- ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 -------------------------- FORM 10-K/A (AMENDMENT NO. 2) (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, 1997 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 INCORPORATION (I.R.S. EMPLOYER IDENTIFICATION NO.) 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 $0.001 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. [X] 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 16, 1998, based on the price at which the Common Stock was sold as of March 16, 1998, was $2,833,602,632. The number of shares of the Registrant's Common Stock outstanding as of March 16, 1998 was 80,463,321 shares. DOCUMENTS INCORPORATED BY REFERENCE None. - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- This Amendment No. 2 on Form 10-K/A to the registrant's 10-K for the fiscal year ended December 31, 1997 is being filed solely to include an audit report of PricewaterhouseCoopers LLP on the consolidated financial statements included in Amendment No. 1 on Form 10-K/A and to omit the audit reports of Price Waterhouse LLP, Coopers & Lybrand L.L.P., Baird, Kurtz & Dobson and Deloitte & Touche LLP. The consolidated financial statements remain the same as they were at the time of their inclusion in Amendment No. 1 on Form 10-K/A other than for the addition of Note 18 "Subsequent Events (unaudited)". INDEX TO FINANCIAL STATEMENTS PAGE ---- Report of Independent Accountants of PricewaterhouseCoopers LLP............ F-2 Consolidated Balance Sheets................................................ F-3 Consolidated Statements of Income.......................................... F-4 Consolidated Statements of Stockholders' Equity............................ F-5 Consolidated Statements of Cash Flows...................................... F-6 Notes to Consolidated Financial Statements................................. F-7 F-1 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, 1996 and 1997, 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 years ended December 31, 1996 and 1997 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. PricewaterhouseCoopers LLP Seattle, Washington February 16, 1998, except as to the pooling of interests with Renal Treatment Centers, Inc. which is as of May 14, 1998 F-2 TOTAL RENAL CARE HOLDINGS, INC. CONSOLIDATED BALANCE SHEETS (IN THOUSANDS) DECEMBER 31, -------------------- 1996 1997 -------- ---------- ASSETS ------ Cash and cash equivalents.................................. $ 21,327 $ 6,143 Investments................................................ 41,202 Patient accounts receivable, less allowance for doubtful accounts of $15,765,000 and $30,695,000, respectively..... 156,207 248,408 Receivable from Tenet...................................... 347 534 Inventories................................................ 10,433 15,766 Deferred income taxes...................................... 5,383 9,853 Prepaid expenses and other current assets.................. 17,304 21,500 -------- ---------- Total current assets..................................... 252,203 302,204 -------- ---------- Property and equipment, net................................ 97,844 172,838 Notes receivable from related parties...................... 1,919 11,344 Deferred taxes, noncurrent................................. 385 Other long-term assets..................................... 1,992 17,198 Intangible assets, net..................................... 311,263 774,266 -------- ---------- $665,221 $1,278,235 ======== ========== LIABILITIES AND STOCKHOLDERS' EQUITY ------------------------------------ Accounts payable........................................... $ 23,841 $ 33,283 Employee compensation and benefits......................... 16,349 25,430 Other accrued liabilities.................................. 12,605 15,927 Current portion of long-term obligations................... 14,433 27,810 -------- ---------- Total current liabilities................................ 67,228 102,450 -------- ---------- Long-term debt............................................. 233,126 723,782 -------- ---------- Deferred income taxes...................................... 61 2,500 -------- ---------- Other long-term liabilities................................ 993 1,594 -------- ---------- Minority interests......................................... 4,714 19,079 -------- ---------- Commitments and contingencies (Notes 8, 9 and 13) Stockholders' equity: Preferred stock ($0.001 par value; 5,000,000 shares authorized; none outstanding)........................... -- -- Common Stock ($0.001 par value; 195,000,000 shares authorized; 76,686,364 and 77,991,595 shares issued and outstanding)............................................ 77 78 Additional paid-in capital............................... 343,586 358,492 Notes receivable from stockholders....................... (2,827) (3,030) Retained earnings........................................ 