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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-Q
(MARK ONE)
[X]QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended June 30, 1998
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)
FOR THE QUARTER ENDED JUNE 30, 1998
Delaware 51-0354549
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
21250 Hawthorne Blvd., Suite 800
Torrance, California 90503-5517
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
Registrant's telephone number, including area code: (310) 792-2600
Not Applicable
(FORMER NAME OR FORMER ADDRESS, IF CHANGED SINCE LAST REPORT)
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 [_]
APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY
PROCEEDINGS DURING THE PRECEDING FIVE YEARS:
Indicate by check mark whether the Registrant has filed all documents and
reports required to be filed by Sections 12, 13 or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court. Yes [_] No [_]
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes of
common stock as of the latest practicable date.
OUTSTANDING AT
CLASS AUGUST 1, 1998
----- -----------------
Common Stock, Par Value $0.001......................... 80,860,092 shares
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TOTAL RENAL CARE HOLDINGS, INC.
INDEX
PART I. FINANCIAL INFORMATION
PAGE
NO.
Financial Statements:
Condensed Consolidated Balance Sheets as of June 30, 1998 and December
31, 1997............................................................... 1
Condensed Consolidated Statements of Income for the Three Months and the
Six Months Ended
June 30, 1998 and June 30, 1997........................................ 2
Condensed Consolidated Statements of Cash Flows for the Six Months Ended
June 30, 1998
and June 30, 1997...................................................... 3
Notes to Condensed Consolidated Financial Statements.................... 4
Management's Discussion and Analysis of Financial Condition and Results of
Operations............................................................... 9
Liquidity and Capital Resources........................................... 13
Risk Factors.............................................................. 15
PART II. OTHER INFORMATION
Item 2.Changes in Securities.............................................. 21
Item 5.Other Information.................................................. 21
Item 6.Exhibits and Reports on Form 8-K................................... 21
Signatures.............................................................. 22
- --------
Note: Items 1, 3 and 4 of Part II are omitted because they are not applicable.
TOTAL RENAL CARE HOLDINGS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
JUNE 30, DECEMBER 31,
1998 1997
ASSETS
Current assets:
Cash and cash equivalents.................... $ 1,093,000 $ 6,143,000
Patient accounts receivable, less allowance
for doubtful accounts of $42,689,000 and
$30,695,000, respectively .................. 337,909,000 248,408,000
Receivable from Tenet, a related company..... 443,000 534,000
Other current assets......................... 66,216,000 47,119,000
-------------- --------------
Total current assets....................... 405,661,000 302,204,000
Property and equipment, net.................... 196,183,000 172,838,000
Notes receivable from related parties.......... 17,241,000 11,344,000
Other long-term assets......................... 14,176,000 17,583,000
Intangible assets, net of accumulated
amortization of $95,620,000 and $77,040,000,
respectively.................................. 963,784,000 774,266,000
-------------- --------------
Total assets............................... $1,597,045,000 $1,278,235,000
============== ==============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of long-term obligations..... $ 5,680,000 $ 27,810,000
Other current liabilities.................... 100,366,000 74,640,000
-------------- --------------
Total current liabilities.................. 106,046,000 102,450,000
Long term debt and other....................... 1,045,034,000 725,376,000
Deferred income taxes.......................... 6,374,000 2,500,000
Minority interests............................. 20,316,000 19,079,000
Stockholders' equity:
Preferred stock, ($0.001 par value; 5,000,000
shares authorized; none outstanding)........ -- --
Common stock, voting, ($0.001 par value;
195,000,000 shares authorized; 80,818,168
and 78,040,453 shares issued and
outstanding, respectively).................. 81,000 78,000
Additional paid-in capital................... 399,095,000 358,492,000
Notes receivable from stockholders........... (342,000) (3,030,000)
Retained earnings............................ 20,441,000 73,290,000
-------------- --------------
Total stockholders' equity................. 419,275,000 428,830,000
-------------- --------------
Total liabilities and stockholders'
equity.................................... $1,597,045,000 $1,278,235,000
============== ==============
See accompanying Notes to Condensed Consolidated Financial Statements and
Management's Discussion and Analysis of Financial Condition and Results of
Operations.
1
TOTAL RENAL CARE HOLDINGS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
THREE MONTHS AND THE SIX MONTHS ENDED JUNE 30, 1998 AND 1997
THREE MONTHS SIX MONTHS
-------------------------- --------------------------
1998 1997 1998 1997
Net operating revenues.. $288,350,000 $179,715,000 $547,099,000 $337,652,000
Operating expenses:
Facilities............ 183,324,000 121,373,000 348,619,000 229,101,000
General and
administrative....... 16,505,000 12,120,000 33,415,000 22,036,000
Provision for doubtful
accounts............. 7,779,000 4,788,000 14,542,000 9,396,000
Depreciation and
amortization......... 21,035,000 12,740,000 40,039,000 23,829,000
Merger and related
costs................ 0 0 92,835,000 0
------------ ------------ ------------ ------------
Total operating
expenses............ 228,643,000 151,021,000 529,450,000 284,362,000
Operating income...... 59,707,000 28,694,000 17,649,000 53,290,000
Interest expense, net of
capitalized interest... (16,544,000) (5,717,000) (31,061,000) (9,654,000)
Interest rate swap--
early termination
costs.................. (9,823,000) 0 (9,823,000) 0
Interest income......... 1,022,000 869,000 2,664,000 1,463,000
------------ ------------ ------------ ------------
Income (loss) before
income taxes,
minority
interests,
extraordinary item
and cumulative
effect of change in
accounting principle. 34,362,000 23,846,000 (20,571,000) 45,099,000
Income taxes............ 13,230,000 9,338,000 9,680,000 17,498,000
------------ ------------ ------------ ------------
Income (loss) before
minority interests,
extraordinary item
and cumulative effect
of
change in accounting
principle............ 21,132,000 14,508,000 (30,251,000) 27,601,000
Minority interests in
income of consolidated
subsidiaries........... 1,565,000 1,038,000 2,958,000 2,343,000
------------ ------------ ------------ ------------
Income (loss) before
extraordinary item
and cumulative effect
of change in
accounting principle. 19,567,000 13,470,000 (33,209,000) 25,258,000
Extraordinary loss, net
of tax of $6,087,000
and $7,668,000,
respectively........... 9,932,000 0 12,744,000 0
Cumulative effect of
change in accounting
principle, net of tax
of $4,300,000.......... 0 0 6,896,000 0
------------ ------------ ------------ ------------
Net income (loss)....... $ 9,635,000 $ 13,470,000 $(52,849,000) $ 25,258,000
============ ============ ============ ============
Earnings (loss) per
common share:
Income (loss) before
extraordinary item
and cumulative effect
of change in
accounting
principle............ $ 0.24 $ 0.17 $ (0.42) $ 0.33
Extraordinary loss,
net of tax........... (0.12) 0.00 (0.16) 0.00
Cumulative effect of
change in accounting
principle, net of
tax.................. 0.00 0.00 (0.08) 0.00
------------ ------------ ------------ ------------
Net income (loss)..... $ 0.12 $ 0.17 $ (0.66) $ 0.33
============ ============ ============ ============
Weighted average number
of common shares
outstanding............ 80,714,000 77,562,000 79,692,000 77,228,000
============ ============ ============ ============
Earnings (loss) per
common share--assuming
dilution:
Income (loss) before
extraordinary item
and cumulative effect
of change in
accounting principle. $ 0.24 $ 0.17 $ (0.42) $ 0.32
Extraordinary loss net
of tax............... (0.12) 0.00 (0.16) 0.00
Cumulative effect of
change in accounting
principle, net of
tax.................. 0.00 0.00 (0.08) 0.00
------------ ------------ ------------ ------------
Net income (loss)..... $ 0.12 $ 0.17 $ (0.66) $ 0.32
============ ============ ============ ============
Weighted average number
of common shares and
equivalents
outstanding--assuming
dilution............... 87,263,000 79,706,000 79,692,000 79,738,000
============ ============ ============ ============
See accompanying Notes to Condensed Consolidated Financial Statements and
Management's Discussion and Analysis of Financial Condition and Results of
Operations.
