000 for the seven months ended December 31, 1995 ("1995 Seven Month
Period") from $53,593,000 for the seven months ended December 31, 1994 ("1994
Seven Month Period") representing a 67.4% increase. Of this increase
$24,411,000 was due to increased treatments from acquisitions, existing
facility growth and from de novo developments. The remainder was due to an
increase in net operating revenues per treatment which was $229.55 in the 1995
Seven Month Period compared to $199.36 in the 1994 Seven Month Period, and an
increase in affiliated and unaffiliated
33
facility management fees. The increase in operating revenues per treatment was
due to the addition of TRC's ESRD laboratory, an overall increase in
reimbursement rates, increased ancillary services utilization primarily in the
administration of EPO and the opening of its oral pharmaceutical and IV
therapy program.
Facility Operating Expenses. Facility operating expenses increased
$21,394,000 to $57,406,000 in the 1995 Seven Month Period from $36,012,000 in
the 1994 Seven Month Period and as a percentage of net operating revenues,
facility operating expenses declined to 64.0% in the 1995 Seven Month Period
from 67.2% in the 1994 Seven Month Period. In the 1995 Seven Month Period the
decrease in facility operating expenses as a percentage of revenue was due to
substantial reductions achieved in the costs of providing services, including
medical and pharmaceutical supplies, and overall labor resource efficiencies.
General and Administrative Expenses. General and administrative expenses
increased $2,729,000 to $7,645,000 in the 1995 Seven Month Period from
$4,916,000 in the 1994 Seven Month Period, and as a percentage of net
operating revenues, general and administrative expenses declined to 8.5% in
the 1995 Seven Month Period from 9.2% in the 1994 Seven Month Period. This
decline as a percentage of net revenue is a result of revenue growth and
economies of scale achieved through the leveraging of corporate staff across a
higher revenue base.
Provision for Doubtful Accounts. The provision for doubtful accounts
increased $448,000 to $1,811,000 in the 1995 Seven Month Period from
$1,363,000 in the 1994 Seven Month Period, and as a percentage of net
operating revenues, provision for doubtful accounts decreased to 2.0% in the
1995 Seven Month Period from 2.5% in the 1994 Seven Month Period. The
provision for doubtful accounts is influenced by the amount of net operating
revenues generated from non-governmental payor sources. The decrease for the
1995 Seven Month Period reflects better management of accounts receivable,
including increased collection efforts, billing accuracy and improved
preauthorization procedures with payors.
Depreciation and Amortization. Depreciation and amortization increased
$1,797,000 to $4,383,000 in the 1995 Seven Month Period from $2,586,000 in the
1994 Seven Month Period, and as a percentage of net operating revenues,
depreciation and amortization increased to 4.9% in the 1995 Seven Month Period
from 4.8% in the 1994 Seven Month Period. This increase was attributable to
increased amortization due to acquisition activity and increased depreciation
from new center leaseholds and routine capital expenditures.
Operating Income. Operating income increased $9,750,000 to $18,466,000 in
the 1995 Seven Month Period from $8,716,000 in the 1994 Seven Month Period,
and as a percentage of net operating revenues, operating income increased to
20.6% in the 1995 Seven Month Period from 16.3% in the 1994 Seven Month
Period. This increase in operating income is primarily due to a decrease in
facility operating expenses as a percentage of net operating revenues.
Interest Expense. Interest expense, net of interest income, increased
$2,284,000 to $5,584,000 in the 1995 Seven Month Period from $3,300,000 in the
1994 Seven Month Period, and as a percentage of net operating revenues,
interest expense, net of interest income, was 6.2% in the 1995 Seven Month
Period and 6.2% in the 1994 Seven Month Period. Cash interest expense during
the 1995 Seven Month Period was $1,063,000 and non-cash interest during the
same period was $5,228,000 versus $26,000 and $3,274,000 in the 1994 Seven
Month Period, respectively. The increase in the 1995 Seven Month Period cash
interest expense was due primarily to increased borrowing under the TRC Credit
Facility and the increase in non cash interest expense was due to the August
11, 1994 issuance of the Discount Notes, which resulted in four and a half
months of interest expense recognized in the 1994 Seven Month Period as
compared to a full seven months of interest expense recognized in the 1995
Seven Month Period. In addition, interest accrued in the 1995 Seven Month
Period on a higher accreted principal amount through December 7, 1995, on
which date the Company redeemed 35% of the principal amount of the Discount
Notes at maturity. Cash interest initially would have been incurred on the
Discount Notes on August 15, 1997.
Provision for Income Taxes. Provision for income taxes increased $2,698,000
to $4,631,000 in the 1995 Seven Month Period from $1,933,000 in the 1994 Seven
Month Period, and as a percentage of net operating
34
revenues, provision for income taxes increased to 5.2% in the 1995 Seven Month
Period from 3.6% in the 1994 Seven Month Period. The increase was primarily
due to the increased profitability of the Company in the 1995 Seven Month
Period versus the same period in the prior year.
Minority Interests. Minority interests increased $951,000 to $1,784,000 in
the 1995 Seven Month Period from $833,000 in the 1994 Seven Month Period, and
as a percentage of net operating revenues, minority interest increased to 2.0%
in the 1995 Seven Month Period from 1.6% in the 1994 Seven Month Period. This
increase in minority interest as a percentage of revenue is a result of
increased profitability at these partnership affiliates and subsidiaries and
an increase in the number of company facilities owned by such partnership
affiliates.
Extraordinary Loss. On December 7, 1995 the Company redeemed 35% of the
accreted value of the Discount Notes at a redemption premium of 111% for a
total redemption price of $31,912,000. In connection with this redemption, the
Company recorded an extraordinary loss of $2,555,000 (net of income tax
effect) in December 1995.
FISCAL 1995 AND 1994
Net Operating Revenues. Net operating revenues increased $18,498,000 to
$98,968,000 for the fiscal year ended May 31, 1995 from $80,470,000 for fiscal
year ended May 31, 1994 representing a 23.0% increase. Of this increase,
$11,412,000 was due to increased treatments (including acquisitions) for the
fiscal year ended May 31, 1995. In the fiscal year ended May 31, 1995 and the
fiscal year ended May 31, 1994, net operating revenues on a per-treatment
basis were $205.53 and $190.08, respectively. The increase in net operating
revenues per treatment in the fiscal year ended May 31, 1995 was primarily due
to the addition of a Company-owned laboratory, an overall increase in
reimbursement rates, and increases in administration of EPO per treatment.
Facility Operating Expenses. In the fiscal year ended May 31, 1995, facility
operating expenses increased $8,755,000 to $65,583,000 from $56,828,000 in the
fiscal year ended May 31, 1994 and as a percentage of net operating revenues,
facility operating expenses declined to 66.3% in the fiscal year ended May 31,
1995 from 70.6% in the fiscal year ended May 31, 1994. In the fiscal year
ended May 31, 1995, the decrease in facility operating expenses as a
percentage of net operating revenues was due to substantial reductions
achieved in the costs of providing services, including medical supplies,
general and corporate insurance products and overall labor resource
efficiencies.
General and Administrative Expenses. In the fiscal year ended May 31, 1995,
general and administrative expenses increased $1,658,000 to $9,115,000 from
$7,457,000 in the fiscal year ended May 31, 1994, and as a percentage of net
operating revenues, general and administrative expenses declined to 9.2% in
the fiscal year ended May 31, 1995 from 9.3% in the fiscal year ended May 31,
1994. This decline as a percentage of net operating revenues is a result of
revenue growth and includes the full impact of stand-alone costs incurred
since August 11, 1994 in place of overhead allocations for services provided
by Tenet.
Provision for Doubtful Accounts. In the fiscal year ended May 31, 1995, the
provision for doubtful accounts increased $821,000 to $2,371,000 from
$1,550,000 in the fiscal year ended May 31, 1994, and as a percentage of net
operating revenues, the provision for doubtful accounts increased to 2.4% in
the fiscal year ended May 31, 1995 from 1.9% in the fiscal year ended May 31,
1994. This increase was attributable to an increase in reserves for IDPN
services rendered and increased amounts owed from private third party payors
and patients.
Depreciation and Amortization. In the fiscal year ended May 31, 1995,
depreciation and amortization increased $988,000 to $4,740,000 from $3,752,000
in the fiscal year ended May 31, 1994, and as a percentage of net operating
revenues, depreciation and amortization increased to 4.8% in the fiscal year
ended May 31, 1995 from 4.7% in the fiscal year ended May 31, 1994. This
increase was attributable to increased amortization due to acquisition
activity and increased depreciation from new center leaseholds and routine
capital expenditures.
Operating Income. In the fiscal year ended May 31, 1995, operating income
increased $6,276,000 to $17,159,000 from $10,883,000 in the fiscal year ended
May 31, 1994, and as a percentage of net operating
35
revenues, operating income increased to 17.3% in the fiscal year ended May 31,
1995 from 13.5% in the fiscal year ended May 31, 1994. This increase in
operating income is primarily due to a decrease in facility operating expenses
as a percentage of net operating revenues.
Interest Expense. Prior to the fiscal year ended May 31, 1995, the Company
did not have any significant interest bearing debt. In connection with the
August 1994 Transaction and the implementation of the Company's growth
strategy, the Company incurred substantial debt, some of which requires
interest to be paid in cash and most of which is recognized as non-cash
interest expense. For the fiscal year ended May 31, 1995, total interest
expense, net of interest income, was $7,203,000, with non-cash interest
expense of $6,947,000 and cash interest expense, net of cash interest income,
of $256,000.
Provision for Income Taxes. In the fiscal year ended May 31, 1995, the
provision for income taxes decreased $595,000 to $3,511,000 from $4,106,000 in
the fiscal year ended May 31, 1994, and as a percentage of net operating
revenues, the provision for income taxes decreased to 3.5% in the fiscal year
ended May 31, 1995 from 5.1% in the fiscal year ended May 31, 1994. This
decrease was primarily due to the effects of the August 1994 Transaction, and
the associated resulting increase in deductible non-cash interest expense
causing a decline in income subject to income taxes of $914,000.
Minority Interests. In the fiscal year ended May 31, 1995, minority
interests increased $547,000 to $1,593,000 from $1,046,000 in the fiscal year
ended May 31, 1994, and as a percentage of net operating revenues, minority
interests increased to 1.6% in the fiscal year ended May 31, 1995 from 1.3% in
the fiscal year ended May 31, 1994. The increase resulted from increased
profitability at these partnership affiliates and subsidiaries, relating
primarily to increased treatments.
LIQUIDITY AND CAPITAL RESOURCES
Net cash provided by operating activities of the Company was $18,447,000,
$6,277,000 and $15,069,000 for the Year End 1996, the seven months ended
December 31, 1995 and the fiscal year ended May 31, 1995, respectively. Net
cash provided by operating activities consists of the Company's net income,
increased by an extraordinary item related to the early extinguishment of debt
and non-cash expenses such as depreciation, amortization, accreted interest
and the provision for doubtful accounts, and adjusted by changes in components
of working capital, primarily accounts receivable. Net cash used in investing
activities was $171,546,000, $35,130,000 and $26,607,000 for the Year End
1996, the seven months ended December 31, 1995 and the fiscal year ended May
31, 1995, respectively. The Company's principal uses of cash in investing
activities have been related to acquisitions, purchases of new equipment and
leasehold improvements for the Company's outpatient facilities, as well as the
development of new outpatient facilities. Net cash provided by financing
activities was $142,799,000 for the Year End 1996 consisting primarily of net
proceeds from two public issuances of common stock and net proceeds from the
TRCH Credit Facility, offset by amounts paid in connection with the remaining
Discount Notes; $56,988,000 for the 1995 Seven Month Period consisting
primarily of net proceeds from the Initial Public Offering, less amounts paid
in connection with the redemption of 35% of the outstanding Discount Notes and
net payments of borrowings under the TRC Credit Facility; and $12,135,000 for
the fiscal year ended May 31, 1995, consisting primarily of debt and equity
offering proceeds, and borrowings under the TRC Credit Facility, net of cash
dividends paid to Tenet.
The Company anticipates aggregate capital requirements for purchases of
equipment and leasehold improvements for outpatient facilities including the
development costs of 15 de novo facilities in the year ending December 31,
1997 will be approximately $33,800,000, as compared to $25,464,000 in the Year
End 1996.
The Company's strategy is to continue to expand its operations both through
development of de novo centers and through acquisitions. The development of a
typical outpatient facility generally requires $700,000 for initial
construction and equipment and $200,000 for working capital. Based on the
Company's experience, a de novo facility typically achieves operating
profitability, before depreciation and amortization, by the 12th to 15th month
of operation. However, the period of time for a development facility to break
even is dependent on many factors which can vary significantly from facility
to facility, and, therefore, the Company's past experience may not be
indicative of the performance of future developed facilities.
36
From January 1, 1997 through March 1, 1997, the Company has paid
approximately $8.1 million in consideration for acquisitions involving two
agreements to acquire additional facilities. Additionally, the Company has
entered into letters of intent to acquire additional facilities for
approximately $92 million.
Effective October 17, 1996, the Company refinanced its existing credit
facility with the same lender to permit borrowings of up to $400,000,000.
Under the TRCH Credit Facility, up to $50,000,000 may be used in connection
with letters of credit, and up to $15,000,000 in short-term funds may be
borrowed the same day notice is given to the banks under a "Swing Line"
facility. In general, borrowings under the TRCH Credit Facility bear interest
at one of two floating rates selected by the Company: (i) the Alternate Base
Rate (defined as the higher of The Bank of New York's prime rate or the
federal funds rate plus 0.5%); and (ii) Adjusted LIBOR (defined as the 30-,
60-, 90- or 180-day London Interbank Offered Rate, adjusted for statutory
reserves) plus a margin that ranges from 0.45% to 1.25% depending on the
Company's leverage ratio. Swing Line borrowings bear interest at either a rate
negotiated by the Company and the banks at the time of borrowing or, if no
rate is negotiated and agreed, the Alternate Base Rate.
On November 25, 1996, the Company entered into a seven year interest rate
swap agreement involving the exchange of fixed and floating interest payment
obligations without the exchange of the underlying principal amounts. At
December 31, 1996 the total notional principal amount of this interest rate
swap agreement was $85,000,000 and the effective interest rate thereon was
7.07%. The Company increased the notional amount of the interest rate swap
agreement to $100,000,000 on February 25, 1997.
Maximum borrowings under the TRCH Credit Facility will be reduced by
$50,000,000 on September 30, 2000, $75,000,000 on September 30, 2001, and
another $75,000,000 on September 30, 2002, and the TRCH Credit Facility
terminates on September 30, 2003. The TRCH Credit Facility contains financial
and operating covenants including, among other things, requirements that the
Company maintain certain financial ratios and satisfy certain financial tests,
and imposes limitations on the Company's ability to make capital expenditures,
to incur other indebtedness and to pay dividends. As of the date hereof, the
Company is in compliance with all such covenants.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
See the Index included at "Item 14. Exhibits, Financial Statement Schedules
and Reports on Form 8-K."
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
37
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
INFORMATION CONCERNING MEMBERS OF THE BOARD OF DIRECTORS
The following table sets forth certain information concerning members of the
Board of Directors of the Company:
NAME AGE POSITION
Victor M.G. Chaltiel 55 Chairman of the Board, Chief Executive Officer,
President and Director
Maris Andersons 59 Director
Peter T. Grauer 51 Director
Marsha M. Plotnitsky 41 Director
David B. Wilson 37 Director
Victor M.G. Chaltiel has been the Chairman, CEO and President of the Company
and a Director of the Company since August 1994. Mr. Chaltiel served as
President and CEO of Abbey Healthcare Group, Inc. ("Abbey") from November 1993
to February 1994 and prior thereto as Chairman, CEO and President of Total
Pharmaceutical Care, Inc. ("TPC") from March 1989 to November 1993, when Abbey
completed its acquisition of TPC. From May 1985 to October 1988, Mr. Chaltiel
served as President, Chief Operating Officer and a Director of Salick Health
Care, Inc., a publicly-held company focusing on the development of outpatient
cancer and dialysis treatment centers. Mr. Chaltiel served in a consulting
capacity with Salick Health Care, Inc. from October 1988 until he joined TPC.
Prior to May 1985, Mr. Chaltiel was associated with Baxter International, Inc.
("Baxter") for 18 years in numerous corporate and divisional management
positions, including Corporate Group Vice President with responsibility for
the International Group and five domestic divisions with combined revenue in
excess of $1 billion, President of Baxter's Artificial Organs Division, Vice
President of its International Division, Area Managing Director for Europe and
President of its French operations. While at Baxter, Mr. Chaltiel was
instrumental in the development and successful worldwide commercialization of
Continuous Ambulatory Peritoneal Dialysis, currently the most common mode of
home dialysis.
Maris Andersons has been a Director of the Company since August 1994. Mr.
Andersons is a Senior Vice President and Senior Advisor, Corporate Finance, of
Tenet Healthcare Corporation ("Tenet") and has held various senior executive
offices with Tenet since 1976. Prior to joining Tenet, Mr. Andersons served as
a Vice President of Bank of America.
Peter T. Grauer has been a Director of the Company since August 1994. Mr.
Grauer has been a Managing Director of DLJ Merchant Banking, Inc. ("DLJMB")
since September 1992. From April 1989 to September 1992, he was a Co-Chairman
of Grauer & Wheat, Inc., an investment firm specializing in leveraged buyouts.
Prior thereto Mr. Grauer was a Senior Vice President of Donaldson, Lufkin &
Jenrette Securities Corporation ("DLJ"). Mr. Grauer is a Director of S.D.
Warren Holdings Corporation, Doane Products Co. and Jitney Jungle Stores Co.
Marsha M. Plotnitsky has been a Director of the Company since July 1995. Ms.
Plotnitsky is a Managing Director in Mergers and Acquisitions at DLJ. She
joined DLJ in 1984 and has been in her present position since 1991.
David B. Wilson has been a Director of the Company since August 1994. Mr.