18,263 73,290 -------- ---------- Total stockholders' equity........................... 359,099 428,830 -------- ---------- $665,221 $1,278,235 ======== ========== See accompanying notes to consolidated financial statements. F-3 TOTAL RENAL CARE HOLDINGS, INC. CONSOLIDATED STATEMENTS OF INCOME (IN THOUSANDS, EXCEPT PER SHARE DATA) YEAR SEVEN MONTHS ENDED ENDED DECEMBER 31, YEAR ENDED DECEMBER 31, MAY 31, -------------------- ------------------------------ 1995 1994 1995 1995 1996 1997 -------- ----------- -------- ---------- -------- -------- (UNAUDITED) (UNAUDITED) Net operating revenues.. $214,425 $122,065 $176,463 $299,411 $498,024 $760,997 -------- -------- -------- -------- -------- -------- Operating expenses: Facilities............ 146,560 83,370 115,219 198,654 344,180 510,990 General and administrative....... 17,856 10,099 12,117 21,000 32,350 50,099 Provision for doubtful accounts............. 5,492 3,486 4,552 7,580 15,737 20,525 Depreciation and amortization......... 12,343 7,098 10,808 18,603 32,445 54,603 Merger costs.......... 500 2,088 2,808 -------- -------- -------- -------- -------- -------- Total operating expenses............ 182,251 104,053 143,196 247,925 427,520 636,217 -------- -------- -------- -------- -------- -------- Operating income........ 32,174 18,012 33,267 51,486 70,504 124,780 Interest expense, net of capitalized interest... (8,651) (4,472) (7,694) (12,830) (13,417) (28,214) Interest rate swap-- early termination costs.................. Interest income......... 800 634 863 1,029 3,858 3,175 -------- -------- -------- -------- -------- -------- Income before income taxes, minority interests, extraordinary item and cumulative effect of change in accounting principle............ 24,323 14,174 26,436 39,685 60,945 99,741 Income taxes............ 7,827 4,759 9,931 13,841 22,960 40,212 -------- -------- -------- -------- -------- -------- Income before minority interests, extraordinary item and cumulative effect of change in accounting principle.............. 16,496 9,415 16,505 25,844 37,985 59,529 Minority interests in income of consolidated subsidiaries........... 1,593 878 1,784 2,544 3,578 4,502 -------- -------- -------- -------- -------- -------- Income before extraordinary item and cumulative effect of change in accounting principle.............. 14,903 8,537 14,721 23,300 34,407 55,027 Extraordinary loss related to early extinguishment of debt, net of tax............. 2,555 2,555 7,700 Cumulative effect of a change in accounting principle, net of tax.. -------- -------- -------- -------- -------- -------- Net income.............. $ 14,903 $ 8,537 $ 12,166 $ 20,745 $ 26,707 $ 55,027 ======== ======== ======== ======== ======== ======== Earnings per common share: Income before extraordinary item and cumulative effect of a change in accounting principle, net of tax........... $ 0.33 $ 0.20 $ 0.26 $ 0.43 $ 0.46 $ 0.71 Extraordinary loss.... (0.04) (0.05) (0.10) Cumulative effect of a change in accounting principle, net of tax............... -------- -------- -------- -------- -------- -------- Net income............ $ 0.33 $ 0.20 $ 0.22 $ 0.38 $ 0.36 $ 0.71 ======== ======== ======== ======== ======== ======== Weighted average number of common shares outstanding... 45,301 42,682 57,109 53,936 74,042 77,524 ======== ======== ======== ======== ======== ======== Earnings per common share--assuming dilution: Income before extraordinary item and cumulative effect of a change in accounting principle, net of tax........... $ 0.31 $ 0.19 $ 0.25 $ 0.40 $ 0.45 $ 0.69 Extraordinary loss.... (0.05) (0.04) (0.10) Cumulative effect of a change in accounting principle, net of tax.................. -------- -------- -------- -------- -------- -------- Net income............ $ 0.31 $ 0.19 $ 0.20 $ 0.36 $ 0.35 $ 0.69 ======== ======== ======== ======== ======== ======== Weighted average number of common shares and equivalents outstanding--assuming dilution............. 47,506 44,879 60,693 57,744 77,225 79,975 ======== ======== ======== ======== ======== ======== See accompanying notes to consolidated financial statements. F-4 TOTAL RENAL CARE HOLDINGS, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (IN THOUSANDS, EXCEPT SHARE DATA) COMMON STOCK ------------------ NOTES ADDITIONAL RECEIVABLE RETAINED PAID-IN FROM EARNINGS SHARES AMOUNT CAPITAL STOCKHOLDERS (DEFICIT) TOTAL ---------- ------ ---------- ------------ --------- -------- Balance at May 31, 1994................... 21,642,062 $22 $ 25,282 $ 40,296 $ 65,600 Shares issued to Tenet.. 4,888,890 4 4 Shares issued in change of control: DLJMB.................. 11,666,667 12 10,488 10,500 Employees.............. 2,077,778 2 1,868 $ (995) 875 Shares issued in offerings.............. 7,393,315 7 51,994 52,001 Stock issuance costs.... (2,172) (2,172) Dividend paid to Tenet: Cash................... (75,500) (75,500) Intercompany receiv- able.................. (6,152) (6,152) Shares issued in acquisitions........... 729,687 1 2,258 2,259 Shares issued to employees and others... 