2
TOTAL RENAL CARE HOLDINGS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
SIX MONTHS ENDED JUNE 30, 1998 AND 1997
1998 1997
Cash flows from operating activities:
Net (loss) income.............................. $ (52,849,000) $ 25,258,000
Adjustments to reconcile net (loss) income to
net cash (used in) provided by operating
activities:
Depreciation and amortization................ 40,039,000 23,829,000
Extraordinary item, net of tax............... 12,744,000
Provision for doubtful accounts.............. 14,542,000 9,396,000
Change in accounting principle, net of tax... 6,896,000
Compensation expense from stock option
exercise.................................... 16,000,000
Other non-cash merger related expenses....... 10,094,000
Other........................................ (73,677,000) (53,622,000)
-------------- -------------
Total adjustments.......................... 26,638,000 (20,397,000)
-------------- -------------
Net cash (used in) provided by operating
activities.............................. (26,211,000) 4,861,000
-------------- -------------
Cash flows from investing activities:
Purchases of property and equipment.......... (35,842,000) (26,287,000)
Cash paid for acquisitions, net of cash
acquired.................................... (216,669,000) (165,383,000)
Sale of investments.......................... 41,202,000
Other........................................ (34,268,000) (2,233,000)
-------------- -------------
Net cash used in investing activities.... (286,779,000) (152,701,000)
-------------- -------------
Cash flows from financing activities:
Borrowings from bank credit facility......... 1,397,000,000 151,000,000
Principal payments on long-term obligations.. (1,114,070,000) (11,491,000)
Net proceeds from sale of common stock....... 19,615,000 2,412,000
Other........................................ 5,395,000 (240,000)
-------------- -------------
Net cash provided by financing
activities.............................. 307,940,000 141,681,000
-------------- -------------
Net decrease in cash........................... (5,050,000) (6,159,000)
Cash at beginning of period.................... 6,143,000 21,327,000
-------------- -------------
Cash at end of period.......................... $ 1,093,000 $ 15,168,000
============== =============
See accompanying Notes to Condensed Consolidated Financial Statements and
Management's Discussion and Analysis of Financial Condition and Results of
Operations.
3
TOTAL RENAL CARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. The unaudited financial information furnished herein, in the opinion of
management, reflects all adjustments consisting only of normal recurring
adjustments which are necessary to state fairly the consolidated financial
position, results of operations, and cash flows of Total Renal Care Holdings,
Inc., ("TRCH" or the "Company") as of and for the periods indicated. TRCH
presumes that users of the interim financial information herein have read or
have access to the Company's audited consolidated financial statements and
Management's Discussion and Analysis of Financial Condition and Results of
Operations for the preceding fiscal year and that the adequacy of additional
disclosure needed for a fair presentation, except in regard to material
contingencies or recent significant events, may be determined in that context.
Accordingly, footnote and other disclosures which would substantially
duplicate the disclosures contained in Form 10-K for the year ended December
31, 1997 filed on March 31, 1998 and Form 10K/A for the year ended December
31, 1997 filed on May 18, 1998 by the Company have been omitted. Certain
reclassifications of prior period amounts have been made to conform to current
period classifications. The financial information herein is not necessarily
representative of a full year's operations.
2. On February 27, 1998, the Company acquired Renal Treatment Centers, Inc.
("RTC"), with headquarters in Berwyn, Pennsylvania ("Merger"). In connection
with the Merger, the Company issued 34,565,729 shares of its common stock in
exchange for all of the outstanding shares of RTC common stock. RTC
stockholders received 1.335 shares of the Company's common stock for each
share of RTC common stock that they owned. The Company also issued 2,156,424
options in substitution for previously outstanding RTC stock options,
including 1,662,354 of vested options that were exercised on the merger date
or shortly thereafter. In addition, the Company guaranteed $125,000,000 of
RTC's 5 5/8% subordinated convertible notes and provided for underlying shares
at a conversion price of $25.62. In connection with this transaction, the
Board and the Company's stockholders authorized an additional 140,000,000
shares of common stock.
The Merger was accounted for as a pooling of interests and as such, the
condensed consolidated financial statements have been restated to include RTC
for all periods presented. There were no transactions between the Company and
RTC prior to the combination and immaterial adjustments were made to conform
RTC's accounting policies. The results of operations for the separate
companies and the combined results presented in the condensed consolidated
financial statements follow:
THREE MONTHS SIX MONTHS
ENDED JUNE ENDED JUNE
30, 1997 30 1997
Net operating revenues
TRCH........................................... $104,752,000 $193,782,000
RTC............................................ 74,963,000 143,870,000
------------ ------------
$179,715,000 $337,652,000
============ ============
Income (loss) before extraordinary item and
cumulative effect of change in accounting
principle
TRCH........................................... $ 8,866,000 $ 16,691,000
RTC............................................ 4,604,000 8,567,000
------------ ------------
$ 13,470,000 $ 25,258,000
============ ============
Net income (loss)
TRCH........................................... $ 8,866,000 $ 16,691,000
RTC............................................ 4,604,000 8,567,000
------------ ------------
$ 13,470,000 $ 25,258,000
============ ============
Additionally, the results of operations for the separate companies and the
combined results presented in the condensed consolidated financial statements
for the six months ended June 30, 1998 contain two months of RTC
4
TOTAL RENAL CARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
operations prior to the Merger, including net operating revenues of
$72,482,000, income before extraordinary item and cumulative effect of change
in accounting principle of $4,827,000 and net income of $4,827,000.