Wilson has been a Senior Vice President of DLJMB since January 1993, and from
January 1992 to January 1993 he was a Vice President of DLJ. From April 1989
to December 1991 he was a Vice President at Grauer & Wheat, Inc.
No arrangement or understanding exists between any director and any other
person or persons pursuant to which any director was or is to be selected as a
director other than pursuant to the Shareholders Agreement. See "Certain
Relationships and Related Transactions." None of the directors has any family
relationship among themselves or with any executive officer of the Company.
38
INFORMATION CONCERNING EXECUTIVE OFFICERS
The following table sets forth certain information concerning each person
who is an executive officer of the Company:
NAME AGE POSITION
Victor M. G. Chaltiel 55 Chairman of the Board, Chief Executive Officer,
President and Director
Leonard W. Frie 50 Executive Vice President and Chief Operating Officer
Barry C. Cosgrove 39 Vice President, General Counsel and Secretary
John E. King 36 Vice President, Finance and Chief Financial Officer
Executive officers of the Company are elected by and serve at the discretion
of the Board. Set forth below is a brief description of the business
experience of all executive officers other than Mr. Chaltiel, who is also a
director. See "Information Concerning Members of the Board of Directors."
Leonard W. Frie has been Executive Vice President and Chief Operating
Officer of the Company since August 1994. Mr. Frie was President of the
Company from April 1994 through August 1994. Prior thereto, Mr. Frie served as
President of Medical Ambulatory Care, Inc. and its subsidiaries since 1984.
Barry C. Cosgrove has been Vice President, General Counsel and Secretary of
the Company since August 1994. Prior to joining the Company, from May 1991 to
April 1994, Mr. Cosgrove served as Vice President, General Counsel and
Secretary of TPC. From February 1988 to 1991, Mr. Cosgrove served as Vice
President and General Counsel of McGaw Laboratories, Inc. (a subsidiary of the
Kendall Company). Prior to February of 1988, Mr. Cosgrove was with the Kendall
Company for seven years in numerous corporate, legal and management positions,
including Assistant to the General Counsel.
John E. King has been the Vice President, Finance and Chief Financial
Officer of the Company since its inception in April 1994. Prior thereto, Mr.
King served in the same capacity with Medical Ambulatory Care, Inc. since May
1, 1993. From December 1990 to April 1993, he was the Chief Financial Officer
for one of Tenet's general acute hospitals.
None of the executive officers has any family relationship among themselves
or with any director of the Company.
SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Section 16(a) of the Exchange Act ("Section 16") requires the Company's
executive officers, directors and beneficial owners of more than 10% of the
Company's Common Stock (collectively, "Insiders") to file reports of ownership
and changes in ownership of Common Stock of the Company with the Securities
and Exchange Commission and the New York Stock Exchange, and to furnish the
Company with copies of all Section 16(a) forms they file. The Company became
subject to Section 16 in conjunction with the registration of its Common Stock
under the Exchange Act effective October 31, 1995. Based solely on its review
of the copies of such forms received by it, or written representations from
certain reporting persons that no Form 5's were required for those persons,
the Company believes that its Insiders complied with all applicable Section 16
filing requirements during fiscal 1996.
39
ITEM 11. EXECUTIVE COMPENSATION.
The following table sets forth the compensation paid or accrued by the
Company to the Chief Executive Officer and to each of the executive officers
for each of the fiscal years in the three-year period ended December 31, 1996
and for the twelve month period ended December 31, 1995 ("Calendar 1995"):
SUMMARY COMPENSATION TABLE
LONG TERM COMPENSATION
----------------------------------
ANNUAL COMPENSATION AWARDS PAYOUTS
------------------------------------ ----------------------------------
ALL
RESTRICTED SECURITIES OTHER
OTHER ANNUAL STOCK UNDERLYING LTIP COMPEN-
NAME AND SALARY BONUS COMPENSATION AWARD(S) OPTIONS PAYOUTS SATION
PRINCIPAL POSITION YEAR ($) ($) ($) ($) (#) ($) ($)
Victor M.G. Chaltiel Fiscal 1996 $285,186 $438,633 -- -- 100,000 -- $5,366(1)
Chairman of the Board, Calendar 1995+ 277,413 419,728++ -- -- -- $3,803,800 9,520(2)
Chief Executive Fiscal 1995 217,708(3) 412,500 -- -- 886,667 -- 207,645(4)
Officer, President and Fiscal 1994 -- -- -- -- -- -- --
Director
Leonard W. Frie Fiscal 1996 181,484 139,568 -- -- 95,484 -- 26,914(5)
Executive Vice Calendar 1995+ 176,535 133,551++ -- -- 63,334 14,300 80,849(6)
President and Chief Fiscal 1995 165,625 131,250 -- $99,061(7) 66,667 28,179 241,880(8)
Operating Officer Fiscal 1994* 130,000 29,700 -- -- -- -- 22,231(9)
Barry C. Cosgrove Fiscal 1996 145,189 111,655 -- -- 69,650 -- 10,556(10)
Vice President, General Calendar 1995+ 144,480 106,842++ -- -- 37,500 53,625 8,320(11)
Counsel and Secretary Fiscal 1995 116,777(12) 105,000 -- -- 50,000 -- 6,695(13)
Fiscal 1994 -- -- -- -- -- -- --
John E. King Fiscal 1996 99,533 93,750 -- -- 44,650 -- 15,509(14)
Vice President, Finance Calendar 1995+ 90,789 68,681++ -- -- 12,500 17,875 42,362(15)
and Chief Financial Fiscal 1995 88,958 67,500 -- 22,877(16) 16,667 2,500 41,487(17)
Officer Fiscal 1994* 85,000 21,250 -- -- -- -- 33,393(18)
- --------
+ The Company changed its fiscal year from May 31 to December 31 in 1995.
++Includes the applicable pro-rata portion of the fiscal 1995 bonus amount.
* During fiscal 1994 and a portion of fiscal 1995 the Company was a
division of National Medical Enterprises, Inc., now known as Tenet.
(1) Includes (i) an automobile allowance of $4,846, and (ii) $520 paid by the
Company for an umbrella insurance policy.
(2) Includes (i) an automobile allowance of $9,000, and (ii) $520 paid by the
Company for an umbrella insurance policy.
(3) Mr. Chaltiel joined the Company as of August 11, 1994. This figure
represents the amount actually earned by Mr. Chaltiel from August 11,
1994 through May 31, 1995.
(4) Includes (i) an automobile allowance of $7,125, (ii) $520 paid by the
Company for an umbrella insurance policy, and (iii) a fee of $200,000
received by Mr. Chaltiel from the Company prior to his employment.
(5) Includes (i) an automobile allowance of $8,500, (ii) $520 paid by the
Company for an umbrella insurance policy, (iii) $4,894 in deferred
compensation, and (iv) $13,000 in payment of cash value of accrued Paid
Time Off.
(6) Includes (i) an automobile allowance of $8,500, (ii) $520 paid by the
Company for an umbrella insurance policy, (iii) a relocation fee of
$67,435, (iv) $4,371 in deferred compensation, and (v) $23 reimbursed by
Tenet with respect to an insurance policy.
(7) Granted by Tenet based on Mr. Frie's unvested stock options in Tenet as
of August 22, 1994 and the trading value of Tenet shares on that date.
(8) Includes (i) an automobile allowance of $8,500, (ii) $520 paid by the
Company for an umbrella insurance policy, (iii) a relocation fee of
$88,598, (iv) $10,524 in deferred compensation, (v) $338 reimbursed by
Tenet with respect to an insurance policy, (vi) $900 paid by Tenet with
respect to life and disability insurance under Tenet's Supplemental
Executive Retirement Plan, (vii) a bonus of $32,500 from Tenet, and
(viii) a fee of $100,000 received from Tenet.
40
(9) Includes (i) an automobile allowance of $8,500, (ii) $520 paid by the
Company for an umbrella insurance policy, (iii) $11,707 in deferred
compensation, (iv) $604 reimbursed by Tenet with respect to an insurance
policy, and (v) $900 paid by Tenet with respect to life and disability
insurance available under Tenet's Supplemental Executive Retirement Plan.
(10) Includes (i) an automobile allowance of $7,800, (ii) $520 paid by the
Company for an umbrella insurance policy, and (iii) $2,236 in deferred
interest income.
(11) Includes (i) an automobile allowance of $7,800, and (ii) $520 paid by the
Company for an umbrella insurance policy.
(12) Mr. Cosgrove joined the Company as of August 8, 1994. This figure
represents the amount actually earned by Mr. Cosgrove from August 8, 1994
through May 31, 1995.
(13) Includes (i) an automobile allowance of $6,175, and (ii) $520 paid by the
Company for an umbrella insurance policy.
(14) Includes (i) an automobile allowance of $7,800, (ii) $520 paid by the
Company for an umbrella insurance policy, (iii) housing reimbursement of
$3,624, and (iv) $3,565 in payment of cash value of accrued Paid Time
Off.
(15) Includes (i) an automobile allowance of $7,800, (ii) $19,025 paid by the
Company for relocation expenses, (iii) housing reimbursement of $14,990,
(iv) $520 paid by the Company for an umbrella insurance policy, and (v)
$27 reimbursed by Tenet with respect to an insurance policy.
(16) Granted by Tenet based on Mr. King's unvested stock options in Tenet as
of August 22, 1994 and the trading value of Tenet shares on that day.
(17) Includes (i) an automobile allowance of $7,800, (ii) $19,025 paid by the
Company for relocation expenses, (iii) $520 paid by the Company for an
umbrella insurance policy, (iv) housing reimbursement of $13,707, and
(iv) $435 reimbursed by Tenet with respect to an insurance policy.
(18) Includes (i) an automobile allowance of $7,800, (ii) $24,039 paid by the
Company for relocation expenses, (iii) $520 paid by the Company for an
umbrella insurance policy, (iv) $707 reimbursed by Tenet with respect to
an insurance policy, and (v) $327 in payment of cash value of accrued
Paid Time Off.
The following table sets forth information concerning options granted to
each of the named executive officers during fiscal 1996:
OPTION/SAR GRANTS IN LAST FISCAL YEAR
POTENTIAL
REALIZABLE VALUE
AT ASSUMED
ANNUAL RATES OF
STOCK PRICE
APPRECIATION FOR
INDIVIDUAL GRANTS OPTION TERM
- ----------------------------------------------------------------------- ---------------------
NUMBER OF % OF TOTAL
SECURITIES OPTIONS/SARS EXERCISE
UNDERLYING GRANTED TO OR BASE
OPTIONS/SARS EMPLOYEES IN PRICE EXPIRATION 5% 10%
NAME GRANTED(#)(1) FISCAL YEAR ($/SH) DATE ($)(2) ($)(2)
Victor M.G. Chaltiel.... 100,000 9.2% $39.375 5/8/06 $2,476,274 $6,275,359
Leonard W. Frie......... 32,150 2.9 39.375 5/8/06 796,122 2,017,528
Barry C. Cosgrove....... 32,150 2.9 39.375 5/8/06 796,122 2,017,528
John E. King............ 32,150 2.9 39.375 5/8/06 796,122 2,017,528
- --------
(1) All options are nonqualified stock options and were granted under the
Company's 1994 Equity Compensation Plan. Such options vest over four year
periods at an annual rate of 25% beginning on the first anniversary of the
date of grant.
(2) The potential realizable dollar value of a grant is the product of: (a)
the difference between: (i) the product of the per-share market price at
the time of the grant and the sum of one (1) plus the adjusted stock price
appreciation rate (the assumed rate of appreciation compounded annually
over the term of the option or SAR); and (ii) the per-share exercise price
of the option or SAR; and (b) the number of securities underlying the
grant at fiscal year-end. Actual gains, if any, on stock option exercises
and Common Stock holdings are dependent on the future performance of the
Common Stock and overall stock market conditions. There can be no
assurance that the amounts reflected in this table will be achieved.
41
The following table sets forth information concerning the aggregate number
of options exercised by each of the named executive officers during fiscal
1996:
AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND
FISCAL YEAR-END OPTION VALUES
VALUE OF UNEXERCISED
NUMBER OF UNEXERCISED IN-THE-MONEY
OPTIONS OPTIONS
AT FY-END AT FY-END
SHARES --------------------- --------------------
ACQUIRED ON VALUE EXERCISABLE/ EXERCISABLE/
NAME EXERCISE(#) REALIZED($) UNEXERCISABLE(#) UNEXERCISABLE($)(1)
Victor M.G. Chaltiel.... 0 0 0/100,000 $ 0/$ 0
Leonard W. Frie......... 0 0 46,667/ 48,817 1,621,678/ 579,178
Barry C. Cosgrove....... 0 0 25,000/ 44,650 868,750/ 434,375
John E. King............ 0 0 8,333/ 36,317 289,572/ 144,803
- --------
(1) Value is determined by subtracting the exercise price from the fair market
value of $36.25 per share (the closing price for the Company's Common
Stock as reported by the New York Stock Exchange as of December 31, 1996)
and multiplying the remainder by the number of underlying shares of Common
Stock.
EMPLOYMENT AGREEMENTS
Mr. Chaltiel entered into an employment agreement with the Company on August
11, 1994, pursuant to which he is employed by the Company for an initial term
of three years, with one year automatic extensions at the end of each year.
Such agreement is terminable by the Company at any time, subject, among other
things, to severance payments as provided in the employment agreement. His
base salary for fiscal 1996 was $285,186, subject to annual review by the
Board for possible increases, with a minimum increase tied to the California
consumer price index. Until May 31, 1999, Mr. Chaltiel will be entitled to a
yearly bonus of up to 150% of his base salary based upon the Company achieving
certain EBITDA performance targets. He also may be awarded an additional bonus
at the discretion of the Board if Company EBITDA targets are exceeded by more
than 15%. After May 31, 1999, Mr. Chaltiel will be awarded bonuses in a manner
as determined in the sole discretion of the Board, on a basis reasonably
consistent with past bonuses for similar performance. Although not yet
formally effected, the Company anticipates that Mr. Chaltiel's employment
agreement will be amended to reflect the Company's new fiscal year end of
December 31.
Mr. Chaltiel was also granted options pursuant to the Company's 1994 Equity
Compensation Plan defined below representing a total of approximately 886,667
shares of Common Stock. The options had an exercise price of $1.50. By their
terms, half of the options were to vest over a four-year period and the other
half were to vest on the ninth anniversary of the date of grant, subject to
accelerated vesting in the event that the Company satisfied certain EBITDA
performance targets. On September 18, 1995, the Board and the stockholders of
the Company approved an agreement dated as of the same date by and between the
Company and Mr. Chaltiel pursuant to which the vesting schedule for these
options was accelerated such that all of Mr. Chaltiel's outstanding options
became vested and exercisable immediately. In connection with this agreement,
Mr. Chaltiel agreed to exercise all of his options at that time to purchase
886,667 shares of Common Stock at an exercise price of $1.50 per share. Mr.
Chaltiel paid the exercise price pursuant to a $1,330,000 four-year promissory
note bearing interest at the lesser of the prime rate or 8%. This note is
subject to repayment, in part or in full, to the extent of the receipt of any
proceeds received by Mr. Chaltiel upon disposition of such shares of Common
Stock, and Mr. Chaltiel pledged these shares as collateral for repayment of
this note. Also, in accordance with the agreement, the Company agreed to
advance Mr. Chaltiel funds of up to $1,521,520 principal amount in the
aggregate relating to Mr. Chaltiel's tax liability in connection with
additional taxes associated with the exercise of such options. Such loans are
evidenced by two additional promissory notes executed by Mr. Chaltiel. The
first note for $1,348,447 was executed concurrently with Mr. Chaltiel's
exercise of his options. The second note for $173,073 was executed as of April
15, 1996. Simultaneously with the execution of the agreement, Mr. Chaltiel
42
and the Company entered into a Release and Pledge Agreement whereby the
Company released 1,113,333 shares of Common Stock owned by Mr. Chaltiel from a
previous pledge agreement and substituted the newly acquired 886,667 shares of
Common Stock therefor.
Mr. Frie entered into an employment agreement with the Company on August 11,
1994 and Messrs. Cosgrove and King entered into employment agreements with the
Company dated September 1, 1994. Pursuant to said employment agreements,
Messrs. Frie, Cosgrove and King are employed by the Company for an initial
term of three years, two years and one year, respectively, with one-year
automatic extensions at the end of each initial term. Each such agreement is
terminable by the Company at any time subject, among other things, to
severance payments as set forth therein. Base salary under the employment
agreements is subject to annual review by the Board for possible increases,
with a minimum increase tied to the California consumer price index. These
employment agreements also provide for annual bonuses, through May 31, 1999,
of up to 75% of base salary, one half of which will be based on the
achievement of certain EBITDA performance targets and the other half of which
will be awarded at the discretion of the Board. After May 31, 1999, bonuses
will be awarded in the sole discretion of the Board. Although not formally
effected, the Company anticipates that the employment agreements of the above
named officers will be amended to reflect the Company's new fiscal year end of
December 31. Each of Messrs. Frie, Cosgrove and King have also been granted
options pursuant to the 1994 Equity Compensation Plan. The Options will vest
on the ninth anniversary of the date of grant, subject to accelerated vesting
in the event that the Company satisfies certain EBITDA performance targets. If
yearly performance targets are satisfied, the options will vest at a rate of
25% at the end of each year through December 31, 1997. As a result of the
Company's performance in fiscal 1995, 25% of the options vested as of May 31,
1995 and an additional 25% of the Options vested each as of December 31, 1995
and December 31, 1996, respectively. The remaining 25% will be subject to
early vesting on December 31, 1997. The exercise price of the options is $1.50
per share. Upon voluntary termination of employment, the Company may have the
right to acquire all shares in the Company held by the terminated employee at
Fair Market Value Per Share (as defined therein). Upon involuntary termination
of employment, the Company may have the right to acquire all shares in the
Company held by the terminated employee at 80% of Fair Market Value Per Share
(as defined therein).