1,275,420 1 1,147 (513) 635 Options exercised....... 476,275 1 315 316 Acquisition of treasury stock.................. (5,797) (47) (47) Dividend distribution... (1,473) (1,473) Net income.............. 14,903 14,903 ---------- --- -------- ------- -------- -------- Balance at May 31, 1995................... 50,144,297 50 91,133 (1,508) (27,926) 61,749 Net proceeds from initial public offering............... 11,500,000 12 98,282 98,294 Shares and options issued in acquisitions........... 1,574,616 1 8,453 8,454 Shares issued to employees and others... 46,117 59 (13) 46 Shares issued to repay debt................... 67,447 523 523 Options exercised....... 2,355,894 3 2,866 (1,330) 1,539 Conversion of mandatorily redeemable common stock........... 1,136,112 1 3,989 3,990 Payments on notes receivable, net of interest accrued....... 78 78 Income tax benefit related to stock options exercised...... 1,792 1,792 Acquisition of treasury stock.................. (43,868) (347) (347) Dividend distribution... (1,499) (1,499) Adjustment to conform fiscal years of RTC.... 6,377 6,377 Net income.............. 12,166 12,166 ---------- --- -------- ------- -------- -------- Balance at December 31, 1995................... 66,780,615 67 206,750 (2,773) (10,882) 193,162 Net proceeds from stock offerings.............. 6,666,667 7 128,311 128,318 Shares issued in acquisitions........... 161,095 2,810 2,810 Shares issued in connection with merger................. 2,422,534 2 105 3,097 3,204 Shares issued to employees and others... 1,883 15 15 Shares issued to repay debt................... 190,109 1,474 1,474 Options exercised....... 463,461 1 3,183 3,184 Interest accrued on notes receivable, net of payments............ (54) (54) Income tax benefit related to stock options exercised...... 938 938 Dividend distribution... (659) (659) Net income.............. 26,707 26,707 ---------- --- -------- ------- -------- -------- Balance at December 31, 1996................... 76,686,364 77 343,586 (2,827) 18,263 359,099 Shares issued in acquisitions........... 17,613 273 273 Shares issued to employees and others... 174,775 1,773 1,773 Options exercised....... 447,456 2,019 2,019 Shares issued to repay debt................... 664,580 1 5,147 5,148 Interest accrued on notes receivable, net of payments............ (203) (203) Income tax benefit related to stock options exercised...... 5,453 5,453 Grant of stock options.. 235 235 Issuance of treasury stock to repay debt.... 807 6 6 Net income.............. 55,027 55,027 ---------- --- -------- ------- -------- -------- Balance at December 31, 1997................... 77,991,595 $78 $358,492 $(3,030) $ 73,290 $428,830 ========== === ======== ======= ======== ======== See accompanying notes to consolidated financial statements. F-5 TOTAL RENAL CARE HOLDINGS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS) YEAR SEVEN MONTHS ENDED ENDED DECEMBER 31, YEAR ENDED DECEMBER 31, MAY 31, -------------------- -------------------------------- 1995 1994 1995 1995 1996 1997 -------- ----------- -------- ---------- --------- --------- (UNAUDITED) (UNAUDITED) Cash flows from operating activities: Net income............ $ 14,903 $ 8,537 $ 12,166 $ 20,745 $ 26,707 $ 55,027 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization......... 12,343 7,098 10,808 18,603 32,445 54,603 Extraordinary loss.... 4,258 4,258 12,623 Non-cash interest..... 6,947 3,274 5,228 8,901 4,396 Other non-cash merger related expenses..... Compensation expense from stock option exercise............. Deferred income taxes................ (1,213) (481) (2,219) (2,233) (1,258) (5,131) Provision for doubtful accounts............. 5,492 3,486 4,552 7,580 15,737 20,525 Change in accounting principle, net of tax.................. Loss (gain) on disposition of property and equipment............ (37) (3) (144) (146) (20) 76 Equity in (earnings) losses from affiliate............ (96) (51) (267) (267) 16 (40) Minority interests in income of consolidated subsidiaries......... 1,593 878 1,784 2,544 3,578 4,502 Changes in operating assets and liabilities, net of effect of acquisitions: Accounts receivable.. (28,612) (16,919) (26,608) (40,247) (52,909) (109,811) Inventories.......... (383) (804) (968) (267) (3,030) (1,843) Prepaid expenses and other current assets.............. (1,363) (398) (277) (432) (8,805) (143) Other long-term assets.............. (300) (300) (9,166) Accounts payable..... 1,618 2,842 (560) (3,194) 2,147 (992) Employee compensation and benefits........ 3,473 1,453 (354) 1,216 6,043 8,539 Other accrued liabilities......... 5,115 1,262 3,757 6,867 (207) 2,791 Income taxes payable............. (475) (483) 2,323 816 (6,315) 2,329 Other long-term liabilities......... 107 1,214 916 (222) 13 -------- -------- -------- -------- --------- --------- Net cash provided by operating activities......... 19,305 9,798 14,393 25,360 30,926 21,279 -------- -------- -------- -------- --------- --------- Cash flow from investing activities: Purchases of property and equipment........ (8,935) (4,912) (8,896) (14,713) (41,740) (62,033) Additions to intangible assets.... (1,573) (734) (1,520) (3,086) (10,775) (35,224) Cash paid for acquisitions, net of cash acquired........ (72,799) (29,532) (35,450) (56,911) (179,002) (455,090) Purchase of investments.......... (38,500) (26,223) (55,311) Sale of investments... 38,589 38,589 2,662 14,109 41,202 Investment in affiliate............ (972) (972) (46) (2,935) Issuance of long-term notes receivable..... (1,379) (1,379) (540) (12,502) Proceeds from disposition of property and equipment............ 62 28 244 495 236 365 -------- -------- -------- -------- --------- --------- Net cash used in investing activities......... (83,156) (22,784) (47,973) (73,904) (273,069) (526,217) Cash flows from financing activities: Advances from Tenet... 2,874 3,499 Proceeds from long- term borrowings...... 18,539 14,987 258 258 107 4,511 Principal payments on long-term obligations.......... (14,414) (61) (2,094) (9,044) (8,649) (26,269) Proceeds from convertible notes.... 121,250 Cash dividends paid to Tenet................ (75,500) (75,500) Payment of dividend distribution......... (1,473) (1,023) (417) (1,499) (659) Net proceeds from debt offering............. 66,841 66,140 Cash paid to retire bonds................ (31,912) (31,912) (68,499) Proceeds from bank credit facility...... 13,253 31,981 50,916 239,835 505,000 Payment of bank credit facility............. (4,000) (31,625) (31,625) (188,510) Net proceeds from issuance of Common Stock................ 62,159 11,122 99,947 100,267 131,517 3,792 Income tax benefit related to stock options exercised.... 1,792 1,792 938 5,453 Cash received on notes receivable from stockholders......... 175 175 170 35 Distributions to minority interests... (1,708) (723) (1,102) (2,087) (2,442) (2,768) -------- -------- -------- -------- --------- --------- Net cash provided by financing activities......... 66,571 18,441 67,003 77,241 225,058 489,754 -------- -------- -------- -------- --------- --------- Net increase (decrease) in cash............... 2,720 5,455 33,423 28,697 (17,085) (15,184) Cash and cash equivalents at beginning of period... 2,109 4,260 4,989 9,715 38,412 21,327 -------- -------- -------- -------- --------- --------- Cash and cash equivalents at end of period................ $ 4,829 $ 9,715 $ 38,412 $ 38,412 $ 21,327 $ 6,143 ======== ======== ======== ======== ========= ========= 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 NOTE 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 also in Argentina, Puerto Rico, Europe and 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. On February 27, 1998 the Company acquired Renal Treatment Centers, Inc. ("RTC"), with headquarters in Berwyn, Pennsylvania (the "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 shareholders 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 the 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. In conjunction with this transaction, the Board and the Company's stockholders authorized an additional 140,000,000 shares of Common Stock. The RTC merger transaction has been accounted for as a pooling of interests and as such, the consolidated financial statements have been restated to include RTC for all periods presented. RTC has always used a December 31 year end while the Company used a May 31 year end until May 31, 1995 after which it changed to a December 31 fiscal year end. Accordingly, the restated consolidated financial statements combine the Company's balance sheet as of December 31, 1997 and 1996 and the results of operations and cash flows for the twelve months ended December 31, 1997 and 1996, the seven month period ended December 31, 1995 and the twelve months ended May 31, 1995 with RTC's balance sheet as of December 31, 1997 and 1996 and the results of operations and cash flows for the twelve months ended December 31, 1997 and 1996, the six months ended December 31, 1995 and the twelve months ended December 31, 1994, respectively. Net revenue and net income of RTC for the six month period ended June 30, 1995 was $77,816,000 and $6,377,000, respectively, with the net income reflected as an adjustment to retained earnings effective July 1, 1995. See Note 17. There were no transactions between the Company and RTC prior to the combination and immaterial adjustments were recorded to conform RTC's accounting policies. Certain reclassifications were made to the RTC financial statements to conform to the Company's presentations. 