In connection with the Merger, fees and expenses incurred to date or
anticipated which related to the Merger and to the integration of the combined
companies have been expensed as required under the pooling of interests
accounting method. Such fees and expenses amounted to $92,835,000 which were
paid or accrued in the first quarter of 1998. The charge includes $21,580,000
for financial advisory, legal, accounting and other direct transaction costs,
$45,260,000 for payments under severance and employment agreements and other
costs associated with certain compensation plans and costs of $25,995,000 to
combine the two operations. Costs to combine operations include the impairment
of certain systems and equipment, elimination of duplicate departments and
facilities, and other costs associated with planning and executing the merger
of operations. Certain of the Merger costs estimated at $36,000,000 are not
deductible for tax purposes. During the three months ended June 30, 1998, the
Company made payments of approximately $12,500,000 to settle certain merger
costs and at June 30, 1998, the accrual for such Merger costs amounted to
approximately $24,100,000.
As a result of the Merger, the RTC Revolving Credit Agreement ("RTC Credit
Agreement") was terminated and the outstanding balance of approximately
$297,228,000 was paid off through additional borrowings under the Company's
Credit Facilities (as defined in Note 6). The remaining net unamortized
deferred financing costs in the amount of $4,392,000 related to the RTC Credit
Agreement were recognized as an extraordinary loss in the consolidated
statement of income for the six months ended June 30, 1998.
3. During the quarter ended March 31, 1998, the Company purchased nine
centers and a pharmacy operation. Total cash consideration for these
transactions was $51 million.
During the quarter ended June 30, 1998, the Company purchased 25 centers and
acquired additional ownership interest in certain of the Company's
partnerships. Total cash consideration for these transactions was
$166 million.
These transactions were accounted for under the purchase method. The cost of
these acquisitions will be allocated primarily to intangible assets such as
patient charts, noncompete agreements, goodwill and capital equipment.
The results of operations on a pro forma basis as though the above
acquisitions had been combined with the Company at the beginning of each
period presented for the six months ended June 30, are as follows:
1998 1997
Pro forma net operating revenues................ $566,279,000 $383,948,000
Pro forma net (loss) income before extraordinary
item and cumulative effect of change in
accounting principle........................... (32,065,000) 28,002,000
Pro forma net (loss) income..................... $(51,705,000) $ 28,002,000
Pro forma (loss) earnings per share before
extraordinary item and cumulative effect of
change in accounting principle:
Basic......................................... $ (0.40) $ 0.36
Assuming dilution............................. $ (0.40) $ 0.35
4. In April 1998, Statement of Position No. 98-5, Reporting on the Costs of
Start-up Activities ("SOP 98-5"), was issued and was adopted by the Company in
the first quarter of 1998 (effective January 1, 1998). SOP 98-5 requires that
pre-opening and organization costs, incurred in conjunction with facility pre-
opening activities, which previously had been treated as deferred costs and
amortized over five years, should be expensed as incurred. As a result of the
adoption of SOP 98-5, all existing unamortized pre-opening, development and
organizational costs have been recognized as the cumulative effect of a change
in accounting principle in the condensed consolidated statement of income for
the six months ended June 30, 1998.
5
TOTAL RENAL CARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
5. The reconciliation of the numerators and denominators used to calculate
earnings (loss) per common share for all periods presented is as follows:
THREE MONTHS SIX MONTHS
ENDED JUNE 30 ENDED JUNE 30
------------------------ -------------------------
1998 1997 1998 1997
Applicable Common Shares
Average outstanding
during the period...... 80,724,000 77,704,000 79,703,000 77,370,000
Reduction in shares in
connection with notes
receivable from
employees................ (10,000) (142,000) (11,000) (142,000)
----------- ----------- ------------ -----------
Weighted average number of
shares outstanding for
use in computing earnings
per share................ 80,714,000 77,562,000 79,692,000 77,228,000
Dilutive effect of
outstanding stock
options.................. 1,670,000 2,144,000 2,181,000
Dilutive effect of
convertible debt and
earnout note............. 4,879,000 329,000
----------- ----------- ------------ -----------
Weighted average number of
shares and equivalents
outstanding for use in
computing earnings per
share--assuming dilution. 87,263,000 79,706,000 79,692,000 79,738,000
=========== =========== ============ ===========
Income (loss) before
extraordinary item and
cumulative effect of
change in accounting
principle................ $19,567,000 $13,470,000 $(33,209,000) $25,258,000
Interest, net of tax
resulting from dilutive
effect of convertible
debt and earnout note.... 1,055,000 -- -- 34,000
----------- ----------- ------------ -----------
Income (loss) for use in
computing earning per
share.................... 20,622,000 13,470,000 (33,209,000) 25,292,000
Extraordinary loss, net of
tax...................... 9,932,000 12,744,000
Cumulative effect of
change in accounting
principle, net of tax.... 6,896,000
----------- ----------- ------------ -----------
Income (loss)--assuming
dilution................. $10,690,000 $13,470,000 $(52,849,000) $25,292,000
=========== =========== ============ ===========
Earnings (loss) per common
share:
Income (loss) per common
share before
extraordinary item and
cumulative effect of
change in accounting
principle................ $ 0.24 $ 0.17 $ (0.42) $ 0.33
Extraordinary loss, net of
tax...................... (0.12) (0.16)
Cumulative effect of
change in accounting
principle, net of tax.... (0.08)
----------- ----------- ------------ -----------
Net income (loss) per
common share............. $ 0.12 $ 0.17 $ (0.66) $ 0.33
=========== =========== ============ ===========
Earnings (loss) per common
share--assuming dilution:
Income (loss) before
extraordinary item and
cumulative effect of
change in accounting
principle................ $ 0.24 $ 0.17 $ (0.42) $ 0.32
Extraordinary item, net of
tax...................... (0.12) (0.16)
Cumulative effect of
change in accounting
principle, net of tax.... (0.08)
----------- ----------- ------------ -----------
Net income (loss) per
common share--assuming
dilution................. $ 0.12 $ 0.17 $ (0.66) $ 0.32
=========== =========== ============ ===========
6
TOTAL RENAL CARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Included in the above calculation is the effect of the RTC Subordinated
Convertible Notes for the three months ended June 30, 1998, however, the
effect is not included for the six months ended June 30, 1998 and the three
and six months ended June 30, 1997 because it is anti-dilutive.
6. On April 30, 1998, the Company replaced its existing $1,050,000,000
credit facilities with an aggregate of $1,350,000,000 in two senior bank
facilities ("Senior Credit Facilities"). The Senior Credit Facilities consist
of a seven-year $950,000,000 revolving senior credit facility and a ten-year
$400,000,000 senior term facility. The terms and rates are comparable to those
in effect with the previous credit facilities and allow for an expansion of
the leverage ratio as well as a waiver for cash costs associated with the
Merger. As a result of this refinancing, remaining net deferred financing
costs in the amount of approximately $16,019,000, less tax of 6,087,000 was
recognized as an extraordinary loss in the second quarter of 1998.