On December 14, 1995, the Board amended the employment contract agreement
and stock option agreement of each executive officer (other than Mr. Chaltiel)
to provide for the immediate vesting of all of such officers' stock options at
any time following the sale of fifty percent or more of the stock or assets of
the Company, or upon a merger, consolidation or reorganization in which the
Company does not survive, if any of such officers' employment is terminated
for any reason.
43
REPORT OF THE COMPENSATION COMMITTEE
REGARDING COMPENSATION
The Compensation Committee oversees the general compensation policies of the
Company, the Company's compensation and stock incentive plans, establishes the
compensation of Mr. Chaltiel, the Company's Chairman of the Board, Chief
Executive Officer and President, and reviews Mr. Chaltiel's recommendations as
to the compensation levels for the other executive officers.
COMPENSATION POLICY
The goal of the Company's executive compensation program is to provide a
strong and direct link among stockholder values, Company performance and
executive compensation through the design and implementation of a sound
compensation program that will attract and retain highly qualified personnel.
Compensation programs are intended to complement the Company's short- and
long-term business objectives and to focus executive efforts on the
fulfillment of these objectives. The Board believes that cash compensation in
the form of salary and performance-based bonuses provides Company executives
with short-term rewards for success in operations, and that long-term
compensation through the award of restricted stock and stock options
encourages growth in management stock ownership which leads to expansion of
management's stake in the long-term performance and success of the Company.
Base Salary. In establishing 1996 base salary levels for executive officer
positions, the Board considered the terms of the relevant employment
agreements. For fiscal 1996, the Company's executive officers (other than Mr.
Chaltiel) generally received raises in their annual base salary of
approximately 3%. As the Company's philosophy is to reward executive officers
through bonuses, stock and stock options, increases in base salary for fiscal
1996 are minimal compared to the improved corporate performance as well as
increased job responsibilities as a result of the increased size of the
Company.
Bonus. Annual bonuses for executive officers are intended to reflect the
Company's belief that management's contribution to stockholder returns comes
from maximizing earnings and the quality of those earnings. Bonus awards are
based largely on the Company's attainment of EBITDA performance targets
established in each executive officer's employment agreement and each
executive officer's target bonus is fixed as a percentage of his base salary.
For fiscal 1996, bonuses paid to the Company's executive officers (other than
Mr. Chaltiel) ranged from $93,750 to $139,568 (or 75% of such executive
officers' base salaries).
Restricted Stock and Stock Options. On August 5, 1994, the Company adopted
the 1994 Equity Compensation Plan. The purpose of the 1994 Plan is to provide
incentives and reward the contributions of key employees and officers for the
achievement of long-term Company performance goals, as measured by earnings
per share and the market value of the Common Stock. The Board set guidelines
for the number and terms of stock option or restricted stock awards based on
factors similar to those considered with respect to the other components of
the Company's compensation program. The awards under the 1994 Plan are
designed to align the interests of executives with those of the stockholders.
Generally, stock options become exercisable at the end of nine years, but they
may vest over a period of four years based on Company performance. The
individual forfeits any installment which has not vested during the period of
his or her employment. Under the 1994 Plan, the Board awarded stock options in
fiscal 1996 to all executive officers.
On October 24, 1995, the Company established the 1995 Equity Compensation
Plan. The purpose of the 1995 Plan is to offer stock compensation to
employees, directors, and other persons providing services to the Company and,
accordingly, to strengthen the mutuality of interests between those persons
and the Company's stockholders by providing those persons with a proprietary
interest in the Company's long-term growth and financial success. No awards
have been made under this plan.
44
COMPENSATION OF CHAIRMAN OF THE BOARD, CHIEF EXECUTIVE OFFICER AND PRESIDENT
The Board believes that Victor M.G. Chaltiel, the Company's Chairman of the
Board, Chief Executive Officer and President, provides valuable services to
the Company and that his compensation should therefore be competitive with
that paid to executives at comparable companies. In addition, the Board
believes that an important portion of his compensation should be based on
Company performance. Mr. Chaltiel's base salary is determined pursuant to his
employment agreement. Mr. Chaltiel received an increase in his base salary
effective as of October 1, 1996 of $9,178 (or 3% of base salary). The increase
was based only upon a general cost of living increase as the Board's
philosophy is to reward executive officers through bonuses, stock and stock
options. Mr. Chaltiel is entitled under his employment agreement to a yearly
bonus of up to 150% of his base salary based upon the Company achieving
certain EBITDA performance targets. He also may be awarded an additional bonus
at the discretion of the Board if Company EBITDA targets are exceeded by more
than 15%. In fiscal 1996, Mr. Chaltiel's bonus was $438,633 (or 150% of his
base salary).
BOARD OF DIRECTOR INTERLOCKS AND INSIDER PARTICIPATION
No executive officer or director of the Company serves as a member of the
board of directors or compensation committee of any other entity which has one
or more executive officers serving as a member of the Company's Board. During
fiscal 1996, Messrs. Chaltiel and Andersons were officers, employees or
consultants of the Company.
INTERNAL REVENUE CODE SECTION 162(M)
Under Section 162 of the Internal Revenue Code of 1986, as amended, the
amount of compensation paid to certain executives that is deductible with
respect to the Company's corporate taxes is limited to $1,000,000 annually. It
is the current policy of the Board to maximize, to the extent reasonably
possible, the Company's ability to obtain a corporate tax deduction for
compensation paid to executive officers of the Company to the extent
consistent with the best interests of the Company and its stockholders.
COMPENSATION COMMITTEE
Maris Andersons
Peter T. Grauer
David B. Wilson
45
STOCK PRICE PERFORMANCE
The following graph shows a comparison of cumulative total returns for the
Company, the Standard & Poor's 400 and a Company-constructed Peer Group Index
(as defined below). The graph assumes that the value of an investment in
Common Stock and in each such index was $100 on October 31, 1995 (the date the
Company's Common Stock was registered under Section 12 of the Securities
Exchange Act of 1934), and that all dividends have been reinvested. The
Company-constructed Peer Group Index consists of the following companies:
Renal Care Group, Renal Treatment Centers and Vivra. The Company believes that
the companies in the Peer Group Index are the primary competitors of the
Company. The Peer Group Index is weighted for the market capitalization of
each company within the group.
The comparison in the graph below is based on historical data and is not
intended to forecast the possible future performance of the Company's Common
Stock.
COMPARISON OF CUMULATIVE TOTAL RETURN AMONG
TOTAL RENAL CARE HOLDINGS, INC., THE STANDARD & POOR'S 400,
AND TOTAL RENAL CARE HOLDINGS, INC.'S SELF-CONSTRUCTED PEER GROUP
PEER
Measurement Period TRCH GROUP S&P 400
- ------------------ -------- -------- ----------
Oct 31, 95 $100.00 $100.00 $100.00
Nov l, 95 95.706 100.462 100.243
Nov 2, 95 102.454 101.451 101.113
Nov 3, 95 98.16 103.517 101.393
Nov 6, 95 95.706 104.253 101.038
Nov 7, 95 93.252 104.506 100.721
Nov 8, 95 93.865 102.571 101.572
Nov 9, 95 99.387 103.098 101.867
Nov 10, 95 100.614 102.614 101.852
Nov 13, 95 101.841 102.867 101.892
Nov 14, 95 101.841 104.853 101.439
Nov 15, 95 100.614 104.737 102.368
Nov 16, 95 100.614 105.524 102.816
Nov 17, 95 101.841 104.672 103.213
Nov 20, 95 105.521 104.882 102.675
Nov 21, 95 105.521 105.048 103.215
Nov 22, 95 107.975 105.532 102.887
Nov 23, 95 107.975 105.532 102.887
Nov 24, 95 111.043 106.792 103.205
Nov 27, 95 119.018 107.749 103.309
Nov 28, 95 130.675 107.947 104.276
Nov 29, 95 137.423 108.095 104.456
Nov 30, 95 131.902 106.315 104.032
Dec l, 95 131.902 105.969 104.123
Dec 4, 95 128.834 107.106 105.17
Dec 5, 95 130.675 110.915 105.988
Dec 6, 95 139.264 113.865 106.376
Dec 7, 95 138.65 113.074 105.855
Dec 8, 95 139.877 112.431 106.196
Dec 11, 95 140.491 113.273 106.579
Dec 12, 95 145.399 112.598 106.464
Dec 13, 95 146.012 113.919 106.958
Dec 14, 95 146.012 115.916 106.152
Dec 15, 95 146.012 114.067 105.896
Dec 18, 95 140.491 112.681 104.124
Dec 19, 95 133.742 111.428 104.86
Dec 20, 95 129.448 112.417 103.73
Dec 21, 95 127.607 115.103 104.74
Dec 22, 95 127.607 115.103 105.037
Dec 25, 95 127.607 115.103 105.037
Dec 26, 95 127.607 114.197 105.355
Dec 27, 95 137.423 116.851 105.216
Dec 28, 95 137.423 115.334 105.104
Dec 29, 95 147.239 116.869 105.439
Jan l, 96 147.239 116.869 105.439
Jan 2, 96 143.558 118.039 106.383
Jan 3, 96 144.785 118.847 106.348
Jan 4, 96 138.65 117.479 105.931
Jan 5, 96 138.037 119.143 105.752
Jan 8, 96 137.423 119.522 106.173
Jan 9, 96 134.969 119.208 104.528
Jan 10, 96 136.196 118.959 102.677
Jan 11, 96 136.196 116.19 103.417
Jan 12, 96 141.104 117.443 103.091
Jan 15, 96 143.558 117.063 102.643
Jan 16, 96 146.626 116.8 103.864
Jan 17, 96 146.012 117.97 103.363
Jan 18, 96 139.264 123.198 103.89
Jan 19, 96 139.264 124.155 104.689
Jan 22, 95 138.037 121.169 105.173
Jan 23, 95 137.423 120.281 105.051
Jan 24, 95 136.81 117.826 106.399
Jan 25, 95 137.423 118.718 105.822
Jan 26, 95 135.583 120.201 106.696
Jan 29, 96 134.356 119.277 107.054
Jan 30, 96 134.356 117.844 108.171
Jan 31, 96 136.196 118.866 108.923
Feb 1, 96 139.877 124.621 109.683
Feb 2, 96 144.172 125.541 109.205
Feb 5, 95 146.012 128.625 110.189
Feb 6, 95 153.374 127.404 110.888
Feb 7, 95 157.055 127.404 111.313
Feb 8, 95 150.92 129.375 112.437
Feb 9, 95 149.08 129.032 112.469
Feb 12, 96 152.761 128.703 113.334
Feb 13, 96 144.172 130.848 113.145
Feb 14, 96 144.172 132.073 112.483
Feb 15, 96 142.331 131.941 111.791
Feb 16, 96 144.172 130.49 111.309
Feb 19, 96 144.172 130.49 111.309
Feb 20, 96 142.331 126.234 110.312
Feb 21, 96 142.945 124.508 111.573
Feb 22, 96 148.466 126.007 113.486
Feb 23, 96 147.239 129.148 113.468
Feb 26, 96 149.693 128.25 111.993
Feb 27, 96 150.307 131.712 111.408
Feb 28, 96 146.626 131.742 110.934
Feb 29, 96 144.785 132.102 110.139
Mar l, 96 146.012 130.951 110.623
Mar 4, 96 146.626 128.523 111.763
Mar 5, 96 147.239 128.916 112.689
Mar 6, 96 145.399 126.572 112.101
Mar 7, 96 149.08 129.739 112.611
Mar 8, 96 147.239 126.799 109.29
Mar 11, 95 144.785 125.875 110.848
Mar 12, 95 144.172 123.808 110.619
Mar 13, 95 145.399 126.569 110.926
Mar 14, 95 146.012 126.468 111.233
Mar 15, 95 145.399 127.219 111.424
Mar 18, 96 146.012 131.158 113.142
Mar 19, 96 146.012 129.719 112.858
Mar 20, 96 145.399 131.175 112.259
Mar 21, 96 144.172 133.323 112.164
Mar 22, 96 142.945 137.042 112.379
Mar 25, 96 146.626 140.084 112.148
Mar 26, 96 150.307 138.196 112.708
Mar 27, 96 151.534 136.218 111.986
Mar 28, 96 152.147 134.493 111.986
Mar 29, 96 152.761 133.215 111.376
Apr 1, 96 161.35 136.224 112.603
Apr 2, 96 160.736 138.525 112.891
Apr 3, 96 162.577 137.74 113.145
Apr 4, 96 171.779 140.608 113.304
Apr 5, 96 171.779 140.608 113.304
Apr 8, 96 173.006 139.059 111.66
Apr 9, 96 174.233 140.162 111.339
Apr 10, 96 177.914 140.431 109.975
Apr 11, 96 174.847 138.52 109.725
Apr 12, 96 173.62 139.105 110.374
Apr 15, 96 173.62 136.688 111.385
Apr 16, 96 175.46 140.67 112.081
Apr 17, 96 177.914 140.755 111.241
Apr 18, 96 173.62 145.001 111.589
Apr 19, 96 174.233 149.415 111.79
Apr 22, 96 176.687 150.819 112.215
Apr 23, 96 187.117 160.137 113.027
Apr 24, 96 198.16 157.105 112.832
Apr 25, 96 195.092 153.491 113.319
Apr 26, 96 193.252 153.977 113.42
Apr 29, 96 186.503 150.956 113.588
Apr 30, 96 187.73 154.401 113.6
May 1, 96 188.957 152.868 113.692
May 2, 96 178.528 145.195 111.996
May 3, 96 184.233 141.557 111.757
May 6, 96 184.049 145.864 111.718
May 7, 96 191.411 147.32 111.138
May 8, 96 193.252 146.764 111.948
May 9, 96 195.706 147.224 112.056
May 10, 96 212.27 149.76 112.996
May 13, 96 22l.472 154.498 114.806
May 14, 96 215.337 151.777 115.638
May 15, 96 212.27 153.235 115.712
May 16, 96 207.362 157.888 115.684
May 17, 96 201.841 158.705 116.402
May 20, 96 202.454 161.709 117.32
May 21, 96 200.614 161.543 117.07
May 22, 96 196.933 165.811 117.943
May 23, 96 194.479 166.996 117.692
May 24, 96 201.227 169.747 118.031
May 27, 96 201.227 169.747 118.031
May 28, 96 197.546 166.263 116.975
May 29, 96 194.479 166.693 116.214
May 30, 96 201.841 167.656 117.085
May 31, 96 202.454 167.555 116.711
Jun 3, 96 203.068 166.382 116.51
Jun 4, 96 200.614 164.38 117.25
Jun 5, 96 195.706 161.776 118.113
Jun 6, 96 198.16 159.598 117.106
Jun 7, 96 193.865 158.379 117.477
Jun 10, 96 189.571 157.371 117.322
Jun 11, 96 188.957 158.874 117.098
Jun 12, 96 189.571 158.526 116.86
Jun 13, 96 188.957 157.386 116.553
Jun 14, 96 190.798 158.075 116.139
Jun 17, 96 190.184 156.379 116.016
Jun 18, 96 190.798 152.108 115.336
Jun 19, 96 190.798 151.716 115.405
Jun 20, 96 190.184 147.831 115.497
Jun 21, 96 189.571 145.704 116.389
Jun 24, 96 185.89 149.156 116.673
Jun 25, 96 190.184 151.344 116.496
Jun 26, 96 188.344 150.658 115.701
Jun 27, 96 192.638 150.798 116.224
Jun 28, 96 207.362 155.229 116.429
Jul 1, 96 207.362 151.535 117.287
Jul 2, 96 205.522 150.765 116.892
Jul 3, 96 201.227 152.759 116.635
Jul 4, 96 201.227 152.759 116.635
Jul 5, 96 200.614 150.279 114.293
Jul 8, 96 191.411 149.838 113.588
Jul 9, 96 193.252 149.274 113.85
Ju1 10, 96 192.025 147.526 114.006
Jul 11, 96 175.46 139.944 112.145
Jul 12, 96 173.006 138.871 112.072
Ju1 15, 96 165.031 131.617 110.477
Ju1 16, 96 159.509 134.248 108.731
Jul 17, 96 166.258 138.763 109.814
Jul 18, 96 167.485 143.585 111.474
Jul 19, 96 174.233 142.899 110.681
Jul 22, 96 170.552 141.266 109.763
Jul 23, 96 167.485 139.394 108.374
Jul 24, 96 165.031 137.442 108.331
Jul 25, 96 169.325 141.641 109.157
Jul 26, 96 172.393 145.765 110.056
Jul 29, 96 174.233 145.265 109.148
Jul 30, 96 174.847 144.212 109.896
Jul 31, 96 175.46 144.383 110.81
Aug 1, 96 170.552 146.317 112.509
Aug 2, 96 172.393 149.453 114.48
Aug 5, 96 179.755 154.512 114.217
Aug 6, 96 182.209 154.253 114.689
Aug 7, 96 186.503 163.271 115.022
Aug 8, 96 182.822 162.679 114.664
Aug 9, 96 186.503 160.682 114.446
Aug 12, 95 188.344 160.612 115.051
Aug 13, 95 186.503 156.606 114.104
Aug 14, 95 186.503 159.734 114.415
Aug 15, 95 185.89 159.648 114.471
Aug 16, 95 185.276 159.5 114.793
Aug 19, 96 183.436 160.1 114.991
Aug 20, 96 178.528 156.256 114.785
Aug 21, 96 182.822 159.037 114.668
Aug 22, 96 184.049 159.223 115.668
Aug 23, 96 185.89 159.015 115.13
Aug 26, 96 189.571 157.446 114.578
Aug 27, 96 193.252 159.395 115.024
Aug 28, 96 195.706 159.673 114.817
Aug 29, 96 198.773 157.554 113.528
Aug 30, 96 201.841 158.14 112.632
Sep 2, 96 201.841 158.14 112.632
Sep 3, 96 198.773 155.843 113.167
Sep 4, 96 197.546 155.443 113.393
Sep 5, 96 195.092 152.621 112.32
Sep 6, 96 195.706 152.227 113.374
Sep 9, 96 193.865 156.355 114.734
Sep 10, 96 190.798 156.772 114.781
Sep 11, 96 187.117 158.421 115.317
Sep 12, 96 184.049 161.263 115.974
Sep 13, 96 185.276 161.567 117.559
Sep 16, 96 192.025 161.168 118.202
Sep 17, 96 188.957 159.227 118.234
Sep 18, 96 188.957 158.812 118.066
Sep 19, 96 193.252 161.685 118.43
Sep 20, 96 192.638 164.281 119.106
Sep 23, 96 191.411 163.672 118.895
Sep 24, 96 190.798 163.78 118.718
Sep 25, 96 190.798 162.717 118.734
Sep 26, 96 190.798 163.083 118.603
Sep 27, 96 191.411 166.127 118.588
Sep 30, 96 196.319 165.635 118.839
Oct 1, 96 191.411 161.675 119.006
Oct 2, 96 199.387 161.806 119.853
Oct 3, 96 200 161.883 119.658
Oct 4, 96 211.043 163.139 121.025
Oct 7, 96 217.791 164.286 121.448
Oct 8, 96 220.859 167.622 120.959
Oct 9, 96 218.405 166.674 120.306
Oct 10, 96 219.632 167.431 120.005
Oct 11, 96 222.086 169.056 121.065
Oct 14, 96 226.38 169.425 121.625
Oct 15, 96 217.178 169.619 121.437
Oct 16, 96 210.43 169.079 121.856
Oct 17, 96 201.841 167.184 122.136
Oct 18, 96 204.908 164.796 122.743
211.656 162.154 122.401
The information contained above under the captions "Report of the
Compensation Committee Regarding Compensation" and "Stock Price Performance"
shall not be deemed to be "soliciting material" or to be "filed" with the
Securities and Exchange Commission, nor shall such information be incorporated
by reference into any future filing under the Securities Act or the Exchange
Act, except to the extent that the Company specifically incorporates it by
reference into such filing.