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. In February 1996, RTC acquired, through two separate transactions, Intercontinental Medical Services, Inc. ("IMS") and Midwest Dialysis Unit and its affiliates (collectively "MDU"). Each of the transactions was separately accounted for as a pooling of interests. The consolidated financial statements include the results of IMS and MDU as of January 1, 1996. Prior year financial statements have not been restated to reflect these transactions because the effect of such transactions is not material. F-7 TOTAL RENAL CARE HOLDINGS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) In July 1996, RTC acquired Panama City Artificial Kidney Center, Inc. and North Florida Artificial Kidney Center, Inc. (collectively "the Group"). In July 1995, RTC acquired Wichita Dialysis Center, P.A., Southeast Kansas Dialysis Center, P.A., Garden City Dialysis Center, P.A. and Wichita Dialysis Center, East, P.A. (the "Wichita Companies"). In March 1995, RTC acquired Healthcare Corporation and its affiliates (collectively, "HCC"). These transactions were accounted for as a pooling of interests. Accordingly, the consolidated financial statements have been prepared to give retroactive effect to the mergers. 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, 1995, the seven months ended December 31, 1995 and the years ended December 31, 1996 and 1997, the Company received approximately 72%, 68%, 64% and 61%, respectively, of its dialysis revenues from Medicare and Medicaid programs. Accounts receivable from Medicare and Medicaid amounted to $119,611,000 and $205,564,000 as of December 31, 1996, and 1997, 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 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 January 1998, a permanent 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. 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. In the Fall of 1997, the Office of Inspector General of the HHS issued an F-8 TOTAL RENAL CARE HOLDINGS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) advisory opinion which would allow the Company to make grants to a foundation that may provide for such premium payments on behalf of ESRD patients. In addition, legislation is currently pending which would permit the Company to pay premiums for insurance coverage for patients with proven financial hardship. Cash and cash equivalents--Cash equivalents are highly liquid investments with original maturities of three months or less. Investments--Investments were comprised of investments in corporate bonds and government and government agency securities. Investment income is recognized when earned and realized gains and losses are recognized on a trade date basis, computed based on original cost. The investments are stated at cost, which approximates fair market value. All investments were managed by one financial institution. Subsequent to December 31, 1996, all investments were liquidated, resulting in an immaterial realized gain. 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. Capitalized interest--The Company capitalizes interest associated with the costs of significant facility expansion and construction. Interest is capitalized by using an interest rate which is equal to the weighted average borrowing rate on the Company's long-term debt. Approximately $685,000 in interest expense was capitalized for the year ended December 31, 1997. Intangible assets--Business acquisition costs allocated to patient lists are amortized generally over five to eight years using the straight-line method. Business acquisition costs allocated to covenants not to compete are amortized over the terms of the agreements, typically three to eleven years, using the straight-line method. Deferred debt issuance costs are amortized over the term of the debt using the effective interest method. Pre-opening and development costs, included in other intangible assets, are amortized over five years. (See Note 18.) 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 40 years using the straight-line method. 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 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. F-9 TOTAL RENAL CARE HOLDINGS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) 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, 1997, these included 29 active 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 10). Earnings per share--In February 1997, the Financial Accounting Standards Board issued the Statement of Financial Accounting Standards No. 128, Earnings Per Share ("SFAS 128"). The Company adopted SFAS 128 in the fourth quarter of 1997, as required by this pronouncement. SFAS 128 establishes standards for computing and presenting earnings per share. Basic earnings per share is calculated by dividing net income before extraordinary item, and net income by the weighted average number of shares of Common Stock outstanding. Accordingly, earnings per common share assuming dilution includes the dilutive effects of stock options and warrants using the treasury stock method, in determining the weighted average number of shares of Common Stock outstanding. The effect of the Company's $125,000,000 convertible debt issued during 1996 is included only if antidilutive. For the years ended December 31, 1996 and 1997, the effect of the convertible debt is antidilutive and as such, is not to be included