7. In conjunction with the refinancing of its Senior Credit Facilities the
Company's two existing forward interest rate swap agreements with notional
amounts of $100,000,000 and $200,000,000 were canceled in April 1998. The loss
associated with the early cancellation of those swaps was approximately
$9,823,000. During the quarter ended June 30, 1998, the Company entered into
forward interest rate cancellable swap agreements, with a combined notional
amount of $800,000,000. The lengths of the agreements are between three and
ten years with cancellation clauses at the swap holders' option from one to
seven years. The underlying blended interest rate is fixed at approximately
5.85% plus an applicable margin based upon the Company's current leverage
ratio. Currently, the effective interest rate for these swaps is 7.1%.
8. Subsequent to June 30, 1998, the Company completed acquisitions or signed
definitive agreements or entered into agreements in principle to acquire 46
dialysis facilities for consideration of approximately $175 million, which has
been or will primarily be funded by additional borrowings under the Company's
Senior Credit Facilities.
9. The outstanding $125,000,000 of 5 5/8% subordinated convertible notes
issued by RTC are guaranteed by the Company. The following summarizes
financial information of RTC:
JUNE 30, DECEMBER 31,
1998 1997
Cash and cash equivalents............................ $ 11,163,000 $ 743,000
Accounts receivable, net............................. 135,899,000 95,927,000
Other current assets................................. 25,747,000 19,484,000
------------ ------------
Total current assets............................... 172,809,000 116,154,000
Property and equipment, net.......................... 74,502,000 72,777,000
Intangible assets, net............................... 400,817,000 384,529,000
Other assets......................................... 3,426,000 12,035,000
------------ ------------
Total assets....................................... $651,554,000 $585,495,000
============ ============
Current liabilities (including $317,836,000 payable
to TRCH at June 30,
1998)............................................... $345,616,000 $ 62,673,000
Long-term debt....................................... 125,685,000 367,219,000
Other long-term liabilities.......................... 22,211,000 444,000
Stockholder's equity................................. 158,042,000 155,159,000
------------ ------------
$651,554,000 $585,495,000
============ ============
7
TOTAL RENAL CARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
THREE MONTHS ENDED JUNE
30, SIX MONTHS ENDED JUNE 30,
------------------------ --------------------------
1998 1997 1998 1997
Net operating revenues..... $123,990,000 $74,963,000 $238,651,000 $143,870,000
Total operating expenses... 98,224,000 64,979,000 242,081,000 125,330,000
------------ ----------- ------------ ------------
Operating Income (loss) ... 25,766,000 9,984,000 (3,430,000) 18,540,000
Interest expense, net...... 1,201,000 2,155,000 4,788,000 3,979,000
------------ ----------- ------------ ------------
Income (loss) before income
taxes..................... 24,565,000 7,829,000 (8,218,000) 14,561,000
Income taxes............... 5,778,000 3,225,000 4,794,000 5,994,000
------------ ----------- ------------ ------------
Net income (loss).......... $ 18,787,000 $ 4,604,000 $(13,012,000) $ 8,567,000
============ =========== ============ ============
10. The financial information of RTC as originally presented in Form 10-Q
for the three and six months ended June 30, 1997 has been restated to correct
net revenues and the provision for doubtful accounts receivable with the
following effect (in thousands, except per share amounts):
FOR THE THREE FOR THE SIX
MONTHS ENDED MONTHS ENDED
JUNE 30, 1997 JUNE 30, 1997
------------------- -------------------
AS AS
ORIGINALLY AS ORIGINALLY AS
REPORTED RESTATED REPORTED RESTATED
Net revenues........................... $77,273 $74,963 $148,381 $143,870
Operating expense...................... $64,325 $64,979 $124,054 $125,330
Operating profit....................... $12,948 $ 9,984 $ 24,327 $ 18,540
Net income............................. $ 6,746 $ 4,604 $ 12,765 $ 8,567
Earnings per common share.............. $ 0.27 $ 0.18 $ 0.52 $ 0.35
Earnings per common share--assuming
dilution.............................. $ 0.26 $ 0.18 $ 0.49 $ 0.33
11. On June 15, 1998, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards No. 133, Accounting for Derivative
Instruments and Hedging Activities (FAS 133). FAS 133 is effective for all
fiscal quarters of all fiscal years beginning after June 15, 1999 (January 1,
2000 for the Company). FAS 133 requires that all derivative instruments be
recorded on the balance sheet at their fair value. Changes in the fair value
of derivatives are recorded each period in current earnings or other
comprehensive income, depending on whether a derivative is designated as part
of a hedge transaction and, if it is, the type of hedge transaction.
Management of the Company anticipates that, due to its limited use of
derivative instruments, the adoption of FAS 133 will not have a significant
effect on the Company's results of operations or its financial position.
12. The Company's 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. One of the Company's laboratory operations,
Dialysis Laboratories, Inc. ("DLI"), is presently the subject of a third-party
carrier review. The third-party carrier has requested medical and billing
records for certain patients and DLI is in the process of providing the
requested records. The third-party carrier has suspended payments to DLI but
continues to process DLI's invoices in the ordinary course.
8
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FORWARD LOOKING STATEMENTS
This Management's Discussion and Analysis of Financial Condition and Results
of Operations contains certain "forward-looking statements" as defined in the
Private Securities Litigation Reform Act of 1995. Such statements relating to
future events and financial performance are forward-looking statements
involving risks and uncertainties that are detailed from time to time in the
Company's various Securities and Exchange Commission filings.
MERGER
As described in Note 2 to the condensed consolidated financial statements,
the Company merged (the "Merger") with Renal Treatment Centers, Inc. ("RTC")
on February 27, 1998 in a transaction accounted for as a pooling of interests.
Accordingly, the condensed consolidated financial statements have been
restated to include RTC for all periods presented.
RESULTS OF OPERATIONS
Three Months Ended June 30, 1998 Compared to the Three Months Ended June 30,
1997.
Net Operating Revenues. Net operating revenues for the three months ended
June 30, 1998 ("Second Quarter of 1998") increased $108,635,000 to
$288,350,000 from $179,715,000 for the three months ended June 30, 1997
("Second Quarter of 1997") representing a 60.4% increase. Of this increase,
$85,839,000 was due to increased treatments from acquisitions, existing
facility growth and de novo developments. The remaining increase in net
operating revenues per treatment which was $243.01 in the Second Quarter of
1998 compared to $223.79 in the Second Quarter of 1997 was attributable to an
increase in non-governmental (private) payor services stemming from the
Medicare secondary payor extension causing private payors to be in a primary
position for an additional twelve month period, the addition from the partial
roll-out of the TRCH laboratory services to the RTC patient base, an overall
increase in rates and to increased ancillary usage primarily in EPO
administration.