46
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The following table sets forth information regarding the ownership of the
Company's Common Stock as of December 31, 1996 by (i) all those persons known
by the Company to own beneficially more than 5% of the Company's Common Stock,
(ii) each director and each executive officer of the Company and (iii) all
directors and executive officers as a group. Except as otherwise noted under
"Certain Relationships and Related Transactions," the Company knows of no
agreements among its stockholders which relate to voting or investment power
over its Common Stock or any arrangement the operation of which may at a
subsequent date result in a change of control of the Company.
NUMBER OF SHARES PERCENTAGE OF SHARES
NAME OF BENEFICIAL OWNER(1) BENEFICIALLY OWNED(1) BENEFICIALLY OWNED(1)
Victor M.G. Chaltiel............... 910,514 3.4%
c/o Total Renal Care Holdings,
Inc.
21250 Hawthorne Blvd.
Torrance, California 90503
DLJ Merchant Banking Partners,
L.P.(2)........................... 951,588 3.6%
DLJ International Partners,
C.V.(2)........................... 427,134 1.6%
DLJ Offshore Partners, C.V.(2)..... 24,765 *
DLJ First ESC LLC(2)............... 237,711 *
DLJ Merchant Banking Funding,
Inc.(2)........................... 383,036 1.4%
NME Properties Corp................ 3,000,000 11.3%
c/o Tenet Healthcare Corporation
30 South La Patera Lane
Goleta, California 93117
Maris Andersons(3)................. 333 *
Barry C. Cosgrove(4)............... 105,670 *
Leonard W. Frie(5)................. 134,108 *
Peter T. Grauer(6)................. 0 --
John E. King(7).................... 32,445 *
Marsha M. Plotnitsky(6)............ 0 --
David B. Wilson(6)................. 0 --
All directors and executive
officers as a group (8 persons)... 1,183,070 4.5%
- --------
* Amount represents less than 1% of the Company's Common Stock.
(1) Unless otherwise indicated, the persons named in the table have sole
voting and sole investment power with respect to all shares of Common
Stock shown as beneficially owned by them, subject to community property
rules where applicable and the information contained in this table and
these notes.
(2) The address of DLJ Merchant Banking Partners, L.P. ("DLJMBP"), DLJ First
ESC, LLC ("DLJESC") and DLJ Merchant Banking Funding, Inc. ("DLJMBF") is
277 Park Avenue, New York, New York 10172. The address of DLJ
International Partners, C.V. ("DLJIP") and DLJ Offshore Partners, C.V.
("DLJOP") is John B. Gorsiraweg 6, Willemstad, Curacao, Netherlands
Antilles. As a general partner of each of DLJMBP, DLJIP and DLJOP, DLJ
Merchant Banking, Inc. may be deemed to beneficially own indirectly all of
the shares held directly by DLJMBP, DLJIP and DLJOP, and as the indirect
parent of each of DLJ Merchant Banking, Inc. and DLJMBF, Donaldson, Lufkin
& Jenrette, Inc. ("DLJ") may be deemed to beneficially own indirectly all
of the shares held by DLJMBP, DLJIP, DLJOP and DLJ LBO Plans Management
Corporation ("DLJLBO"), the manager of DLJESC and DLJMBF. DLJ is a 78.2%
owned subsidiary of The Equitable Companies Incorporated ("Equitable").
The address of DLJ Merchant Banking, Inc., DLJLBO and DLJ is 277 Park
Avenue, New York, New York 10172. Equitable filed a Schedule 13G with the
Securities and Exchange Commission on February 14, 1996 with respect to
these shares. Also parties to this filing were AXA Assurances I.A.R.D.
Mutuelle, AXA Assurances Vie Mutuelle, Alpha Assurances I.A.R.D. Mutuelle,
Alpha Assurances Vie Mutuelle, Uni Europe Assurance Mutuelle
(collectively, the "Mutuelles AXA") and AXA. The Mutuelles AXA, as a
group, and AXA disclaimed
47
beneficial ownership of any shares held by subsidiaries of Equitable. In
addition, the above-referenced Schedule 13G disclosed that Wood, Struthers
& Winthrop Management Corp., an indirect subsidiary of DLJ, acquired 10,000
shares of the Company's Common Stock solely for investment purposes on
behalf of client discretionary investment advisory accounts.
(3) Includes 333 shares of Common Stock issuable upon the exercise of the
portion of options held by him that are exercisable within 60 days after
December 31, 1996.
(4) Includes 25,000 shares of Common Stock issuable upon the exercise of the
portion of options held by him that are exercisable within 60 days after
December 31, 1996.
(5) Includes 46,667 shares of Common Stock issuable upon the exercise of
options held by him that are exercisable within 60 days after December 31,
1996.
(6) Mr. Grauer is a Managing Director of DLJMB. Ms. Plotnitsky is a Managing
Director of DLJ, an affiliate of DLJMB. Mr. Wilson is a Senior Vice
President of DLJMB. The share ownerships of Mr. Grauer, Ms. Plotnitsky and
Mr. Wilson do not include any of the shares included in the table above as
beneficially owned by DLJMB, as to which Mr. Grauer, Ms. Plotnitsky and
Mr. Wilson disclaim beneficial ownership.
(7) Includes 8,333 shares of Common Stock issuable upon the exercise of the
portion of options held by him that are exercisable within 60 days after
December 31, 1996.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
During fiscal 1996, Company compensation determinations were made by the
Board. Victor M.G. Chaltiel is Chairman of the Board, Chief Executive Officer,
President and a Director of the Company and Total Renal Care, Inc. Pursuant to
Mr. Chaltiel's employment agreement and the 1994 Plan, Mr. Chaltiel purchased
1,113,334 shares of Common Stock at $1.50 per share. Mr. Chaltiel paid
$835,000 of the purchase price in cash, with the remainder being evidenced by
a four-year promissory note bearing interest at the lesser of the prime rate
or 8% per annum, which note is secured by a pledge of certain shares of stock
of the Company owned by Mr. Chaltiel. In July 1995, the Board approved a one-
year deferral of all scheduled principal and accrued interest payments under
all outstanding promissory notes, including this four-year promissory note. On
September 18, 1995, the Company and Mr. Chaltiel entered into an agreement
pursuant to which Mr. Chaltiel purchased 886,667 shares of Common Stock upon
exercise of options held by him. Mr. Chaltiel paid for such shares with a
four-year promissory note for $1,330,000 bearing interest at the lesser of the
prime rate or 8%. This note is subject to repayment, in part or in full, to
the extent of the receipt of proceeds received by Mr. Chaltiel, upon
disposition of such shares of Common Stock, and Mr. Chaltiel pledged these
shares as collateral for repayment of this note. The Company agreed to advance
Mr. Chaltiel funds of up to $1,521,520 principal amount in the aggregate
relating to Mr. Chaltiel's tax liability in connection with the shares. Such
loans are evidenced by two additional promissory notes executed by Mr.
Chaltiel. The first note for $1,348,447 was executed concurrently with Mr.
Chaltiel's exercise of his options. The second note for $173,073 was executed
as of April 15, 1996. Simultaneously with the execution of the agreement, Mr.
Chaltiel and the Company entered into a Release and Pledge Agreement whereby
the Company released 1,113,333 shares of Common Stock owned by Mr. Chaltiel
from a previous pledge agreement and substituted the newly acquired 886,667
shares of Common Stock therefor.
Certain of the Company's officers and employees have received loans from the
Company in connection with the purchase of shares of Common Stock. All of the
loans have similar terms. The loans bear interest at the lower of 8% or the
prime rate, and are secured by all of the borrower's interests in Common Stock
of the Company, including all vested stock options. When made, the loans had a
four-year term and one quarter of the original principal amount thereof plus
all accrued interest thereon had to be paid annually, subject to the
limitation that the borrower was not required to make any payment that
exceeded 50% of the proceeds of such borrower's after-tax bonus from the
Company (based on maximum tax rates then in effect). To date, the Board has
approved deferrals of all scheduled principal and accrued interest payments
under all such loans. No other terms of the loans have been changed.
As of December 31, 1996, Leonard W. Frie, Barry C. Cosgrove and John E. King
had loans outstanding from the Company with principal amounts of $100,000, and
$70,000 and $25,000, respectively (with respect to
48
Mr. Cosgrove, $50,000 was borrowed to purchase shares of Common Stock and
$20,000 was borrowed for relocation costs). Victor M.G. Chaltiel had an
outstanding loan of $835,000 prior to the addition on September 18, 1995 of
$2,678,447 pursuant to similar loans in connection with Mr. Chaltiel's
exercise of options for 886,667 shares of Common Stock and related personal
income tax obligations. These loans are secured by a pledge of 866,667 shares
of Common Stock. Mr. Chaltiel received a similar loan from the Company on
April 15, 1996, in the amount of $173,073, in connection with additional taxes
associated with the exercise of such options.
Maris Andersons, a Director of the Company, serves as a consultant to the
Company. He has been granted options, vesting over four years, to purchase an
aggregate of 46,183 shares of Common Stock in consideration for these
services. As of December 31, 1996, Mr. Andersons has exercised 8,000 of said
options leaving a balance of 38,183 options to purchase shares of common
stock.
In August 1994, the Company, NME Properties, DLJMB, and certain members of
management entered into a Shareholders Agreement (the "Shareholders
Agreement") that governs their relationships. Pursuant to the Shareholders
Agreement, the Company's Board consists of five members: four nominated by
DLJMB and one nominated by NME Properties. The Shareholders Agreement also
provides for restrictions on transfers of Common Stock, including a
prohibition on stock transfers by DLJMB and NME Properties if such transfer
would result in a Change of Control (as defined in the Shareholders
Agreement). The Shareholders Agreement also includes certain rights of first
refusal in favor of DLJMB in the event NME Properties proposes to transfer
shares of Common Stock and certain rights and obligations on the part of NME
Properties to participate in transfers of shares by DLJMB.
The Shareholders Agreement restricts DLJMB from owning more than 50% of (or
controlling) other dialysis entities except as part of the process of
combining such entities with the Company. The Shareholders Agreement also
provides that DLJMB and NME Properties each have the right, subject to certain
conditions, to request that the Company register shares of the Common Stock
they own under the Securities Act of 1933, as amended (the "Securities Act"),
(but not more than four times each), and to participate in other registrations
of the Company's securities, in each case at the Company's expense.
The Company has entered into indemnity agreements with each of its directors
and all of its officers, which agreements require the Company, among other
things, to indemnify them against certain liabilities that may arise by reason
of their status or service as directors, officers, employees or agents of the
Company (other than liabilities arising from conduct in bad faith or which is
knowingly fraudulent or deliberately dishonest), and, under certain
circumstances, to advance their expenses incurred as a result of proceedings
brought against them.
49
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
(a)Documents filed as part of this Report:
(1) Index to Financial Statements:
PAGE
Report of Independent Accountants of Price Waterhouse LLP F-1
Independent Auditors' Report of KPMG Peat Marwick LLP F-2
Consolidated Balance Sheets as of December 31, 1995 and December
31, 1996 F-3
Consolidated Statements of Income for years ended May 31, 1994
and May 31, 1995, the seven months ended December 31, 1994
(unaudited) and December 31, 1995 and the years ended December
31, 1995 (unaudited) and December 31, 1996 F-4
Consolidated Statements of Stockholders' Equity for the years
ended May 31, 1994 and May 31, 1995, the transitional period
ended December 31, 1995 and the year ended December 31, 1996 F-5
Consolidated Statements of Cash Flows for years ended May 31,
1994 and May 31, 1995, the seven months ended December 31, 1994
(unaudited) and December 31, 1995 and the years ended December
31, 1995 (unaudited) and December 31, 1996 F-6
Notes to Consolidated Financial Statements F-7
(2) Index to Financial Statement Schedules:
Report of Independent Accountants on Financial Statement
Schedule of Price Waterhouse LLP S-1
Independent Auditors' Report of KPMG Peat Marwick LLP S-2
Schedule II--Valuation and Qualifying Accounts S-3
(3)(a) Exhibits:
3.1 Amended and Restated Certificate of Incorporation of the Company, dated
December 4, 1995.++++
3.2 Bylaws of the Company, dated October 6, 1995.+
4.1 Shareholders Agreement, dated August 11, 1994 between DLJMB, DLJIP,
DLJOP, DLJMBF, NME Properties, Continental Bank, as voting trustee, and
the Company.++
4.2 Agreement and Amendment, dated as of June 30, 1995, between DLJMBP,
DLJIP, DLJOP, DLJMBF, DLJESC, Tenet Healthcare Corporation, the Company,
Victor M.G. Chaltiel, the Putnam Purchasers, the Crescent Purchasers and
the Harvard Purchasers, relating to the Shareholders Agreement dated as
of August 11, 1994 between DLJMB, DLJIP, DLJOP, DLJMBF, NME Properties,
Continental Bank, as voting trustee, and the Company.++
10.1 Credit Agreement by and among Total Renal Care Holdings, Inc., the
Lenders party thereto, BNY Capital Markets, Inc. and Donaldson Lufkin &
Jenrette Securities Corporation as Arrangers, DLJ Capital Funding, Inc.
as Documentation Agent and The Bank of New York as Administrative Agent,
dated as of October 11, 1996 (the "TRCH Credit Facility").++
10.2 Guaranty by Total Renal Care, Inc. to The Bank of New York, as
Administrative Agent, pursuant to the TRCH Credit Facility.++
10.3 Subscription Agreement dated May 26, 1994 between DLJMB, DLJIP, DLJOP,
DLJMBF, NME Properties, Tenet and the Company.+
10.4 Services Agreement dated August 11, 1994 between the Company and Tenet.++
10.5 Noncompetition Agreement dated August 11, 1994 between the Company and
Tenet.++
50
10.6 Employment Agreement dated as of August 11, 1994 by and between the
Company and Victor M.G. Chaltiel (with forms of Promissory Note and
Pledge and Stock Subscription Agreement attached as exhibits thereto)
(the "Chaltiel Employment Agreement").++*
10.7 Amendment to Chaltiel Employment Agreement, dated as of August 11,
1994.++*
10.8 Employment Agreement dated as of September 1, 1994 by and between the
Company and Barry C. Cosgrove.++*
10.9 Employment Agreement dated as of August 11, 1994 by and between the
Company and Leonard W. Frie (the "Frie Employment Agreement").++*
10.10 Amendment to Frie Employment Agreement, dated as of October 11, 1994.++*
10.11 Employment Agreement dated as of September 1, 1994 by and between the
Company and John E. King.++*
10.12 First Amended and Restated 1994 Equity Compensation Plan (the "1994
Plan") of the Company (with form of Promissory Note and Pledge attached
as an exhibit thereto), dated August 5, 1994.++*
10.13 Form of Stock Subscription Agreement relating to the 1994 Plan.++*
10.14 Form of Purchased Shares Award Agreement relating to the 1994 Plan.++*
10.15 Form of Nonqualified Stock Option relating to the 1994 Plan.++*
10.16 1995 Equity Compensation Plan.+*
10.17 Employee Stock Purchase Plan.+*
10.18 Option Exercise and Bonus Agreement dated as of September 18, 1995
between the Company and Victor M.G. Chaltiel.+*
11 Computation of Per Share Earnings.X
21 List of Subsidiaries of the Company.X
23.1 Consent of KPMG Peat Marwick LLP.X
23.2 Consent of Price Waterhouse LLP.X
24 Powers of Attorney with respect to the Company. X
27 Financial Data Schedule.X
- --------
X Included in this filing.
++ Filed on October 18, 1996 as an exhibit to the Company's Current Report on
Form 8-K.
+++ Filed+on March 18, 1996 as an exhibit to the Company's Transitional Report
on Form 10-K for the transition period from June 1, 1995 to December 31,
1995.
+ Filed on October 24, 1995 as an exhibit to Amendment No. 2 to the Company's
Registration Statement on Form S-1 (Registration Statement No. 33-97618).
++ Filed on October 10, 1995 as an exhibit to Amendment No. 1 to the
Company's Registration Statement on Form S-1 (Registration Statement No.