in the diluted EPS calculation. Earnings per share for all periods presented have been restated following the provisions of SFAS 128. Interest rate swap agreements--The Company has entered into two interest rate swap agreements as a means of managing its interest rate exposure (See Notes 8 and 18). The Company has not entered these agreements for trading or speculative purposes. These agreements have 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 these agreements is a large international financial institution. These interest rate swap agreements subject the Company to financial risk that will vary during the life of the agreements 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, investments, accounts receivable, notes receivable from related parties, accounts payable, employee compensation and benefits, and other accrued liabilities. These balances, as presented in the financial statements at December 31, 1996 and 1997, approximate their fair value. Borrowings under the Company's three credit facilities, of which F-10 TOTAL RENAL CARE HOLDINGS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) $590,000,000 was outstanding as of December 31, 1997, reflect fair value as they are 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 $49,000 at December 31, 1997. The fair value of convertible subordinated notes was approximately $149,700,000 at December 31, 1997. Foreign currency translation--The Company's principal operations outside of the United States are in Argentina. The currency in Argentina floats with the U.S. dollar, therefore, there are no significant foreign currency translation adjustments. The Company's operations in Europe were nominal through December 31, 1997. 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 audited. In the opinion of management, the unaudited consolidated financial information 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. NOTE 2--PROPERTY AND EQUIPMENT Property and equipment comprise the following: DECEMBER 31, -------------------------- 1996 1997 ------------ ------------ Land.................... $ 473,000 $ 1,410,000 Buildings............... 5,428,000 6,463,000 Leaseholds and improvements........... 40,162,000 78,956,000 Equipment............... 93,194,000 147,824,000 Construction in progress............... 4,638,000 7,352,000 ------------ ------------ 143,895,000 242,005,000 Less accumulated depreciation and amortization........... (46,051,000) (69,167,000) ------------ ------------ Property and equipment, net.................... $ 97,844,000 $172,838,000 ============ ============ Depreciation and amortization expense on property and equipment was $5,315,000, $4,855,000, $13,903,000 and $22,160,000 for the year ended May 31, 1995, the seven months ended December 31, 1995, and the years ended December 31, 1996 and 1997, respectively. F-11 TOTAL RENAL CARE HOLDINGS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) NOTE 3--INTANGIBLE ASSETS A summary of intangible assets is as follows: DECEMBER 31, -------------------------- 1996 1997 ------------ ------------ Goodwill......................................... $244,539,000 $624,740,000 Patient lists.................................... 58,119,000 122,463,000 Noncompetition agreements........................ 38,984,000 61,797,000 Deferred debt issuance costs..................... 9,122,000 23,415,000 Other............................................ 6,277,000 18,891,000 ------------ ------------ 357,041,000 851,306,000 Less accumulated amortization.................... (45,778,000) (77,040,000) ------------ ------------ $311,263,000 $774,266,000 ============ ============ Amortization expense applicable to intangible assets was $7,028,000, $5,953,000, $18,542,000 and $32,443,000 for the year ended May 31, 1995, the seven months ended December 31, 1995, and the years ended December 31, 1996 and 1997, respectively. NOTE 4--PREPAID EXPENSES AND OTHER CURRENT ASSETS Prepaid expenses and other current assets comprise the following: DECEMBER 31, ----------------------- 1996 1997 ----------- ----------- Supplier rebates and other non-trade receivables... $ 6,594,000 $10,886,000 Prepaid income taxes............................... 6,491,000 5,501,000 Prepaid expenses................................... 4,084,000 4,910,000 Deposits........................................... 135,000 203,000 ----------- ----------- $17,304,000 $21,500,000 =========== =========== NOTE 5--NOTES RECEIVABLE FROM RELATED PARTIES During the year ended December 31, 1997 the Company entered into various agreements to provide funding for expansion to certain companies that provide renal dialysis or renal related services. These notes receivables are secured by the assets and operations of these companies. Approximately $9,205,000 was outstanding and included in notes receivable from related parties at December 31, 1997. Additionally, a note receivable from the Company's President was approximately $1,678,000 and $1,820,000 at December 31, 1996 and 1997, respectively. NOTE 6--OTHER ACCRUED LIABILITIES Other accrued liabilities comprise the following: DECEMBER 31, ----------------------- 1996 1997 ----------- ----------- Customer refunds..................................... $ 6,068,000 $ 5,278,000 Accrued interest..................................... 