Facility Operating Expenses. Facility operating expenses consist of cost and
expenses specifically attributable to the operation of dialysis facilities,
including operating and maintenance cost of such facilities, equipment, direct
labor, and supply and service costs relating to patient care. Facility
operating expense increased $61,951,000 to $183,324,000 in the Second Quarter
of 1998 from $121,373,000 in the Second Quarter of 1997 and as a percentage of
net operating revenues, facility operating expenses decreased to 63.6% in the
Second Quarter of 1998 from 67.5% in the Second Quarter of 1997. This decrease
was primarily a result of revenue growth and the effects from the Company's
Best Demonstrated Practices Program, including efficiencies in medical
supplies.
General and Administrative Expenses. General and administrative expenses
include headquarters expenses and administrative, legal, quality assurance,
information systems and centralized accounting support functions. General and
administrative expenses increased $4,385,000 to $16,505,000 in the Second
Quarter of 1998 from $12,120,000 in the Second Quarter of 1997. As a
percentage of net operating revenues, general and administrative expenses
decreased to 5.7% in the Second Quarter of 1998 from 6.7% in the Second
Quarter of 1997. 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 is
influenced by the amount of net operating revenues generated from non-
governmental payor sources in addition to the relative percentage of accounts
receivable by aging category. The provision for doubtful accounts increased
$2,991,000 to $7,779,000 in the Second Quarter of 1998 from $4,788,000 in the
Second Quarter of 1997. As a percentage of net operating revenues, the
provision for doubtful accounts remained the same at 2.7% for both periods.
9
Depreciation and Amortization. Depreciation and amortization increased
$8,295,000 to $21,035,000 in the Second Quarter of 1998 from $12,740,000 in
the Second Quarter of 1997. As a percentage of net operating revenues,
depreciation and amortization increased to 7.3% in the Second Quarter of 1998
from 7.1% in the Second Quarter of 1997. The increase was primarily
attributable to increased amortization due to acquisition activity and
increased depreciation from new center leaseholds and routine capital
expenditures.
Operating Income. Operating income increased $31,013,000 to $59,707,000 in
the Second Quarter of 1998 from $28,694,000 in the Second Quarter of 1997. As
a percentage of net operating revenues, operating income increased to 20.7% in
the Second Quarter of 1998 from 16.0% in the Second Quarter of 1997. The
increase was primarily due to increased revenues, a decrease in facility
operating and general and administrative costs partially offset by an increase
in depreciation and amortization expense.
Interest Expense. Interest expense, net of interest income, increased
$10,674,000 to $15,522,000 in the Second Quarter of 1998 from $4,848,000 in
the Second Quarter of 1997. As a percentage of net operating revenues,
interest expense, net of interest income, increased to 5.4% in the Quarter of
1998 from 2.7% in the Quarter of 1997. The increase in interest expense, net
of interest income was due primarily to an increase in borrowings made under
the credit facilities to fund the Company's acquisitions.
Interest rate swap--early termination costs. In conjunction with the
refinancing of the senior credit facilities the Company's two existing forward
interest rate swap agreements were canceled in April 1998. The early
termination costs associated with the cancellation of those swaps was
$9,823,000.
Provision for Income Taxes. Provision for income taxes increased $3,892,000
to $13,230,000 in the Second Quarter of 1998 from $9,338,000 in the Second
Quarter of 1997 and the effective tax rate after minority interest decreased
to 39.8% in the Second Quarter of 1998 compared to 40.9% in the Second Quarter
of 1997. The reduction in the effective tax rate was due to a decrease in the
blended state tax rate and less amortization of non-deductible goodwill as a
percentage of taxable income.
Minority Interest. 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 interest increased $527,000 to $1,565,000 in the Second
Quarter of 1998 from $1,038,000 in the Second Quarter of 1997, and as a
percentage of net operating revenues, minority interest decreased to 0.5% in
the Second Quarter of 1998 from 0.6% in the Second Quarter of 1997. 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 conjunction with replacing its Senior Credit
Facilities, the Company recorded all of the remaining net deferred financing
costs as an extraordinary loss of $9,932,000, (net of income tax effect).
Six Months Ended June 30, 1998 Compare to the Six Months Ended June 30, 1997
Net Operating Revenues. Net operating revenues for the six months ended June
30, 1998 increased $209,447,000 to $547,099,000 from $337,652,000 for the six
months ended June 30, 1997 representing a 62.0% increase. Of this increase,
$178,894,000 was due to increased treatments from acquisitions, existing
facility growth and de novo developments. The remaining increase in net
operating revenues per treatment which was $239.30 in the Second Quarter of
1998 compared to $225.94 in the Second Quarter of 1997 was attributable to an
increase in non-governmental (private) payor services stemming from the
Medicare secondary payor extension causing private payors to be in a primary
position for an additional twelve month period, to an overall increase in
rates and to increased ancillary usage primarily in EPO administration and the
addition from the partial roll-out of the TRCH laboratory services to the RTC
patient base.
Facility Operating Expenses. Facility operating expense increased
$119,518,000 to $348,619,000 in the first six months of 1998 from $229,101,000
in the first six months of 1997 and as a percentage of net operating revenues,
facility operating expenses decreased to 63.7% in the First six months of 1998
from 67.9% in the first
10
six months of 1997. This decrease was primarily a result of revenue growth and
the effects from the Company's Best Demonstrated Practices Program, including
efficiencies in medical supplies.
General and Administrative Expenses. General and administrative expenses
increased $11,379,000 to $33,415,000 in the first six months of 1998 from
$22,036,000 in the first six months of 1997. As a percentage of net operating
revenues, general and administrative expenses decreased to 6.1% in the first
six months of 1998 from 6.5% in the first six months of 1997. 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 $5,146,000 to $14,542,000 in the first six months of 1998 from
$9,396,000 in the first six months of 1997. As a percentage of net operating
revenues, the provision for doubtful accounts decreased to 2.7% in the First
six months of 1998 from 2.8% in the first six months of 1997, which reflects
improvements made to the billing and collection processes to curtail write-
offs for untimely follow-up on claims previously billed.
Depreciation and Amortization. Depreciation and amortization increased
$16,210,000 to $40,039,000 in the first six months of 1998 from $23,829,000 in
the first six months of 1997. As a percentage of net operating revenues,
depreciation and amortization increased to 7.3% in the first six months of
1998 from 7.1% in the first six months of 1997. The increase was primarily
attributable to increased amortization due to acquisition activity and
increased depreciation from new center leaseholds and routine capital
expenditures.
Merger and Related Expenses. In connection with the Merger, fees and
expenses incurred to date or anticipated which related to the Merger and to
the integration of the combined companies have been expensed as required under
the pooling of interests accounting method. Such fees and expenses amounted to
$92,835,000 which were paid or accrued in the first six months of 1998. The
charge includes $21,580,000 for financial advisory, legal, accounting and
other direct transaction costs, $45,260,000 for payments under severance and
employment agreements and other costs associated with certain compensation
plans and costs of $25,995,000 to combine the two operations. Costs to combine
operations include the impairment of certain systems and equipment,
elimination of duplicate departments and facilities, and other costs
associated with planning and executing the merger of operations. Certain of
the Merger costs estimated at $36,000,000 are not deductible for tax purposes.