33-97618).
+++ Filed on October 2, 1995 as an exhibit to the Company's Registration
Statement on Form S-1 (Registration Statement No. 33-97618).
+ Filed on June 6, 1994 as an exhibit to the Company's Registration Statement
on Form S-1 (Registration Statement No. 33-79770).
++ Filed on August 29, 1995 as an exhibit to the Company's Form 10-K for the
year ended May 31, 1995.
* Management contract or executive compensation plan or arrangement.
51
(b) Reports on Form 8-K:
Current Report on Form 8-K/A-1, dated February 13, 1996, reporting under
Item 7 the combined financial statements of Southwest Renal Care, Ltd. and
Dialysis Medical Supplies, Inc. and unaudited pro forma financial
information.
Current Report on Form 8-K, dated March 18, 1996, reporting under (i)
Item 2 the acquisition of the stock of Upstate Dialysis Center, Inc., the
signing of a definitive agreement to manage Greer Kidney Center, Inc. and
the purchase of the Nephrology Services Business of Caremark International,
Inc., (ii) Item 5 the entry into an Agreement and Plan of Merger pursuant
to which a wholly-owned subsidiary of TRC was to be merged with and into
Downtown Dialysis Center, Inc. and (iii) Item 7 the financial statements of
each of Caremark International, Inc.'s Nephrology Services Business, Greer
Kidney Center, Inc., Upstate Dialysis Center, Inc., Downtown Dialysis
Center, Inc. and unaudited pro forma financial information.
Current Report on Form 8-K, dated August 29, 1996, reporting under Item 5
the issuance of press releases by TRCH dated August 6, 1996 and August 29,
1996, respectively.
Current Report on Form 8-K, dated October 18, 1996, reporting under Item
7 the TRCH Credit Facility, the financial statements of each of Burbank
Dialysis Group, Inc., Pasadena Dialysis Center, Inc., the combined
financial statements of Piedmont Dialysis, Inc. and Peralta Renal Center,
Inc., the combined financial statements of Bertha Sirk Dialysis Center,
Inc. and Greenspring Dialysis Center, Inc. and the combined financial
statements of Houston Kidney Center, LLP, Northwest Kidney Center, LLP,
North Houston Kidney Center, LLP and Houston Kidney Center Southeast, LLP
and unaudited pro forma financial information.
Current Report on Form 8-K, dated October 25, 1996, reporting under Item
5 and Item 7 the press release dated October 25, 1996 announcing third
quarter earnings.
Current Report on Form 8-K, dated October 30, 1996, reporting under Item
5 the pro forma financial statements to reflect as of September 30, 1996,
certain insignificant acquisitions consummated as of October 1, 1996 and
probable acquisitions as of October 30, 1996 and the retirement of 12%
Senior Subordinated Discount Notes and reporting under Item 7 the unaudited
combined pro forma financial statements as of September 30, 1996.
52
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders of
Total Renal Care Holdings, Inc.
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of income, of stockholders' equity, and of cash flows
present fairly, in all material respects, the financial position of Total
Renal Care Holdings, Inc. and its subsidiaries at December 31, 1995 and 1996,
and the results of their operations and their cash flows for the year ended
May 31, 1995, the seven months ended December 31, 1995 and the year ended
December 31, 1996 in conformity with generally accepted accounting principles.
These financial statements are the responsibility of the Company's management;
our responsibility is to express an opinion on these financial statements
based on our audits. We conducted our audits of these statements in accordance
with generally accepted auditing standards which require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on
a test basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for the
opinion expressed above.
PRICE WATERHOUSE LLP
Seattle, Washington
February 13, 1997
F-1
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders
Total Renal Care Holdings, Inc.:
We have audited the accompanying consolidated statements of income,
stockholders' equity and cash flows of Total Renal Care Holdings, Inc.
(formerly Total Renal Care, Inc.) and subsidiaries for the year ended May 31,
1994. These consolidated financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audit provides a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the results of operations and cash
flows of Total Renal Care Holdings, Inc. and subsidiaries for the year ended
May 31, 1994, in conformity with generally accepted accounting principles.
KPMG Peat Marwick LLP
Seattle, Washington
July 8, 1994
F-2
TOTAL RENAL CARE HOLDINGS, INC.
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, DECEMBER 31,
1995 1996
ASSETS
Cash and cash equivalents.......................... $ 30,181,000 $ 19,881,000
Patient accounts receivable, less allowance for
doubtful accounts of $5,668,000 and $7,911,000,
respectively...................................... 37,884,000 91,009,000
Receivable from Tenet.............................. 432,000 347,000
Inventories........................................ 2,482,000 6,045,000
Deferred income taxes.............................. 1,542,000 3,233,000
Prepaid expenses and other current assets.......... 2,973,000 10,771,000
------------ ------------
Total current assets........................... 75,494,000 131,286,000
Property and equipment, net........................ 25,505,000 58,266,000
Notes receivable from related parties.............. 1,379,000 1,919,000
Investment in affiliate, at equity................. 972,000 1,018,000
Other long-term assets............................. 885,000 974,000
Intangible assets, net............................. 59,763,000 180,617,000
------------ ------------
$163,998,000 $374,080,000
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Accounts payable................................... $ 7,901,000 $ 9,818,000
Employee compensation and benefits................. 5,012,000 12,360,000
Other accrued liabilities.......................... 7,006,000 7,745,000
Income taxes payable............................... 314,000
Current portion of long-term obligations........... 570,000 2,064,000
------------ ------------
Total current liabilities...................... 20,803,000 31,987,000
------------ ------------
Long-term debt..................................... 55,324,000 102,552,000
------------ ------------
Deferred income taxes.............................. 510,000 2,868,000
------------ ------------
Other long-term liabilities........................ 1,214,000 993,000
------------ ------------
Minority interests................................. 3,343,000 4,714,000
------------ ------------
Commitments and contingencies (Notes 8, 12 and 13)
Stockholders' equity
Common stock ($.001 par value, 55,000,000 shares
authorized; 22,308,207 and 26,472,982 shares
issued and outstanding)......................... 22,000 26,000
Additional paid-in capital....................... 123,710,000 255,897,000
Notes receivable from stockholders............... (2,773,000) (2,827,000)
Retained deficit................................. (38,155,000) (22,130,000)
------------ ------------
Total stockholders' equity..................... 82,804,000 230,966,000
------------ ------------
$163,998,000 $374,080,000
============ ============
See accompanying notes to consolidated financial statements.
F-3
TOTAL RENAL CARE HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF INCOME
SEVEN MONTHS ENDED
YEAR ENDED MAY 31, DECEMBER 31, YEAR ENDED DECEMBER 31,
------------------------ ------------------------ --------------------------
1994 1995 1994 1995 1995 1996
(UNAUDITED) (UNAUDITED)
Net operating revenues.. $80,470,000 $98,968,000 $53,593,000 $89,711,000 $134,843,000 $272,947,000
----------- ----------- ----------- ----------- ------------ ------------
Operating expenses
Facilities............. 56,828,000 65,583,000 36,012,000 57,406,000 86,977,000 183,987,000
General and
administrative........ 7,457,000 9,115,000 4,916,000 7,645,000 11,844,000 19,267,000
Provision for doubtful
accounts.............. 1,550,000 2,371,000 1,363,000 1,811,000 2,819,000 5,496,000
Depreciation and
amortization.......... 3,752,000 4,740,000 2,586,000 4,383,000 6,537,000 15,368,000
----------- ----------- ----------- ----------- ------------ ------------
Total operating
expenses.............. 69,587,000 81,809,000 44,877,000 71,245,000 108,177,000 224,118,000
----------- ----------- ----------- ----------- ------------ ------------
Operating income........ 10,883,000 17,159,000 8,716,000 18,466,000 26,666,000 48,829,000
Interest expense........ (56,000) (7,447,000) (3,378,000) (6,291,000) (10,117,000) (7,052,000)
Interest income......... 43,000 244,000 78,000 707,000 873,000 1,877,000
----------- ----------- ----------- ----------- ------------ ------------
Income before income
taxes, minority
interests and
extraordinary item.... 10,870,000 9,956,000 5,416,000 12,882,000 17,422,000 43,654,000
Income taxes............ 4,106,000 3,511,000 1,933,000 4,631,000 6,209,000 16,351,000
----------- ----------- ----------- ----------- ------------ ------------
Income before minority
interests and
extraordinary item.... 6,764,000 6,445,000 3,483,000 8,251,000 11,213,000 27,303,000
Minority interests in
income of consolidated
subsidiaries........... 1,046,000 1,593,000 833,000 1,784,000 2,544,000 3,578,000
----------- ----------- ----------- ----------- ------------ ------------
Income before
extraordinary item.... 5,718,000 4,852,000 2,650,000 6,467,000 8,669,000 23,725,000
Extraordinary loss
related to early
extinguishment of debt,
net of tax............. 2,555,000 2,555,000 7,700,000
----------- ----------- ----------- ----------- ------------ ------------
Net income.............. $ 5,718,000 $ 4,852,000 $ 2,650,000 $ 3,912,000 $ 6,114,000 $ 16,025,000
=========== =========== =========== =========== ============ ============
Earnings (loss) per
common share:
Income before
extraordinary item.... $ 0.36 $ 0.52 $ 0.92
Extraordinary items.... (0.14) (0.16) (0.30)
----------- ------------ ------------
Net income............. $ 0.22 $ 0.36 $ 0.62
=========== ============ ============
Weighted average number
of common shares and
equivalents
outstanding............ 17,824,000 16,794,000 25,793,000
=========== ============ ============
Pro forma data
(unaudited)............
Net income per common
share................. $ 0.22 $ 0.08
=========== ===========
Weighted average number
of common shares and
equivalents
outstanding........... 15,316,000 14,381,000
=========== ===========
See accompanying notes to consolidated financial statements.
F-4
TOTAL RENAL CARE HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
NOTES
COMMON STOCK ADDITIONAL RECEIVABLE RETAINED
------------------ PAID-IN FROM EARNINGS
SHARES AMOUNT CAPITAL STOCKHOLDERS (DEFICIT) TOTAL
Balance at May 31,
1993................... 66,667 $ 29,015,000 $ 29,015,000
Net income.............. 5,718,000 5,718,000
---------- ------------ ------------
Balance at May 31,
1994................... 66,667 34,733,000 34,733,000
Shares issued to Tenet.. 2,933,334 $ 3,000 $ 1,000 4,000
Shares issued in change
of control:
DLJMB.................. 7,000,000 7,000 10,493,000 10,500,000
Employees.............. 1,246,667 1,000 1,869,000 $ (995,000) 875,000
Shares issued in
offering............... 600,000 1,000 899,000 900,000
Stock issuance costs.... (2,172,000) (2,172,000)
Dividend paid to Tenet:
Cash................... (75,500,000) (75,500,000)
Intercompany
receivable............ (6,152,000) (6,152,000)
Shares issued to
employees and others... 765,252 1,000 1,147,000 (513,000) 635,000
Shares issued in
acquisitions........... 297,464 446,000 446,000
Net income.............. 4,852,000 4,852,000
---------- ------- ------------ ----------- ------------ ------------
Balance at May 31,
1995................... 12,909,384 13,000 12,683,000 (1,508,000) (42,067,000) (30,879,000)
Net proceeds from
initial public
offering............... 6,900,000 6,000 98,288,000 98,294,000
Shares and options
issued in
acquisitions........... 742,820 1,000 5,334,000 5,335,000
Shares issued to
employees and others... 27,670 59,000 (13,000) 46,000
Options exercised....... 1,046,666 1,000 1,565,000 (1,330,000) 236,000
Conversion of
mandatorily redeemable
common stock........... 681,667 1,000 3,989,000 3,990,000
Payments on notes
receivable, net of
interest accrued....... 78,000 78,000
Income tax benefit
related to stock
options exercised...... 1,792,000 1,792,000
Net income.............. 3,912,000 3,912,000
---------- ------- ------------ ----------- ------------ ------------
Balance at December 31,
1995................... 22,308,207 22,000 123,710,000 (2,773,000) (38,155,000) 82,804,000
Net proceeds from stock
offerings.............. 4,000,000 4,000 128,314,000 128,318,000
Shares issued in
acquisitions........... 96,657 2,810,000 2,810,000
Shares issued to
employees and others... 1,130 15,000 15,000
Options exercised....... 66,988 110,000 110,000
Interest accrued on
notes receivable, net
of payments............ (54,000) (54,000)
Income tax benefit
related to stock
options exercised...... 938,000 938,000
Net income.............. 16,025,000 16,025,000
---------- ------- ------------ ----------- ------------ ------------
Balance at December 31,
1996................... 26,472,982 $26,000 $255,897,000 $(2,827,000) $(22,130,000) $230,966,000
========== ======= ============ =========== ============ ============
See accompanying notes to consolidated financial statements.
F-5
TOTAL RENAL CARE HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
SEVEN MONTHS ENDED
YEAR ENDED MAY 31, DECEMBER 31, YEAR ENDED DECEMBER 31,
----------------------- ------------------------ -------------------------
1994 1995 1994 1995 1995 1996
(UNAUDITED) (UNAUDITED)
Cash flows from
operating activities
Net income............ $5,718,000 $ 4,852,000 $ 2,650,000 $ 3,912,000 $ 6,114,000 $ 16,025,000
Adjustments to
reconcile net income
to net cash provided
by operating
activities:
Depreciation and
amortization......... 3,752,000 4,740,000 2,586,000 4,383,000 6,537,000 15,368,000
Extraordinary item.... 4,258,000 4,258,000 12,623,000
Noncash interest...... 6,947,000 3,274,000 5,228,000 8,901,000 4,396,000
Deferred income
taxes................ 213,000 (716,000) 16,000 (469,000) (726,000) 667,000
Provision for doubtful
accounts............. 1,550,000 2,371,000 1,363,000 1,811,000 2,819,000 5,496,000
Loss (gain) on
disposition of
property and
equipment............ 98,000 (34,000) (144,000) (146,000) (20,000)
Minority interests in
income of
consolidated
subsidiaries......... 1,046,000 1,593,000 833,000 1,784,000 2,544,000 3,578,000
Changes in operating
assets and
liabilities, net of
effect of
acquisitions:
Accounts receivable.. (1,957,000) (9,547,000) (4,023,000) (15,256,000) (20,801,000) (32,939,000)
Inventories.......... (108,000) (122,000) (303,000) (331,000) (150,000) (1,976,000)
Prepaid expenses and
other current
assets.............. 109,000 (856,000) (261,000) (134,000) (532,000) (7,638,000)
Other long-term
assets.............. (300,000) (300,000)
Accounts payable..... 272,000 (536,000) 728,000 205,000 (968,000) (2,688,000)
Employee compensation
and benefits........ 445,000 1,994,000 2,000 (622,000) 1,090,000 4,995,000
Other accrued
liabilities......... 924,000 4,383,000 544,000 461,000 4,182,000 1,096,000
Income taxes
payable............. 465,000 277,000 (931,000) (314,000)
Other long-term
liabilities......... 107,000 1,214,000 916,000 (222,000)
---------- ----------- ----------- ----------- ----------- ------------
Net cash provided by
operating
activities......... 12,062,000 15,069,000 7,981,000 6,277,000 12,807,000 18,447,000
---------- ----------- ----------- ----------- ----------- ------------
Cash flow from
investing activities
Purchases of property
and equipment........ (4,380,000) (3,835,000) (860,000) (3,748,000) (6,880,000) (25,464,000)
Additions to
intangible assets.... (161,000) (358,000) (159,000) (972,000) (1,167,000) (7,530,000)
Cash paid for
acquisitions, net of
cash acquired........ (22,476,000) (5,722,000) (28,303,000) (45,056,000) (138,202,000)
Investment in
affiliate............ (972,000) (972,000) (46,000)
Issuance of long-term
notes receivable..... (1,379,000) (1,379,000) (540,000)
Proceeds from
disposition of
property and
equipment............ 82,000 62,000 28,000 244,000 273,000 236,000
Proceeds from
collection of notes
receivable........... 95,000
---------- ----------- ----------- ----------- ----------- ------------
Net cash used in
investing
activities......... (4,364,000) (26,607,000) (6,713,000) (35,130,000) (55,181,000) (171,546,000)
---------- ----------- ----------- ----------- ----------- ------------
Cash flows from
financing activities
Advances (to) from
Tenet................ (5,604,000) 2,874,000 3,499,000
Proceeds from issuance
of note payable...... 258,000 258,000 107,000
Principal payments on
long-term
obligations.......... (39,000) (367,000) (11,000) (880,000) (1,238,000) (918,000)
Cash dividends paid to
Tenet................ (75,500,000) (75,500,000)
Net proceeds from debt
offering............. 66,841,000 66,140,000
Cash paid to retire
bonds................ (31,912,000) (31,912,000) (68,499,000)
Proceeds from bank
credit facility...... 13,253,000 21,341,000 31,295,000 209,335,000
Payment of bank credit
facility............. (4,000,000) (31,625,000) (31,625,000) (124,335,000)
Net proceeds from
issuance of common
stock................ 10,742,000 10,810,000 98,941,000 98,965,000 128,443,000
Income tax benefit
related to stock
options exercised.... 1,792,000 1,792,000 938,000
Cash received on notes
receivable from
stockholders......... 175,000 175,000 170,000
Distributions to
minority interests... (819,000) (1,708,000) (723,000) (1,102,000) (2,087,000) (2,442,000)
---------- ----------- ----------- ----------- ----------- ------------
Net cash provided by
(used in) financing
activities......... (6,462,000) 12,135,000 4,215,000 56,988,000 65,623,000 142,799,000
---------- ----------- ----------- ----------- ----------- ------------
Net increase (decrease)
in cash............... 1,236,000 597,000 5,483,000 28,135,000 23,249,000 (10,300,000)
Cash and cash
equivalents at
beginning of period... 213,000 1,449,000 1,449,000 2,046,000 6,932,000 30,181,000
---------- ----------- ----------- ----------- ----------- ------------
Cash and cash
equivalents at end of
period................ $1,449,000 $ 2,046,000 $ 6,932,000 $30,181,000 $30,181,000 $ 19,881,000
========== =========== =========== =========== =========== ============
Supplemental cash flow information (Note 15)
See accompanying notes to consolidated financial statements.