During the six months ended June 30, 1998, the Company made payments of
approximately $68,700 to settle certain Merger costs and at June 30, 1998 the
accrual for such Merger costs amounted to approximately $24,100,000.
Operating Income. Operating income decreased $35,641,000 to $17,649,000 in
the first six months of 1998 from $53,290,000 in the first six months of 1997
which was due to the costs associated with the Merger. Operating income before
merger and related costs increased $57,194,000 to $110,484,000 in the first
six months of 1998 from $53,290,000 in the first six months of 1997. As a
percentage of net operating revenues, operating income before merger and
related costs increased to 20.2% in the first six months of 1998 from 15.8% in
the first six months of 1997 primarily due to increased revenues, a decrease
in facility operating costs and the provision for doubtful accounts partially
offset by an increase in depreciation and amortization expense.
Interest Expense. Interest expense, net of interest income, increased
$20,206,000 to $28,397,000 in the first six months of 1998 from $8,191,000 in
the first six months of 1997. As a percentage of net operating revenues,
interest expense, net of interest income, increased to 5.2% in the first six
months of 1998 from 2.4% in the first six months of 1997. The increase in
interest expense, net of interest income was due primarily to an increase in
borrowings made under the credit facilities to fund the Company's
acquisitions.
Interest rate swap--early termination costs. In conjunction with the
refinancing of the Senior Credit Facilities the Company's two existing forward
interest rate swap agreements were canceled in April 1998. The early
termination costs associated with the cancellation of those swaps was
$9,823,000.
Provision for Income Taxes. Provision for income taxes decreased $7,818,000
to $9,680,000 in the first six months of 1998 from $17,498,000 in the First
six months of 1997 as a result of the loss incurred. The
11
effective tax rate after minority interest but before merger and related
expenses was 39.8% in the first six months of 1998 compared to 40.9% in the
first six months of 1997. The decrease in the effective tax rate was due to a
reduction in the blended state tax rate and less amortization of non-
deductible goodwill as a percentage of taxable income. Non deductible merger
and related expenses consisting of costs associated with limitations on
deductibility of former RTC officer compensation and costs associated with the
issuance of stock amounted to approximately $36,000,000. Additional tax
expenses of approximately $2,600,000 were recognized in the first six months
of 1998 to conform the RTC tax accrual with the Company's ongoing policies.
Minority Interest. Minority interest increased $615,000 to $2,958,000 in the
first six months of 1998 from $2,343,000 in the first six months of 1997, and
as a percentage of net operating revenues, minority interest decreased to 0.5%
in the first six months of 1998 from 0.7% in the first six months of 1997.
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. On February 27, 1998, in conjunction with the Merger the
Company terminated the RTC Revolving Credit Agreement ("RTC Credit Agreement")
and recorded all of the remaining related unamortized deferred financing costs
as an extraordinary loss of $2,812,000, (net of income tax effect). In April
1998, in conjunction with replacing its Senior Credit Facilities, the Company
also recorded all of the remaining related unamortized deferred financing
costs as an extraordinary loss of $9,932,000, (net of income tax effect).
Cumulative Effect of Change in Accounting Principle. Effective January 1,
1998, the Company adopted Statement of Position No. 98-5, Reporting on the
Costs of Start-up Activities ("SOP 98-5"). SOP 98-5 requires that pre-opening
and organizational costs, incurred in conjunction with pre-opening activities
of the Company on its de novo facilities, which previously had been treated as
deferred costs and amortized over five years, should be expensed as incurred.
In connection with this adoption, the Company recorded a charge of $6,896,000
(net of income tax effect) as a cumulative effect of a change in accounting
principle.
12
LIQUIDITY AND CAPITAL RESOURCES
Net cash (used in) provided by operating activities was $(26,211,000) for
the first six months of 1998 and $4,861,000 for the first six months of 1997.
Net cash used in operating activities consists of the Company's net income
(loss), increased by non-cash expenses such as depreciation, amortization,
non-cash interest and the provision for doubtful accounts, and adjusted by
changes in components of working capital, primarily accounts receivable, and
accrued merger and related expenses in 1998. Net cash used in investing
activities was $286,779,000 and $152,701,000 for the first six months of 1998
and 1997, 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. For the first six months of 1998 net
cash provided by financing activities was $307,940,000 as compared to
$141,681,000 for the first six months of 1997. The primary source of cash for
the first six months of 1998 consisted of borrowings from the bank credit
facility and were used to finance acquisitions, de novo developments and
working capital needs.
As of June 30, 1998, the Company had working capital of $299,615,000,
including cash of $1,093,000.
The Company anticipates that its aggregate capital requirements for
purchases of equipment and leasehold improvements for outpatient facilities,
including de novo facilities after June 30, 1998 through December 31, 1998
will be approximately $34 million.
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 $800,000 to $1,200,000 for
initial construction and equipment and $200,000 to $300,000 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. The Company is currently developing 43 new facilities and plans to
open 24 de novo facilities during the remaining six months of this year.
During the period January 1, 1998 through June 30, 1998, the Company paid
cash of approximately $217 million for the acquisition of 34 facilities and a
pharmacy operation, and the purchase of minority interests in certain of the
Company's partnerships. Subsequent to June 30, 1998, the Company completed
acquisitions of or entered into letters of intent to acquire 46 facilities for
consideration of approximately $175 million which have been or will primarily
be funded by additional borrowings under the Company's Senior Credit
Facilities.
In April 1998, the Company replaced its $1,050,000,000 bank credit
facilities with an aggregate of $1,350,000,000 in two senior bank facilities
("Senior Credit Facilities"). The Credit Facilities consist of a seven-year
$950,000,000 revolving senior credit facility and a ten-year $400,000,000
senior term facility. The terms and rates are comparable to those in effect
with previous credit facilities and allow for an expansion of the leverage
ratio as well as a waiver for cash costs associated with the Merger.
The Senior Credit Facilities contain 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.
As a result of this refinancing, the remaining net deferred financing costs
of approximately $16,019,000, net of taxes of 6,087,000 were recognized as an
extraordinary loss, net of taxes, in the second quarter of 1998.
In conjunction with the refinancing of its Senior Credit Facilities the
Company's two existing forward interest rate swap agreements with notional
amounts of $100,000,000 and $200,000,000 were canceled in April 1998. The loss
associated with the early cancellation of those swaps was approximately
$9,823,000. During the
13
quarter ended June 30, 1998, the Company entered into forward interest rate
cancellable swap agreements, with a combined notional amount of $800,000,000.
The lengths of the agreements are between three and ten years with
cancellation clauses at the swap holders' option from one to seven years. The
underlying blended interest rate is fixed at approximately 5.85% plus an
applicable margin based upon the Company's current leverage ratio. Currently,
the effective interest rate for these swaps is 7.1%.