F-6
TOTAL RENAL CARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Organization
Total Renal Care Holdings, Inc. (the Company) operates kidney dialysis
facilities and provides related medical services in Medicare certified
dialysis facilities in various geographic sectors of the United States and in
Guam.
The Company was a wholly owned subsidiary of Tenet Healthcare Corporation
("Tenet", formerly National Medical Enterprises, Inc.) until August 1994. In
August 1994, the Company completed a public offering of senior subordinated
notes and common stock, the proceeds of which were used to partially fund a
dividend to Tenet. Immediately after payment of the dividend, Donaldson,
Lufkin, Jenrette Merchant Banking Funding, Inc. and certain of its affiliates
(DLJMB) and certain members of management acquired newly issued common stock
of the Company to effect a change in control of the Company. Although there
was a change in control, the Company's accounts were not adjusted from their
historical bases due to the significant continuing ownership interest of
Tenet.
Basis of presentation
The consolidated financial statements include the accounts of Total Renal
Care Holdings, Inc. and its wholly-owned and majority-owned corporate
subsidiaries and partnership investments. All significant intercompany
transactions and balances have been eliminated in consolidation.
Net operating revenues
Revenues are recognized when services and related products are provided to
patients in need of ongoing life sustaining kidney dialysis treatments.
Operating revenues consist primarily of dialysis and ancillary fees from
patient treatments. These amounts are reported at the amounts expected to be
realized from governmental and third-party payors, patients and others for
services provided. Appropriate allowances are established based upon credit
risk of specific third-party payors, historical trends and other factors and
are reflected in the provision for doubtful accounts as a component of
operating expenses in the consolidated statements of income.
During the years ended May 31, 1994 and 1995, the seven months ended
December 31, 1995 and the year ended December 31, 1996, the Company received
approximately 75%, 70%, 67% and 67%, respectively, of its dialysis revenues
from Medicare and Medicaid programs. Accounts receivable from Medicare and
Medicaid amounted to $21,862,000 and $40,159,000 as of December 31, 1995, and
1996, respectively. Medicare historically pays approximately 80% of government
established rates for services provided by the Company. The remaining 20% is
typically paid by state Medicaid programs, private insurance companies or
directly by the patients receiving the services.
Medicare and Medicaid programs funded by the U.S. government generally
reimburse the Company under prospective payment systems at amounts different
from the Company's established private rates. Revenues under these programs
are generally recognized at prospective rates which are subject to periodic
adjustment by federal and state agencies. The Company bills non-governmental
third-party payors at established private rates. The Company has contracts for
the provision of dialysis services to members of certain managed care
organizations which generally include rate provisions at less than the
established private rates.
In August 1993, the provisions of the Omnibus Budget Reconciliation Act of
1993 ("OBRA 93") became effective. The OBRA 93 provisions were originally
interpreted by the Health Care Financing Administration (HCFA) to modify the
requirements that employer group health sponsored insurance plans (private
payors) be the primary payor for end-stage renal disease (ESRD) patients who
subsequently become dually entitled to
F-7
TOTAL RENAL CARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Medicare benefits because of ESRD following initial eligibility under age or
disability provisions. In July 1994, HCFA instructed the Medicare fiscal
intermediaries to retroactively apply the provisions of OBRA 93 to August 10,
1993. In April 1995, HCFA issued instructions of clarification to the fiscal
intermediaries that it had misinterpreted the OBRA regulations and that
Medicare would continue as the primary payor after dual eligibility was
achieved under the ESRD provision. In June 1995, a preliminary injunction was
issued by a federal court preventing HCFA from retroactively applying its
reinterpretation of the OBRA 93 regulations as unlawful retroactive rule-
making. The Company has recognized revenue related to payments which have been
received or are due from private payors in excess of the revenue previously
recognized at lower rates. For the seven months ended December 31, 1995 and
the year ended December 31, 1996 the Company recognized approximately $800,000
and $150,000, respectively, of such payments. The Company believes that there
are not any additional amounts that may be recoverable under the OBRA 93
provisions.
As a Medicare and Medicaid provider, the Company is subject to extensive
regulation by both the federal government and the states in which the Company
conducts its business. Due to heightened awareness of federal and state
budgets, scrutiny is being placed on the healthcare industry, potentially
subjecting the Company to regulatory investigation and changes in billing
procedures.
The provisions of the Kennedy-Kassebaum legislation issued January 1, 1997
may limit the Company's ability to pay for policy premiums for patients even
with proven financial hardship. However, the Company believes that the bill
did not intend to limit the Company's ability to pay premiums for insurance
coverage to third-party or governmental payors. Furthermore, the Company
believes that the bill may be amended to include provisions for the payment of
premiums on behalf of ESRD patients or to allow the Company to make grants to
a foundation that may provide for such premium payments on behalf of ESRD
patients.
Cash and cash equivalents
Cash equivalents are highly liquid investments with original maturities of
three months or less.
Inventories
Inventories are stated at the lower of cost (first-in, first-out) or market
and consist principally of drugs and dialysis related supplies.
Property and equipment
Property and equipment are stated at cost. Maintenance and repairs are
charged to expense as incurred. Depreciation and amortization expense are
computed using the straight-line method over the useful lives of the assets
estimated as follows: buildings, 20 to 40 years; leaseholds and improvements,
over the shorter of their estimated useful life or the lease term; and
equipment, 3 to 15 years.
Intangible assets
Business acquisition costs allocated to patient lists are amortized over
five to seven years using the straight-line method. Business acquisition costs
allocated to covenants not to compete are amortized over the terms of the
agreements, typically seven to ten years, using the straight-line method.
Deferred debt issuance costs are amortized over the term of the debt using the
effective interest method.
The excess of aggregate purchase price over the fair value of net assets of
businesses acquired is recorded as goodwill. Goodwill is amortized over 15 to
25 years using the straight-line method.
F-8
TOTAL RENAL CARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
The carrying value of intangible assets is assessed for any permanent
impairment by evaluating the operating performance and future undiscounted
cash flows from operations of the underlying businesses. Adjustments are made
if the sum of the expected future undiscounted net cash flows is less than
book value. Statement of Financial Accounting Standards No. 121, Accounting
for the Impairment of Long-Lived Assets and for Long-Lived Assets to be
Disposed of (SFAS 121), requires that long-lived assets be reviewed for
impairment whenever events or changes in circumstances indicate that the
carrying amount of assets may not be recoverable.
Income taxes
The Company accounts for income taxes using an asset and liability approach,
which requires recognition of deferred income taxes for all temporary
differences between the tax and financial reporting bases of the Company's
assets and liabilities based on enacted tax rates applicable to the periods in
which the differences are expected to be recovered or settled.
Following the change in control described above, the Company's results of
operations were no longer included in Tenet's consolidated federal and
applicable unitary state income tax returns. For financial reporting purposes,
the provision for income taxes for fiscal year 1994 and through August 11 of
the first quarter of fiscal year 1995 was calculated as if the Company filed
separate federal and state income tax returns.
Minority interests
Minority interests represent the proportionate equity interest of other
partners and stockholders in the Company's consolidated entities which are not
wholly owned. As of December 31, 1996, these included nineteen partnerships
and corporations.
Stock-based compensation
During the year ended December 31, 1996, the Company adopted the Statement
of Financial Accounting Standards No. 123, Accounting for Stock-Based
Compensation (SFAS 123). This pronouncement requires the Company to elect to
account for stock-based compensation on a fair value based model or an
intrinsic value based model. The intrinsic value based model is currently used
by the Company and is the accounting principle prescribed by Accounting
Principles Board No. 25, Accounting for Stock Issued to Employees (APB 25).
Under this model, compensation cost is the excess, if any, of the quoted
market price of the stock at the date of grant or other measurement date over
the amount an employee must pay to acquire the stock. The fair value based
model prescribed by SFAS 123 requires the Company to value stock-based
compensation using an accepted valuation model. Compensation cost is measured
at the grant date based on the value of the award and would be recognized over
the service period which is usually the vesting period. SFAS 123 requires the
Company to either reflect the results of the valuation in the consolidated
financial statements or alternatively continue to apply the provisions of APB
25 and make appropriate disclosure of the impact of such valuation in the
accompanying notes to consolidated financial statements.
The Company has elected to continue to apply the provisions of APB 25 to
their employee stock-based compensation plans and therefore has included the
required disclosure of the pro forma impact on net income and earnings per
share of the difference between compensation expense using the intrinsic value
method and the fair value method (see Note 9).
Earnings per share and unaudited pro forma net income per share
Earnings per share are calculated by dividing net income before
extraordinary item, the extraordinary loss and net income by the weighted
average number of shares of common stock outstanding. When dilutive, stock
options and warrants are included as share equivalents using the treasury
stock method.
F-9
TOTAL RENAL CARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Pro forma net income per share for the year ended May 31, 1995 has been
computed as if the August 11, 1994 recapitalization transaction described
above occurred on June 1, 1994 (Notes 7 and 9). Specifically, net income has
been decreased $1,551,000 to reflect an increase in general and administrative
expenses ($625,000) for estimated incremental costs of the Company as a stand-
alone entity, increases in interest expense ($1,811,000), amortization expense
($105,000) and bank fees ($42,000) for the issuance of the 12% senior
subordinated debt, and a corresponding decrease to the provision for income
taxes ($1,032,000) for the tax effect of the pro forma adjustments. Shares
issued as part of the recapitalization were also assumed to have been
outstanding from June 1, 1994.
During the period from October 1, 1994 to November 2, 1995, the Company
issued approximately 2,190,000 shares and options at prices significantly
below the assumed offering price of the Company's initial public offering (see
Note 9). Such shares and common stock equivalents have been included in the
number of shares outstanding from June 1, 1994 using the treasury stock method
and an offering price of $15.50 per share.
Earnings per share amounts are not presented for fiscal year 1994 as the
historical equity structure is not considered meaningful.
Interest rate swap agreement
The Company has entered into an interest rate swap agreement (Note 7) as a
means of managing its interest rate exposure. The Company has not entered this
agreement for trading or speculative purposes. This agreement has the effect
of converting the Company's line of credit obligation from a variable rate to
a fixed rate. Net amounts paid or received are reflected as adjustments to
interest expense. The counterparty to this agreement is a large international
financial institution. This interest rate swap agreement subjects the Company
to financial risk that will vary during the life of the agreement in relation
to the prevailing market interest rates. The Company is also exposed to credit
loss in the event of non-performance by this counterparty. However, the
Company does not anticipate non-performance by the other party, and no
material loss would be expected from non-performance by the counterparty.
Financial instruments
The Company's financial instruments consist primarily of cash, accounts
receivable, accounts payable, employee compensation and benefits, and other
accrued liabilities. These balances, as presented in the financial statements
at December 31, 1995 and 1996, approximate their fair value. The Company's
$400,000,000 credit facility, of which $85,000,000 was outstanding as of
December 31, 1996, reflects fair value as it is subject to fees and rates
competitively determined in the marketplace. The fair value of the interest
rate swap agreement is based on the present value of expected future cash
flows from the agreement and was in a net payable position of $66,000 at
December 31, 1996.
Use of estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Unaudited financial statements
In December 1995, the Company changed its year-end to December 31 from May
31. The information presented for the seven months ended December 31, 1994 and
the year ended December 31, 1995 has not been
F-10
TOTAL RENAL CARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
audited. In the opinion of management, the unaudited consolidated statements
of income and of cash flows include all adjustments consisting solely of
normal recurring adjustments necessary to present fairly the Company's
consolidated results of operations and cash flows for the seven months ended
December 31, 1994 and the year ended December 31, 1995.
Reclassifications
Certain prior year balances have been reclassified to conform to the current
year presentation.
2. PROPERTY AND EQUIPMENT
Property and equipment comprise the following:
DECEMBER 31,
--------------------------
1995 1996
Land.................... $ 309,000 $ 373,000
Buildings............... 4,072,000 3,978,000
Leaseholds and
improvements........... 12,211,000 25,463,000
Equipment............... 26,737,000 50,174,000
Construction in
progress............... 2,097,000 4,638,000
------------ ------------
45,426,000 84,626,000
Less accumulated
depreciation and
amortization........... (19,921,000) (26,360,000)
------------ ------------
Net property and
equipment.............. $ 25,505,000 $ 58,266,000
============ ============
Depreciation and amortization expense on property and equipment was
$2,961,000, $3,163,000, $2,326,000 and $7,302,000 for the years ended May 31,
1994 and 1995, the seven months ended December 31, 1995, and the year ended
December 31, 1996, respectively.
3. INTANGIBLE ASSETS
A summary of intangible assets is as follows:
DECEMBER 31,
-------------------------
1995 1996
Goodwill.......................................... $46,791,000 $152,122,000
Patient lists..................................... 6,505,000 12,765,000
Noncompetition agreements......................... 10,005,000 22,978,000
Deferred debt issuance costs...................... 3,324,000 4,488,000
Other............................................. 491,000 1,108,000
----------- ------------
67,116,000 193,461,000
Less accumulated amortization..................... (7,353,000) (12,844,000)
----------- ------------
$59,763,000 $180,617,000
=========== ============
Amortization expense applicable to intangible assets was $791,000,
$1,577,000, $2,057,000 and $8,066,000 for the years ended May 31, 1994 and
1995, the seven months ended December 31, 1995, and the year ended December
31, 1996, respectively.
F-11
TOTAL RENAL CARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
4. PREPAID EXPENSE AND OTHER CURRENT ASSETS
Prepaid expense and other current assets comprise the following:
DECEMBER 31,
----------------------
1995 1996
Supplier rebates and other non-trade receivables.... $2,130,000 $ 6,424,000
Prepaid income taxes................................ 2,708,000
Prepaid expenses.................................... 727,000 1,504,000
Deposits............................................ 116,000 135,000
---------- -----------
$2,973,000 $10,771,000
========== ===========
5. OTHER ACCRUED LIABILITIES
Other accrued liabilities comprise the following:
DECEMBER 31,
----------------------
1995 1996
Customer refunds.................................... $4,981,000 $ 6,068,000
Payable to former owners of acquired facility (Note
14)................................................ 1,243,000 263,000
Other............................................... 782,000 1,414,000
---------- -----------
$7,006,000 $ 7,745,000
========== ===========
6. INCOME TAXES
The provision for income taxes consists of the following:
SEVEN MONTHS
YEAR ENDED MAY 31, ENDED YEAR ENDED
--------------------- DECEMBER 31, DECEMBER 31,
1994 1995 1995 1996
Current
Federal................... $3,084,000 $3,275,000 $3,708,000 $12,803,000
State..................... 809,000 952,000 954,000 2,881,000
Deferred
Federal................... 170,000 (555,000) 9,000 544,000
State..................... 43,000 (161,000) (40,000) 123,000
---------- ---------- ---------- -----------
$4,106,000 $3,511,000 $4,631,000 $16,351,000
========== ========== ========== ===========
F-12
TOTAL RENAL CARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Temporary differences which give rise to deferred tax assets and liabilities
are as follows:
DECEMBER 31,
------------------------
1995 1996
Receivables, primarily allowance for doubtful
accounts....................................... $ 1,653,000 $ 2,724,000
Accrued vacation................................ 459,000 831,000
Intangible assets............................... 325,000
Deferred compensation........................... 117,000 107,000
----------- -----------
Gross deferred tax assets..................... 2,554,000 3,662,000
----------- -----------
Depreciation and amortization................... (952,000) (1,811,000)
Intangible assets............................... (1,173,000)
Change in tax accounting method................. (570,000) (313,000)
----------- -----------
Gross deferred tax liabilities................ (1,522,000) (3,297,000)
----------- -----------
Net deferred tax assets....................... $ 1,032,000 $ 365,000
=========== ===========
The reconciliation between the Company's effective tax rate and the U.S.
federal income tax rate on income is as follows:
YEAR ENDED SEVEN MONTHS
MAY 31, ENDED YEAR ENDED
------------- DECEMBER 31, DECEMBER 31,
1994 1995 1995 1996
Federal income tax rate.......... 34.0% 34.0% 35.0% 35.0%
State taxes, net of federal
benefit......................... 5.7% 5.9% 5.3% 4.7%
Nondeductible amortization of
intangible assets............... 0.7% 1.1% 1.1% 0.8%
Other............................ 0.1% 0.2% 0.1% 0.1%
----- ----- ---- ----
Effective tax rate............... 40.5% 41.2% 41.5% 40.6%
Minority interests in
partnerships.................... (2.7%) (5.9%) (5.5%) (3.1%)
----- ----- ---- ----
Effective tax rate before
minority interests.............. 37.8% 35.3% 36.0% 37.5%
===== ===== ==== ====
7. LONG-TERM DEBT
Long-term debt comprises:
DECEMBER 31,
-------------------------
1995 1996
12% Senior Subordinated Discount Notes (net of
unamortized discount of $11,180,000).......... $53,820,000
TRCH Credit Facility........................... $ 85,000,000
Acquisition obligations........................ 15,886,000
Capital lease obligations (Note 8)............. 1,680,000 3,122,000
Other.......................................... 394,000 608,000
----------- ------------
55,894,000 104,616,000
Less current portion........................... (570,000) (2,064,000)
----------- ------------
$55,324,000 $102,552,000
=========== ============
F-13
TOTAL RENAL CARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
12% Senior Subordinated Discount Notes
In August 1994, the Company completed a public offering consisting of units
of 12% Senior Subordinated Discount Notes (the Notes) and common stock.
Aggregate proceeds from the offering were $71,294,000, of which $900,000 was
allocated to the common stock, based upon the estimated value of the stock,
and the remaining $70,394,000 to the Notes. The Notes had a stated maturity of
August 15, 2004 and would begin accruing cash interest commencing on February
15, 1998, at a rate of 12% per annum. Prior to February 15, 1998, interest was
paid in kind through amortization of the discount. The discount was amortized
using the effective interest rate of 12.39%.
On December 7, 1995, the Company redeemed 35% of the accreted value of the
Notes equaling $28,749,000 at a redemption premium of 111% for a total
redemption price of $31,912,000. An extraordinary loss on the early
extinguishment of debt of $4,258,000, net of income tax effect of $1,703,000,
was recorded during the seven months ended December 31, 1995. In July and
September 1996, the Company retired the remaining 65% of the outstanding Notes
for $68,499,000, including consent payments of $1,100,000. An extraordinary
loss on the early extinguishment of debt of $12,623,000, net of income tax
effect of $4,923,000, was recorded in the year ended December 31, 1996.
TRCH Credit Facility
Effective October 17, 1996, the Company refinanced its existing credit
facility with the same lender to permit borrowings of up to $400,000,000 (the
"TRCH Credit Facility"). Under the TRCH Credit Facility, up to $50,000,000 may
be used in connection with letters of credit, and up to $15,000,000 in short-
term funds may be borrowed the same day notice is given to the banks under a
"Swing Line" facility. In general, borrowings under the TRCH Credit Facility
bear interest at one of two floating rates selected by the Company: (i) the
Alternate Base Rate (defined as the higher of The Bank of New York's prime
rate or the federal funds rate plus 0.5%); and (ii) Adjusted LIBOR (defined as
the 30-, 60-, 90- or 180-day London Interbank Offered Rate, adjusted for
statutory reserves) plus a margin that ranges from 0.45% to 1.25% depending on
the Company's leverage ratio. Swing Line borrowings bear interest at either a
rate negotiated by the Company and the banks at the time of borrowing or, if
no rate is negotiated and agreed, the Alternate Base Rate.
Maximum borrowings under the TRCH Credit Facility will be reduced by
$50,000,000 on September 30, 2000, $75,000,000 on September 30, 2001, and
another $75,000,000 on September 30, 2002, and the TRCH Credit Facility
terminates on September 30, 2003. The TRCH Credit Facility contains financial
and operating covenants including, among other things, requirements that the
Company maintain certain financial ratios and satisfy certain financial tests,
and imposes limitations on the Company's ability to make capital expenditures,
to incur other indebtedness and to pay dividends. As of the date hereof, the
Company is in compliance with all such covenants.
The Company and Total Renal Care, Inc. ("TRC"), the Company's sole operating
subsidiary, have guaranteed the Company's obligations under the TRCH Credit
Facility on a senior basis.
Interest Rate Swap Agreement
On November 25, 1996, the Company entered into a seven year interest rate
swap agreement involving the exchange of fixed and floating interest payment
obligations without the exchange of the underlying principal amounts. At
December 31, 1996 the total notional principal amount of this interest rate
swap agreement was $85,000,000 and the effective interest rate thereon was
7.07%. The Company has committed to increase the notional amount of the
interest rate swap agreement to $100,000,000 on February 25, 1997.
F-14
TOTAL RENAL CARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Acquisition Obligations
In conjunction with certain facility acquisitions, the Company has issued
three letters of credit which are outstanding as of December 31, 1996 in the
aggregate amount of $15,886,000. Two of these will be released on April 1,
1997. The remaining letter of credit of $3,000,000 will be released to the
seller in three annual principal installments of $1,000,000 commencing January
1997. The Company has also agreed to pay the seller interest at 6.5% on the
outstanding principal.
Maturities of long-term debt for the years ending December 31 are as
follows:
1997......................................... $ 2,064,000
1998......................................... 1,953,000
1999......................................... 1,826,000
2000......................................... 529,000
2001......................................... 243,000
Thereafter................................... 98,001,000
8. LEASES
The Company leases the majority of its facilities under noncancelable
operating leases expiring in various years through 2006. Most lease agreements
cover periods from five to ten years and contain renewal options of five to
ten years at the fair rental value at the time of renewal or at rates subject
to consumer price index increases since the inception of the lease. In the
normal course of business, operating leases are generally renewed or replaced
by other similar leases.
Future minimum lease payments under noncancelable operating leases for the
years ending December 31 are as follows:
1997......................................... $10,456,000
1998......................................... 9,126,000
1999......................................... 8,292,000
2000......................................... 6,785,000
2001......................................... 5,130,000
Thereafter................................... 19,202,000
-----------
Total minimum lease payments................. $58,991,000
===========
Rental expense under all operating leases for the years ended May 31, 1994
and 1995, the seven months ended December 31, 1995 and the year ended December
31, 1996 amounted to $3,016,000, $3,323,000, $2,644,000 and $9,054,000,
respectively.
F-15
TOTAL RENAL CARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
The Company also leases certain equipment under capital lease agreements.
Future minimum lease payments under capital leases for the years ending
December 31 are as follows:
1997......................................... $1,085,000
1998......................................... 978,000
1999......................................... 824,000
2000......................................... 568,000
2001......................................... 252,000
----------
3,707,000
Less--Portion representing interest.......... 585,000
----------
Total capital lease obligation, including
current portion of $807,000................. $3,122,000
==========
The net book value of fixed assets under capital lease was $1,652,000 and
$1,858,000 at December 31, 1995 and 1996, respectively. Capital lease
obligations are included in long-term debt (Note 7).
9. STOCKHOLDERS' EQUITY
Public offerings of common stock
On November 3, 1995, the Company completed an initial public offering of its
common stock at an offering price of $15.50 per share. The Company received
net proceeds of $98,294,000 after the deduction of underwriting discounts and
commissions and other expenses. The Company used net proceeds of $31,912,000
to redeem 35% of the Notes and $31,000,000 to repay all then outstanding
borrowings on the TRCH Credit Facility (Note 7). The remainder of the proceeds
was used for general corporate purposes, acquisitions, de novo facility
developments and other capital expenditures.
On April 3, 1996 and October 31, 1996 the Company completed equity offerings
of 8,050,000 and 2,500,000 shares of common stock, respectively; 3,500,000 and
500,000, respectively, of which were sold for the Company's account and
4,550,000 and 2,000,000 respectively, of which were sold by certain of the
Company's stockholders. The net proceeds received by the Company of
$109,968,000 and $18,350,000, respectively, were used to repay borrowings
incurred under the TRCH Credit Facility in connection with acquisitions, to
repurchase and subsequently retire its remaining outstanding Discount Notes
(Note 7), to finance other acquisitions and de novo developments and for
working capital and other corporate purposes.
Change in shares and stock split
In July 1994, the Company's Certificate of Incorporation was amended to
increase the number of authorized shares of common stock from 1,000 shares to
35,000,000 shares and to reduce the par value of such stock from $1.00 per
share to $.001 per share. Concurrent with this change, the Board of Directors
approved a 1,000-for-1 stock split. Shares held by Tenet were the only shares
affected by this action. Following the split, Tenet purchased an additional
2,933,334 shares of common stock for $4,400.
During October 1995 the Company's directors authorized an increase in the
authorized number of shares of common stock to 55,000,000, authorized
5,000,000 new shares of $.001 par value preferred stock, and approved a three-
into-two reverse stock split of the Company's common stock. All information in
these consolidated financial statements pertaining to shares of common stock
and per share amounts have been restated to retroactively reflect the stock
splits.
F-16
TOTAL RENAL CARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Dividends
Immediately following the public debt offering in August 1994 (Note 7), the
Company paid Tenet a dividend totaling $81,652,000. The dividend comprised
$75,500,000 in cash and $6,152,000 in the forgiveness of Tenet's intercompany
balance due the Company. Subsequently, the Company has not made, nor is it
intending to make, dividends to its stockholders.
Stock-Based Compensation Plans
At December 31, 1996, the Company has three stock-based compensation plans,
which are described below.
1994 Stock Plan. In August 1994, the Company established the Total Renal
Care Holdings, Inc. 1994 Equity Compensation Plan (the 1994 Stock Plan) which
provides for awards of nonqualified stock options to purchase common stock and
other rights to purchase shares of common stock to certain employees,
directors, consultants and facility medical directors of the Company.
Under terms of the 1994 Stock Plan, the Company may grant awards for up to
four million shares of common stock. Original options granted generally vest
on the ninth anniversary of the date of grant, subject to accelerated vesting
in the event the Company meets certain performance criteria. In April 1996,
the Company changed the vesting schedule for new options granted so that
options vest over four years from the date of grant. The exercise price of
each option equals the market price of the Company's stock on the date of
grant, and an option's maximum term is ten years.
Purchase rights to acquire 788,670 common shares for $1.50-$6.00 per share
have been awarded to certain employees under the 1994 Stock Plan, the majority
of which were granted in connection with the change in control. All such
rights were exercised and the Company received notes for the uncollected
portion of the purchase proceeds. The notes bear interest at the lesser of The
Bank of New York's prime rate or 8%, are full recourse to the employees, and
are secured by the employees' stock. The notes are repayable four years from
the date of issuance, subject to certain prepayment requirements. At December
31, 1995 and 1996, the outstanding notes plus accrued interest totaled
$378,000 and $227,000, respectively.
During the year ended May 31, 1995, 886,667 of the options issued to
purchase common stock were issued to the Company's President. These options
originally vested 50% over four years and 50% in the same manner as other
options granted under the 1994 Stock Plan. In September 1995, the Board of
Directors and stockholders agreed to accelerate the Company's President's
vesting period and all of the options became 100% vested. Pursuant to this
action, the Company's President exercised all of the stock options through
issuance of a full recourse note of $1,330,000 bearing interest at the lesser
of prime or 8%. Additionally, the Company's President executed a full recourse
note for $1,349,000 bearing interest at the lesser of prime or 8% per annum to
meet his tax liability in connection with the stock option exercise. In April
1996, this note was increased by an additional $173,000. These notes are
secured by other shares of company stock and mature in September 1999 or upon
disposition of the common stock by the Company's President.
The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option-pricing model with the following assumptions used for
grants for the seven months ended December 31, 1995 and year ended December
31, 1996, respectively: dividend yield of 0 percent for both periods; expected
volatility of 35.8 to 41.8 percent and 35.5 to 36.7 percent; risk-free
interest rates of 5.5 to 7.1 percent and 6.2 to 6.7 percent and expected lives
of 6 years for both periods.
F-17
TOTAL RENAL CARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
A summary of the status of the 1994 Stock Plan as of and for the seven
months ended December 31, 1995 and year ended December 31, 1996, is presented
below:
SEVEN MONTHS ENDED YEAR ENDED
DECEMBER 31, 1995 DECEMBER 31, 1996
----------------------------- -----------------------------
WEIGHTED AVERAGE WEIGHTED AVERAGE
OPTIONS EXERCISE PRICE OPTIONS EXERCISE PRICE
Outstanding at beginning
of period.............. 1,718,334 $1.50 865,011 $ 3.18
Granted................. 193,343 9.02 1,091,348 37.13
Exercised............... (1,046,666) 1.50 (66,988) 1.53
Forfeited............... (18,334) 4.05
----------- ----- ---------- ------
Outstanding at end of
year................... 865,011 $3.18 1,871,037 $23.03
=========== ===== ========== ======
Options exercisable at
year-end............... 211,113 397,804
Weighted-average fair
value of options
granted during the
year................... $ 5.29 $ 17.54
The following table summarizes information about fixed stock options
outstanding at December 31, 1996:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
----------------------------------------- ------------------------
WEIGHTED-AVERAGE WEIGHTED- WEIGHTED-
RANGE OF EXERCISE REMAINING AVERAGE AVERAGE EXERCISE
PRICES OPTIONS CONTRACTUAL LIFE EXERCISE PRICE OPTIONS PRICE
$1.50 648,641 7.9 years $ 1.50 301,830 $ 1.50
$ 6.00-
$20.50 106,044 8.7 years 8.85 63,527 8.84
$26.25-
$29.88 177,174 9.1 years 28.94 30,850 28.54
$30.00-
$41.88 939,178 9.5 years 38.39 1,597 30.60
------- --------- --------- ------ ------- ------
$ 1.50-
$41.88 1,871,037 8.8 years $23.03 397,804 $ 4.89
======= ========= ========= ====== ======= ======
Stock Purchase Plan. In November 1995, the Company established the Total
Renal Care Holdings, Inc. Employees Stock Purchase Plan (the Stock Purchase
Plan) which entitles qualifying employees to purchase up to $25,000 of common
stock during each calendar year. The amounts used to purchase stock are
typically accumulated through payroll withholdings and through an optional
lump sum payment made in advance of the first day of the Plan. The Stock
Purchase Plan allows employees to purchase stock for the lesser of 100% of the
fair market value on the first day of the purchase right period or 85% of the
fair market value on the last day of the purchase right period. Except for the
initial purchase right period, which began on November 3, 1995 (the date of
completion of the initial public offering, and ended on December 31, 1996),
each purchase right period begins on January 1 or July 1, as selected by the
employee and ends on December 31. Payroll withholdings related to the Stock
Purchase Plan, included in accrued employee compensation and benefits, were
$411,000 and $1,790,000 at December 31, 1995 and 1996, respectively.
Subsequent to December 31, 1996, 104,865 shares were issued to satisfy the
Company's obligations under the Plan.
The fair value of the employees' purchase rights was estimated on the date
of grant using the Black-Scholes model with the following assumptions for
grants on November 3, 1995 and July 1, 1996, respectively: dividend yield of 0
percent for both periods; expected volatility of 36.6 percent for both
periods; risk-free interest rate of 5.5 and 6.6 percent and expected lives of
1.2 and 0.5 years. Using these assumptions, the weighted-average fair value of
those purchase rights granted on November 3, 1995 and July 1, 1996 is $2.86
and $7.37, respectively.
1995 Stock Plan. In November 1995, the Company established the Total Renal
Care Holdings, Inc. 1995 Equity Incentive Plan (1995 Stock Plan) which
provides awards of stock options and the issuance of common shares subject to
certain restrictions to certain employees, directors and other individuals
providing services to
F-18
TOTAL RENAL CARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
the Company. There are 1,000,000 common shares reserved for issuance under the
1995 Stock Plan. No shares or options have been issued as of December 31, 1995
and 1996.
Pro forma net income and earnings per share. The Company applied APB Opinion
No. 25 and related interpretations in accounting for all of its plans.
Accordingly, no compensation cost has been recognized for its fixed stock
option plans and its stock purchase plan. Had compensation cost for the
Company's stock-based compensation plans been determined consistent with SFAS
123, the Company's net income and earnings per share would have been reduced
to the pro forma amounts indicated below:
SEVEN MONTHS
ENDED YEAR ENDED
DECEMBER 31, DECEMBER 31,
1995 1996
Income before extraordinary item................ $ 6,159,000 $20,480,000
Extraordinary loss related to early
extinguishment of debt, net of tax............. 2,555,000 7,700,000
----------- -----------
Net income.................................... $ 3,604,000 $12,780,000
=========== ===========
Primary earnings (loss) per common share:
Income before extraordinary item.............. $ .36 $ .82
Extraordinary item............................ (.15) (.31)
----------- -----------
Net income.................................... $ .21 $ .51
=========== ===========
Weighted average number of common shares and
equivalents.................................... 16,900,000 25,017,000
=========== ===========
Stock issued to employees outside of plans
In connection with the change in control, the Company awarded its Chief
Executive Officer and Chief Operating Officer rights to purchase 1,113,333 and
133,333 common shares, respectively, at a purchase price of $1.50 per share.
These rights were awarded outside of the 1994 Stock Plan in connection with
the respective employment agreements. All such purchase rights were made and
the Company received notes totaling $935,000 for the uncollected portion of
the purchase proceeds. The notes bear terms similar to those issued in
connection with the 1994 Stock Plan.
10. MANDATORILY REDEEMABLE COMMON STOCK
Of the shares of common stock issued in connection with the acquisitions
(Note 14), 1,215,000 included a put option to require the Company to
repurchase the shares in May 2000 at stipulated amounts. The put options
expired upon completion of the Company's initial public offering of common
stock in November, 1995. All of these shares were converted into common stock
during the year ended December 31, 1995.
11. TRANSACTIONS WITH RELATED PARTIES
Tenet
Prior to August 1994, the Company maintained an intercompany
payable/receivable account with Tenet to fund operating cash requirements or
to concentrate excess cash at Tenet for investment purposes. The Company was
charged interest on balances payable to Tenet; however, interest was not
earned on receivable balances. No such interest was incurred subsequent to
August 1994.
The Company was charged an overhead allocation for services rendered on its
behalf by Tenet. For the year ended May 31, 1994, the charge of $1,458,000 was
based on a ratio of the Company's operating costs to total
F-19
TOTAL RENAL CARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Tenet consolidated operating costs through February 28, 1994. There were no
overhead costs charged after February 28, 1994. These amounts have been
included in general and administrative expenses.
The Company also provides dialysis services to Tenet hospital patients under
agreements with terms of one to three years. The contract terms are comparable
to contracts with unrelated third parties. Included in the receivable from
Tenet are amounts related to these services of $432,000 and $347,000 at
December 31, 1995 and 1996, respectively. Net operating revenues received from
Tenet for these services were $2,248,000, $2,130,000, $1,332,000 and
$2,260,000 for the years ended May 31, 1994 and 1995, the seven months ended
December 31, 1995, and the year ended December 31, 1996, respectively.
Prior to October 1994, company employees were eligible to participate in the
Tenet Retirement Savings Plan, a defined contribution retirement plan,
covering substantially all full-time employees, whereby employees'
contributions to the plan were matched by the Company up to certain limits.
Defined contributions made by the Company for the years ended May 31, 1994 and
1995 amounted to $411,000 and $152,000, respectively.
Prior to December 1994, the Company was insured for employee health coverage
and a substantial portion of workers' compensation through self-insurance
programs administered by Tenet. Additionally, all professional and general
liability risks were insured by a wholly owned subsidiary of Tenet. The
Company has no liability for employee health coverage claims incurred prior to
December 31, 1994 or workers' compensation claims prior to August 11, 1994.