As a result of the Merger with RTC, the RTC Revolving Credit Agreement was
terminated and the outstanding balance of $297,228,000 including interest was
paid off through additional borrowings on the Senior Credit Facilities.
Year 2000 Risks. Certain of the Company's older computer software programs
identify years with two digits instead of four. This is likely to cause
problems because the programs may recognize the year 2000 as the year 1900.
Plans are in the process to eliminate all Year 2000 software problems. The
Company fully expects to complete the necessary conversions by the end of the
second quarter of 1999. The Company believes that the cost of modifying those
systems that were not already scheduled for replacement for business reasons
prior to 2000 is immaterial. Although the Company does not expect Year 2000 to
have a material adverse effect on its internal operations, it is possible that
Year 2000 problems could have a significant adverse effect on (i) the
Company's suppliers and their ability to service the Company and to accurately
process payments received and (ii) the ability of certain third party
insurance payors and governmental payors, such as Medicare and the individual
state Medicaid programs, to accurately process remittance (payments) on
patient accounts receivable due to the Company.
The Company believes that the borrowings under the Senior Credit Facilities,
cash generated from operations and other current sources of financing will be
sufficient to meet the Company's need for capital for the foreseeable future,
including working capital, purchases of additional property and equipment for
the operation of its existing facilities and interest on the Senior Credit
Facilities. To continue its growth strategy, however, the Company may need to
issue additional debt or equity securities. There can be no assurance that
additional financing and capital, if and when required, will be available on
terms acceptable to the Company or at all.
14
RISK FACTORS
In evaluating the Company and its business, investors should carefully
consider the following risk factors in addition to the other information
contained herein. This quarterly report contains statements that constitute
"forward-looking" statements within the meaning of the Private Securities
Litigation Reform Act of 1995. Such forward-looking statements relate to
future events or the future financial performance of the Company and involve
known and unknown risks, uncertainties and other factors that may cause the
actual results, performance or achievements of the Company to be materially
different from any future results, performance or achievements expressed or
implied by such forward-looking statements. Such factors include, among other
things, those discussed below, and such factors could cause actual results to
differ materially from those indicated by such forward-looking statements. The
Company undertakes no obligation to publicly update or revise any forward-
looking statements, whether as a result of new information, future events or
otherwise. In light of these risks and uncertainties, there can be no
assurance that the forward-looking information contained in this quarterly
report or the materials incorporated herein by reference will in fact
transpire.
Uncertainties in Integrating Business Operations and Achieving Cost Savings
The Merger represents the largest single acquisition which the Company has
made to date. The process of integrating RTC's operations presents a
significant challenge to the Company's management and may lead to
unanticipated costs. There can be no assurance that the Company will be
successful in completing this integration. The integration of RTC's
operations, and of its accounting, personnel, administrative, legal,
information systems and other functions, involves the risk that remaining key
employees may leave even when offered continuing employment. Robert L. Mayer,
Jr., RTC's Chairman, Chief Executive Officer and President, and Frederick C.
Jansen, RTC's Executive Vice President, were expected to and did resign
following the Merger as did certain other officers for whom the Merger
constituted an event of constructive discharge, including Ronald H. Rodgers,
Jr., RTC's Chief Financial Officer and Thomas J. Karl, RTC's General Counsel.
Except for such officers, substantially all of the personnel responsible for
clinical operations have remained with the Company following the Merger,
although there can be no assurances that such personnel will not resign at any
point in the future or that they can easily be replaced should they resign.
The integration of RTC's operation requires the devotion of a significant
amount of time by senior executives of the Company, which may detract from the
business operations and development of the Company. There can be no assurance
that any of the cost savings, operating efficiencies or other synergies
expected to result from the Merger will be accomplished as rapidly as
currently expected or at all.
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 HCFA for dialysis treatments. Since 1972, qualified
patients suffering from ESRD have been entitled to Medicare benefits
regardless of age or financial circumstances. Approximately 56% of the
Company's net patient revenues during the fiscal year ended December 31, 1997
and approximately 53% during the six months ended June 30, 1998 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. No prediction can be
made as to 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.
No prediction can be made as to whether certain services, for 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 EPO. EPO, a bio-engineered protein,
is beneficial in the treatment of anemia, a medical
15
complication frequently experienced by dialysis patients. Most of the
Company's dialysis patients receive EPO. The Company had revenues from the
administration of EPO (the substantial majority of which are reimbursed
through Medicare and Medicaid programs) of approximately 20% of net patient
revenues, in the fiscal year ended December 31, 1997 and approximately 21%
during the six months ended June 30, 1998. Therefore, 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. The Office of the Inspector General of HHS recently
recommended that Medicare reimbursement for EPO be reduced from $10 to $9 per
1,000 units and HHS has concurred with this recommendation; however, HHS has
not determined whether it will pursue this change through the rulemaking
process. The President's fiscal 1999 budget includes this proposed reduction
in EPO reimbursement.
In April 1996, HCFA notified providers that reimbursement of EPO
administration for a patient with a hematocrit measurement exceeding 36% would
be available only if the 90-day rolling hematocrit measurement for such
patient was 36.5% or less. If the 90-day rolling average hematocrit measure
exceeded 36.5%, reimbursement for EPO administration would be denied, except
in very limited instances. In connection with this notification, HCFA
instructed its fiscal intermediaries to review the rolling three month
hematocrit averages and to ascertain compliance therewith. TRCH's and RTC's
single fiscal intermediary enacted such instructions in December and September
1997, respectively. Subsequently, HCFA notified its fiscal intermediaries that
it was changing the foregoing reimbursement policy effective for monthly
billing periods beginning on or after March 10, 1998. Recently, HCFA announced
that it was eliminating prepayment reviews, raising the 90-day hematocrit
rolling average to 37.5 and allowing medical justification for claims with
hematocrit of greater than 36.0. The Company does not expect this change in
reimbursement to have a material effect on the Company's revenues. No
prediction can be made as to whether future rate or reimbursement method
changes will be made. Furthermore, EPO is produced by a single manufacturer,
and any interruption of supply or product cost increases could adversely
affect the Company's operations.
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. Approximately 5% of the Company's
net patient revenues during both the fiscal year ended December 31, 1997 and
the six months ended June 30, 1998 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 39% of the Company's net patient revenues during the fiscal
year ended December 31, 1997 and 42% during the six months ended June 30, 1998
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 nonexclusive
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. The federal
government has 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
16
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 Medical Directors of its facilities, nor the minority ownership
interests of referring physicians in certain of the Company's dialysis
facilities meet all of the necessary requirements to obtain full protection
afforded by these safe harbors. Although the Company has never been challenged
under these statutes and the Company 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.
Stark I restricts physician referrals for clinical laboratory services to
entities with which a physician or an immediate family member has a "financial
relationship." HCFA has published regulations interpreting Stark I. The
regulations specifically provide that services furnished in an ESRD facility
that are included in the composite 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 many of the Company's
competitors as well.
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 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.
It is unlawful in California 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 facilities in California which account for a
significant percentage of net operating revenues. 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. The Company also
operates dialysis facilities and provides laboratory services in Alabama,
Colorado, Delaware, Florida, Georgia, Hawaii, Illinois, Kansas, Maryland,
Michigan, Minnesota, Missouri, Nebraska, Nevada, New Jersey, New York,
Oklahoma and Puerto Rico, all of which have so-called "fraud and abuse"
statutes which regulate the Company's relationships with physicians.
At present, some 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 that practice and the Company cannot
predict the effect the foregoing would have on the desire of such patients to
use the Company's services.
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The Company's 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. One of the Company's laboratory operations,
Dialysis Laboratories, Inc. ("DLI"), is presently the subject of a third-party
carrier review. The third-party carrier has requested medical and billing
records for certain patients and DLI is in the process of providing the
requested records. The third-party carrier has suspended payments to DLI but
continues to process DLI's invoices in the ordinary course.
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
The Company's business strategy depends in significant part on its ability
to acquire or develop additional dialysis facilities. This 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, 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. Competition for qualified physicians
to act as Medical Directors is also high. Competition for acquisitions has
increased the cost of acquiring existing dialysis facilities. The Company has
also 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, which is possible under the proposed Stark
II regulations, 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, 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
18
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 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 less than 10% 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 "--Operations Subject
to Government Regulation."
Operations Outside the United States
Approximately 7.6% of the Company's patients at June 30, 1998 are serviced
by operations outside the United States. The Company's non-United States
operations are subject to certain political, economic and other uncertainties
not encountered in United States operations, including risks of civil
disturbances (or other risks that may limit or disrupt markets),
expropriations and general hazards associated with the assertions of national
sovereignty over certain areas in which operations are conducted. The
Company's operations outside the United States may face the additional risk of
fluctuating currency values, hard currency shortages, controls of currency
exchange and difficulty in repatriation of income or capital. No prediction
can be made as to what governmental regulations may be enacted in the future
that could adversely affect the international dialysis industry.
Year 2000 Compliance
Year 2000 Risks. Certain of the Company's older computer software programs
identify years with two digits instead of four. This is likely to cause
problems because the programs may recognize the year 2000 as the year 1900.
Plans are in the process to eliminate all Year 2000 software problems. The
Company fully expects to complete the necessary conversions by the end of the
second quarter of 1999. The Company believes that the cost of modifying those
systems that were not already scheduled for replacement for business reasons
prior to 2000 is immaterial. Although the Company does not expect Year 2000 to
have a material adverse effect on its internal operations, it is possible that
Year 2000 problems could have a significant adverse effect on (i) the
Company's suppliers and their ability to service the Company and to accurately
process payments received and (ii) the ability of certain third party
insurance payors and governmental payors, such as Medicare and the individual
state Medicaid programs, to accurately process remittance (payments) on
patient accounts receivable due to the Company.
Forward-Looking Statements
Certain statements contained in this quarterly report, including without
limitation statements containing the words "believes," "anticipates,"
"intends," "expects" and words of similar import, constitute "forward-looking
statements" within the meaning of Section 27A of the Securities Act and
Section 21E of the Exchange Act. Such forward-looking statements involve known
and unknown risks, uncertainties and other factors that may cause the actual
results, performance or achievements of the Company or industry results to be
materially different from any future results, performance or achievements
expressed or implied by such forward-looking statements. Such factors include,
among others, the following: general economic and business conditions, both
nationally and in the regions in which the Company operates; industry
capacity; demographic changes; existing government regulations and changes in,
or the failure to comply with, government regulations; legislative proposals
for health care reform; the ability to enter into managed care provider
arrangements on acceptable terms; changes in Medicare and Medicaid
reimbursement levels; liability and other claims asserted against the
19
Company; competition; dependence on physician referrals; changes in business
strategy or development plans; the ability to attract and retain qualified
personnel, including physicians; the lack of assurance that the cost savings,
growth opportunities and synergies expected from the Merger will be achieved;
the lack of assurances as to the future performance of the combined companies;
the availability and terms of capital to fund the expansion of the Company's
business, including the acquisition of additional facilities; and other
factors referenced in this quarterly report. GIVEN THESE UNCERTAINTIES,
INVESTORS ARE CAUTIONED NOT TO PLACE UNDUE RELIANCE ON SUCH FORWARD-LOOKING
STATEMENTS.
20
PART II
OTHER INFORMATION
ITEMS 1, 3, AND 4 ARE NOT APPLICABLE.
ITEM 2: CHANGES IN SECURITIES
(c) Recent Sales of Unregistered Securities
On June 15, 1998, Total Renal Care, Inc. purchased all of the assets of
Dialysis Center of Middle Georgia, Inc. As partial consideration for the
purchase, the Company issued 47,574 unregistered shares of its common stock to
Dialysis Center of Middle Georgia, Inc. Such unregistered shares were exempt
from registration under the Securities Act of 1933 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.
ITEM 5. OTHER INFORMATION
Rule 14a-4 of the Securities and Exchange Commission's proxy rules allows
the Company to use discretionary voting authority to vote on matters coming
before an annual meeting of stockholders, if the Company does not have notice
of the matter at least 45 days before the date on which the Company first
mailed its proxy materials for the prior year's annual meeting of stockholders
or the date specified by an advance notice provision in the Company's Bylaws.
The Company's Bylaws contain such an advance notice provision. For the
Company's 1999 Annual Meeting of Stockholders, stockholders must submit such
written notice to the Secretary of the Company no earlier than March 7, 1999
nor later than April 6, 1999.
This requirement is separate and apart from the Securities and Exchange
Commission's requirements that a stockholder must meet in order to have a
stockholder proposal included in the Company's proxy statement under Rule 14a-
8. For the Company's 1999 Annual Meeting of Stockholders, any stockholder who
wishes to submit a proposal for inclusion in the Company's proxy materials
pursuant to Rule 14a-8 must submit such proposal to the Secretary of the
Company no later than February 5, 1999.
ITEM 6: EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
27 Financial Data Schedules--3 months ended
27.1 Financial Data Schedules--6 months ended
(b) Reports on Form 8-K
Current Report on Form 8-K, dated April 1, 1998, reporting under Item 5
the issuance by the Company of a press release announcing charges
expected to be taken in connection with the Merger.
Current Report on Form 8-K, dated April 30, 1998, reporting under Item
5 the issuance by the Company of a press release announcing charges
taken in connection with the Merger and a press release announcing
earnings for the first quarter.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
TOTAL RENAL CARE HOLDINGS, INC.
(Registrant)
/s/ John E. King
By: _________________________________
John E. King
Vice President, Finance and
Chief Financial Officer
Date: August 14, 1998
John E. King is signing in the dual capacities as (i) Chief Financial
Officer and (ii) a duly authorized officer of the Company.
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