Insurance expense under these programs amounted to $2,962,000 and $1,409,000
for years ended May 31, 1994 and 1995, respectively.
DLJMB
An affiliate of DLJMB was the underwriter for public debt offering of units,
comprising Senior Subordinated Discount Notes and common stock, and DLJMB
participated in the change in control transaction in which DLJMB and certain
employees acquired 74% of the Company. Fees for these transactions were
$2,496,000 and $1,160,000, respectively. During the year ended December 31,
1995 and 1996 an affiliate of DLJMB also was one of several underwriters for
the initial public offering of common stock as well as the two additional
public stock offerings in which the Company issued 6,900,000, 7,000,000 and
500,000 shares, respectively. Fees for these transactions to DLJMB or its
affiliates were $7,245,000, $5,075,000, and $780,000, respectively.
12. EMPLOYEE BENEFIT PLAN
The Company has a savings plan (the Plan) for substantially all employees,
which has been established pursuant to the provisions of Section 401(k) of the
Internal Revenue Code (IRC). The Plan provides for employees to contribute
from 1% to 15% of their base annual salaries on a tax-deferred basis not to
exceed IRC limitations. The Company, in its sole discretion, may make a
contribution under the Plan each fiscal year as determined by the Board of
Directors. This contribution was allocated for the year ended May 31, 1995 to
each participant not eligible for participation in the 1994 Stock Plan (Note
9) in proportion to the compensation paid during the year and the length of
employment for each of the participants. For the year ended May 31, 1995, the
Company accrued contributions under the Plan in the amount of $200,000. The
Company did not make any contributions subsequent to May 31, 1995.
13. CONTINGENCIES
The Company's laboratory subsidiary is presently the subject of a third-
party carrier review. The carrier has requested certain medical and billing
records; however, the exact nature and scope of this review is uncertain at
this time.
The Company is subject to various claims and lawsuits in the ordinary course
of business. In the opinion of management, the ultimate resolution of these
matters will not have a material adverse effect on the Company's financial
condition, results of operations or cash flows.
F-20
TOTAL RENAL CARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
During the year ended December 31, 1996 an acquisition of two facilities
contained a contingent purchase price of up to $1,200,000, contingent upon the
operating performance of the related facilities through March 31, 1997. As of
December 31, 1996, no additional consideration is due under this arrangement.
14. ACQUISITIONS
Beginning in August 1994, the Company implemented an acquisition strategy
which resulted in the acquisition of eighty-four facilities providing services
to ESRD patients, seven programs providing acute hospital in-patient dialysis
services and two laboratories. In addition, during this period the Company
developed thirteen de novo facilities, entered into a management contract
covering an additional two unaffiliated facilities, and purchased the minority
interest at one of its existing facilities. The following is a summary of
acquisitions activity:
SEVEN MONTHS
YEAR ENDED ENDED YEAR ENDED
MAY 31, DECEMBER 31, DECEMBER 31,
1995 1995 1996
Number of facilities acquired........... 15 12 57
Number of common shares issued.......... 297,464 742,820 61,587
Numbers of mandatorily redeemable shares
issued................................. 681,667
Number of common stock options issued... 40,000
Estimated fair value of common shares
issued................................. $ 446,000 $ 5,284,000 $ 1,830,000
Estimated fair value of mandatorily
redeemable shares issued............... 3,990,000
Estimated fair value of common stock
options issued......................... 51,000
Payable to former owners of acquired
facility............................... 1,243,000
Acquisition obligations (Note 7)........ 15,886,000
Cash paid............................... 23,007,000 28,303,000 138,202,000
----------- ----------- ------------
Aggregate purchase price................ $27,443,000 $34,881,000 $155,918,000
=========== =========== ============
F-21
TOTAL RENAL CARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
All of the acquisitions were accounted for as purchases and, accordingly,
the assets and liabilities of the acquired entities were recorded at their
estimated fair market values at the dates of acquisition. The initial
allocation of fair market value are preliminary and are subject to adjustment
during the first year following the acquisition. The results of operations of
the facilities and laboratories have been included in the Company's financial
statements from their respective acquisition dates. These initial allocations
were as follows:
SEVEN MONTHS
YEAR ENDED ENDED YEAR ENDED
MAY 31, DECEMBER 31, DECEMBER 31,
1995 1995 1996
Identified intangibles.............. $ 4,807,000 $ 8,063,000 $ 20,695,000
Goodwill............................ 18,782,000 24,700,000 102,608,000
Tangible assets..................... 6,845,000 6,798,000 41,100,000
Liabilities assumed................. (2,991,000) (4,680,000) (8,485,000)
----------- ----------- ------------
Total purchase price.............. $27,443,000 $34,881,000 $155,918,000
=========== =========== ============
The Company committed to issue 35,070 shares of common stock and $263,000 of
cash in connection with an acquisition that closed during December 1995. The
shares were not issued until February 1996 and, accordingly, are not reported
as outstanding at December 31, 1995. A liability of $1,243,000 for these
shares and cash is reflected in other liabilities at December 31, 1995.
The following summary, prepared on a pro forma basis, combines the results
of operations as if the acquisitions had been consummated as of the beginning
of each of the periods presented, after including the impact of certain
adjustments such as amortization of intangibles, interest expense on
acquisition financing and income tax effects. Pro forma unaudited net income
per share also gives effect to the August 11, 1994 recapitalization
transaction as if it had occurred on June 1, 1994 as further described in Note
1:
SEVEN MONTHS
YEAR ENDED ENDED YEAR ENDED
MAY 31, DECEMBER 31, DECEMBER 31,
1995 1995 1996
(UNAUDITED) (UNAUDITED) (UNAUDITED)
Net revenues........................ $206,753,000 $154,518,000 $318,211,000
Net income before extraordinary
items.............................. $ 25,755,000 $ 14,295,000 $ 28,665,000
Pro forma net income per share
before extraordinary items......... $ 0.64 $ 0.60 $ 1.11
The unaudited pro forma results are not necessarily indicative of what
actually would have occurred if the acquisitions had been completed prior to
the beginning of the periods presented. In addition, they are not intended to
be a projection of future results and do not reflect any of the synergies,
additional revenue-generating services or direct facility operating expense
reduction that might be achieved from combined operations.
Subsequent to December 31, 1996, the Company entered into three agreements
to acquire additional facilities of which two have been consummated and one is
expected to close imminently. The aggregate purchase price is approximately
$48,100,000. The composition of the final purchase price is expected to be
cash and proceeds from the TRCH Credit Facility, however, a portion of the
purchase price may consist of issuance of the Company's common stock. The
Company is actively pursuing additional acquisitions on which letters of
intent had not been signed as of the date of these financial statements.
F-22
TOTAL RENAL CARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
15. SUPPLEMENTAL CASH FLOW INFORMATION
The table below provides supplemental cash flow information:
SEVEN MONTHS
YEAR ENDED MAY 31, ENDED YEAR ENDED
--------------------- DECEMBER 31 DECEMBER 31,
1994 1995 1995 1996
Cash paid for:
Income taxes.............. $4,821,000 $4,112,000 $ 957,000 $12,871,000
Interest.................. 32,000 256,000 1,063,000 2,120,000
Noncash investing and
financing activities:
Notes receivable for
issuance of common
stock.................... 1,508,000 1,330,000
Dividend of Tenet
intercompany receivable.. 6,152,000
Estimated value of stock
and options issued in
acquisitions............. 4,436,000 5,335,000 2,810,000
Fixed assets acquired
under capital lease
obligations.............. 1,483,000 1,117,000
Contribution to
partnerships............. 1,111,000 943,000
16. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
Summary unaudited quarterly financial data for the year ended December 31,
1995 has been restated from the Company's filings on Form 10-Q to reflect the
calendar quarters due to the change in fiscal year-end (in thousands, except
per share amounts).
MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31, MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31,
1995 1995 1995 1995 1996 1996 1996 1996
Net operating revenues.. $25,469 $30,732 $37,415 $41,335 $50,237 $64,583 $73,333 $84,794
Operating income........ 4,286 6,356 7,776 8,356 9,551 11,556 13,126 14,596
Income before
extraordinary item..... 1,001 1,898 2,485 3,285 4,276 5,726 6,536 7,187
Net income (loss)....... 1,001 1,898 2,485 730 4,276 5,726 (1,164) 7,187
Income before
extraordinary item per
share.................. 0.07 0.12 0.16 0.16 0.19 0.22 0.25 0.27
Net income (loss) per
share (Note 7)......... 0.07 0.12 0.16 0.04 0.19 0.22 (0.04) 0.27
F-23
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this Report on Form 10-K
to be signed on its behalf by the undersigned, thereunto duly authorized in
the City of Torrance, State of California, on the 10th day of March, 1997.
TOTAL RENAL CARE HOLDINGS, INC.
/s/ Victor M.G. Chaltiel
By __________________________________
Victor M.G. Chaltiel
Chairman of the Board,
Chief Executive Officer,
President and Director
KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears
below constitutes and appoints Victor M.G. Chaltiel, Barry C. Cosgrove and
John E. King, and each of them his true and lawful attorneys-in-fact and
agents with full power of substitution and resubstitution, for him and in his
name, place and stead, in any and all capacities, to sign any and all
amendments to this Report on Form 10-K, and to file the same, with all
exhibits thereto, and other documents in connection therewith, with the
Securities and Exchange Commission, granting unto said attorney-in-fact and
agents, and each of them, full power and authority to do and perform each and
every act and thing requisite or necessary to be done in and about the
premises, as fully to all intents and purposes as he might or could do in
person, hereby ratifying and confirming all that said attorneys-in-fact and
agents or any of them, or their or his substitute or substitutes, may lawfully
do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this
Report on Form 10-K has been signed by the following persons on behalf of the
Registrant in the capacities and on the dates indicated.
SIGNATURE TITLE DATE
/s/ Victor M.G. Chaltiel Chairman of the Board, March 10,
_______________________________ Chief Executive Officer, 1997
Victor M.G. Chaltiel President and Director
(Principal Executive
Officer)
/s/ John E. King Vice President and Chief March 10,
_______________________________ Financial Officer 1997
John E. King (Principal Financial
Officer and Principal
Accounting Officer)
/s/ Maris Andersons Director March 10,
_______________________________ 1997
Maris Andersons
/s/ Peter T. Grauer Director March 10,
_______________________________ 1997
Peter T. Grauer
/s/ Marsha M. Plotnitsky Director March 10,
_______________________________ 1997
Marsha M. Plotnitsky
/s/ David B. Wilson Director March 10,
_______________________________ 1997
David B. Wilson
II-1
REPORT OF INDEPENDENT ACCOUNTANTS ON
FINANCIAL STATEMENT SCHEDULE
To the Board of Directors
of Total Renal Care Holdings, Inc.
Our audit of the consolidated financial statements referred to in our report
dated February 13, 1997 appearing on page F-1 of this Annual Report on Form
10-K also included audits of the information included in the Financial
Statement Schedule listed in Item 14(a)(2) of this Form 10-K for the year
ended May 31, 1995, the seven months ended December 31, 1995 and the year
ended December 31, 1996. In our opinion, the Financial Statement Schedule
presents fairly, in all material respects, the information for the year ended
May 31, 1995, the seven months ended December 31, 1995 and the year ended
December 31, 1996 set forth therein when read in conjunction with the related
consolidated financial statements.
PRICE WATERHOUSE LLP
Seattle, Washington
February 13, 1997
S-1
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders
Total Renal Care Holdings, Inc.:
Under the date of July 8, 1994, we reported on the consolidated statements of
income, stockholders' equity and cash flows of Total Renal Care Holdings, Inc.
(formerly Total Renal Care, Inc.) and subsidiaries for the year ended May 31,
1994, which are included herein. In connection with our audit of the
aforementioned consolidated financial statements, we also audited the related
consolidated financial statement schedule for the year ended May 31, 1994,
included herein. The consolidated financial statement schedule is the
responsibility of the Company's management. Our responsibility is to express
an opinion on the consolidated financial statement schedule based on our
audit.
In our opinion, such consolidated financial statement schedule when considered
in relation to the basic consolidated financial statements taken as a whole,
presents fairly, in all material respects, the information set forth therein.
KPMG Peat Marwick LLP
Seattle, Washington
July 8, 1994
S-2
TOTAL RENAL CARE HOLDINGS, INC.
SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS
ADDITIONS DEDUCTIONS
---------------------- ----------
BALANCE AT AMOUNTS BALANCES OF AMOUNTS BALANCE AT
BEGINNING OF CHARGED TO COMPANIES WRITTEN END
DESCRIPTION YEAR INCOME ACQUIRED OFF OF YEAR
Allowance for doubtful
accounts:
Year ended May 31,
1994................... $2,352,000 $1,550,000 $1,975,000 $1,927,000
Year ended May 31,
1995................... 1,927,000 2,371,000 $1,203,000 1,067,000 4,434,000
Seven months ended
December 31, 1995...... 4,434,000 1,811,000 541,000 1,118,000 5,668,000
Year ended December 31,
1996................... 5,668,000 5,496,000 1,896,000 5,149,000 7,911,000
S-3
EXHIBIT INDEX
(3)(a) Exhibits:
EXHIBIT PAGE
NUMBER DESCRIPTION NUMBER
3.1 Amended and Restated Certificate of Incorporation of the
Company, dated December 4, 1995.++++
3.2 Bylaws of the Company, dated October 6, 1995.+
4.1 Shareholders Agreement, dated August 11, 1994 between DLJMB,
DLJIP, DLJOP, DLJMBF, NME Properties, Continental Bank, as
voting trustee, and the Company.++
4.2 Agreement and Amendment, dated as of June 30, 1995, between
DLJMBP, DLJIP, DLJOP, DLJMBF, DLJESC, Tenet Healthcare
Corporation, the Company, Victor M.G. Chaltiel, the Putnam
Purchasers, the Crescent Purchasers and the Harvard
Purchasers, relating to the Shareholders Agreement dated as
of August 11, 1994 between DLJMB, DLJIP, DLJOP, DLJMBF, NME
Properties, Continental Bank, as voting trustee, and the
Company.++
10.1 Credit Agreement by and among Total Renal Care Holdings,
Inc., the Lenders party thereto, BNY Capital Markets, Inc.
and Donaldson Lufkin & Jenrette Securities Corporation as
Arrangers, DLJ Capital Funding, Inc. as Documentation Agent
and The Bank of New York as Administrative Agent, dated as
of October 11, 1996 (the "TRCH Credit Facility").++
10.2 Guaranty by Total Renal Care, Inc. to The Bank of New York,
as Administrative Agent, pursuant to the TRCH Credit
Facility.++
10.3 Subscription Agreement dated May 26, 1994 between DLJMB,
DLJIP, DLJOP, DLJMBF, NME Properties, Tenet and the
Company.+
10.4 Services Agreement dated August 11, 1994 between the Company
and Tenet.++
10.5 Noncompetition Agreement dated August 11, 1994 between the
Company and Tenet.++
10.6 Employment Agreement dated as of August 11, 1994 by and
between the Company and Victor M.G.Chaltiel (with forms of
Promissory Note and Pledge and Stock Subscription Agreement
attached as exhibits thereto) (the "Chaltiel Employment
Agreement").++*
10.7 Amendment to Chaltiel Employment Agreement, dated as of
August 11, 1994.++*
10.8 Employment Agreement dated as of September 1, 1994 by and
between the Company and Barry C. Cosgrove.++*
10.9 Employment Agreement dated as of August 11, 1994 by and
between the Company and Leonard W. Frie (the "Frie
Employment Agreement").++*
10.10 Amendment to Frie Employment Agreement, dated as of October
11, 1994.++*
10.11 Employment Agreement dated as of September 1, 1994 by and
between the Company and John E. King.++*
10.12 First Amended and Restated 1994 Equity Compensation Plan
(the "1994 Plan") of the Company (with form of Promissory
Note and Pledge attached as an exhibit thereto), dated
August 5, 1994.++*
EXHIBIT PAGE
NUMBER DESCRIPTION NUMBER
10.13 Form of Stock Subscription Agreement relating to the 1994
Plan.++*
10.14 Form of Purchased Shares Award Agreement relating to the
1994 Plan.++*
10.15 Form of Nonqualified Stock Option relating to the 1994
Plan.++*
10.16 1995 Equity Compensation Plan.+*
10.17 Employee Stock Purchase Plan.+*
10.18 Option Exercise and Bonus Agreement dated as of September
18, 1995 between the Company and Victor M.G. Chaltiel.+*
11 Computation of Per Share Earnings.X
21 List of Subsidiaries of the Company.X
23.1 Consent of KPMG Peat Marwick LLP.X
23.2 Consent of Price Waterhouse LLP.X
24 Powers of Attorney with respect to the Company (included on
Page II-1). X
27 Financial Data Schedule.X
- --------
X Included in this filing.
++ Filed on October 18, 1996 as an exhibit to the Company's Current Report on
Form 8-K.
+++ Filed+on March 18, 1996 as an exhibit to the Company's Transitional Report
on Form 10-K for the transition period from June 1, 1995 to December 31,
1995.
+ Filed on October 24, 1995 as an exhibit to Amendment No. 2 to the Company's
Registration Statement on Form S-1 (Registration Statement No. 33-97618).
++ Filed on October 10, 1995 as an exhibit to Amendment No. 1 to the
Company's Registration Statement on Form S-1 (Registration Statement No.
33-97618).
+++ Filed on October 2, 1995 as an exhibit to the Company's Registration
Statement on Form S-1 (Registration Statement No. 33-97618).
+ Filed on June 6, 1994 as an exhibit to the Company's Registration Statement
on Form S-1 (Registration Statement No. 33-79770).
++ Filed on August 29, 1995 as an exhibit to the Company's Form 10-K for the
year ended May 31, 1995.
* Management contract or executive compensation plan or arrangement.