4,185,000 5,395,000 Other................................................ 2,352,000 5,254,000 ----------- ----------- $12,605,000 $15,927,000 =========== =========== F-12 TOTAL RENAL CARE HOLDINGS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) NOTE 7--INCOME TAXES The provision for income taxes consists of the following: YEARS ENDED DECEMBER YEAR ENDED SEVEN MONTHS ENDED 31, MAY 31, DECEMBER 31, ------------------------ 1995 1995 1996 1997 ----------- ------------------ ----------- ----------- Current Federal......... $ 7,602,000 $9,546,000 $20,655,000 $35,128,000 State........... 1,438,000 1,462,000 3,562,000 6,430,000 Foreign......... 1,070,000 Deferred Federal......... (1,002,000) (943,000) (1,151,000) (1,963,000) State........... (211,000) (134,000) (106,000) (453,000) ----------- ---------- ----------- ----------- $ 7,827,000 $9,931,000 $22,960,000 $40,212,000 =========== ========== =========== =========== Temporary differences which give rise to deferred tax assets and liabilities are as follows: DECEMBER 31, ------------------------ 1996 1997 ----------- ----------- Receivables, primarily allowance for doubtful accounts....................................... $ 4,860,000 $ 8,635,000 Intangibles, primarily patient lists............ 5,241,000 6,055,000 Property and equipment.......................... 33,000 Accrued vacation................................ 831,000 2,114,000 Deferred compensation........................... 107,000 67,000 Foreign NOL carryforward........................ 944,000 Foreign tax credit carryforward................. 200,000 Other........................................... 14,000 17,000 ----------- ----------- Gross deferred tax assets....................... 11,053,000 18,065,000 Depreciation and amortization................... (1,976,000) (2,454,000) Intangible assets............................... (3,442,000) (6,712,000) Change in tax accounting method................. (313,000) (17,000) ----------- ----------- Gross deferred tax liabilities................ (5,731,000) (9,183,000) Valuation allowance........................... (1,144,000) ----------- ----------- Net deferred tax assets....................... $ 5,322,000 $ 7,738,000 =========== =========== The valuation allowance relates to deferred tax assets established under SFAS No. 109 for foreign net operating loss carryforwards of $2.86 million and foreign tax credit carryforwards of $200,000. These unutilized loss and credit carryforwards which expire in 2002, will be carried forward to future years for possible utilization. No benefit of these carryforwards has been recognized on the financial statements. F-13 TOTAL RENAL CARE HOLDINGS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) The reconciliation between the Company's effective tax rate and the U.S. federal income tax rate on income is as follows: SEVEN MONTHS YEARS ENDED YEAR ENDED ENDED DECEMBER 31, MAY 31, DECEMBER 31, -------------- 1995 1995 1996 1997 ---------- ------------ ------ ------ Federal income tax rate............ 34.0% 35.0% 35.0% 35.0% State taxes, net of federal benefit........................... 4.0 3.8 4.1 4.1 Foreign income taxes............... 0.4 Nondeductible amortization of intangible assets................. 0.9 1.5 1.1 0.8 Federal and state income tax benefit from S corporation status of HCC............................ (4.0) (1.1) (0.3) Valuation allowance................ 1.2 Other.............................. (0.5) 1.1 0.1 0.7 ---- ---- ------ ------ Effective tax rate................. 34.4 40.3 40.0 42.2 Minority interests in partnerships...................... (2.2) (2.7) (2.3) (1.9) ==== ==== ====== ====== Effective tax rate before minority interests......................... 32.2% 37.6% 37.7% 40.3% ==== ==== ====== ====== NOTE 8--LONG-TERM DEBT Long-term debt comprises: DECEMBER 31, -------------------------- 1996 1997 ------------ ------------ Credit Facilities.............................. $ 85,000,000 $590,000,000 Convertible Subordinated Notes, 5 5/8%, due 2006.......................................... 125,000,000 125,000,000 Acquisition obligations........................ 29,091,000 26,651,000 Capital lease obligations(Note 9).............. 6,716,000 5,180,000 Other.......................................... 1,752,000 4,761,000 ------------ ------------ 247,559,000 751,592,000 Less current portion........................... (14,433,000) (27,810,000) ------------ ------------ $233,126,000 $723,782,000 ============ ============ Maturities of long-term debt for the years ending December 31 are as follows: 1998............................................................ $ 27,810,000 1999............................................................ 3,180,000 2000............................................................ 45,775,000 2001............................................................ 60,507,000 2002............................................................ 60,305,000 Thereafter...................................................... 554,015,000 12% Senior Subordinated Discount Notes--In August 1994, the Company completed a public offering consisting of units of 12% Senior Subordinated Discount Notes (the "1994 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 1994 Notes. The 1994 Notes had a stated maturity of August 15, 2004 with the first semi-annual cash interest payment 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%. F-14 TOTAL RENAL CARE HOLDINGS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) On December 7, 1995, the Company redeemed 35% of the accreted value of the 1994 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 1994 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. Credit Facilities--At December 31, 1997 and 1996, the Company had outstanding borrowings under its revolving credit facilities of $353,000,000 and $85,000,000, respectively. (See Note 18). On October 24, 1997, the Company expanded its existing $400 million revolving credit facility to an aggregate of $1,050,000,000 consisting of a seven-year $800 million revolving credit facility and a ten-year $250 million term facility. Under the $800 million revolving credit facility, up to $100,000,000 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. Up to $75,000,000 of the available letters of credit or borrowings under the revolving credit facility may be utilized for foreign financing. In general, borrowings under the credit facilities 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%); or (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 1.75% 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 upon, the Alternate Base Rate. Maximum borrowings under the $800 million revolving credit facility will be reduced by $75,000,000 on September 30, 2001, $125,000,000 on September 30, 2002, and another $200,000,000 on September 30, 2003, and the revolving credit facility terminates on September 30, 2004. Under the $250 million term facility, payments of $2,500,000 shall be made each consecutive year beginning on September 30, 1998 and continuing through September 30, 2006. The remaining balance of $227,500,000 is due on September 30, 2007 when the term facility terminates. The 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. The Company is in compliance with all such covenants. The Company and certain of its subsidiaries, including Total Renal Care, Inc. ("TRC"), TRC West, Inc., Total Renal Care Acquisition Corp., RTC, Renal Treatment Centers-Mid Atlantic, Inc., Renal Treatment Centers-Northeast, Inc., Renal Treatment Centers-California, Inc., Renal Treatment Centers-West, Inc. and Renal Treatment Centers-Southeast, Inc., have guaranteed the Company's obligations under the credit facilities on a senior basis. RTC also had a Credit Agreement which provided for a $350,000,000 revolving credit/term facility available to fund acquisitions and general working capital requirements, of which $237,000,000 and no amounts were outstanding as of December 31, 1997 and December 31, 1996, respectively. Borrowings under the RTC Credit Agreement bear interest at either (i) the agent bank's base rate payable on a quarterly basis or (ii) a one-, two-, three-, or six-month period Libor rate plus .50% to 1.50%, depending on RTC's ratio of consolidated debt to annualized cash flow, payable at maturity, or, in the case of a six-month period rate, at three months and maturity. The weighted average interest rate of all loans outstanding at December 31, 1997 was 6.9%. The loans are collateralized by all stock of RTC's subsidiaries and the assignment of all intercompany notes. The RTC Credit Agreement was terminated and repaid with borrowings under the TRCH Credit Facilities on February 27, 1998. F-15 TOTAL RENAL CARE HOLDINGS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) Convertible Subordinated Notes--In June 1996, RTC issued $125,000,000 of 5 5/8% Convertible Subordinated Notes due 2006 (the "RTC Notes"). The RTC Notes are convertible, at the option of the holder, at any time after August 12, 1996 through maturity, unless previously redeemed or repurchased, into Common Stock at a conversion price of $25.62 principal amount per share, subject to certain adjustments. At any time on or after July 17, 1999, all or any part of the RTC Notes will be redeemable at the Company's option on at least 15 and not more than 60 days notice as a whole or, from time to time, in part at redemption prices ranging from 103.94% to 100% of the principal amount thereof, depending on the year of redemption, together with accrued interest to, but excluding, the date fixed for redemption. The 5 5/8% subordinated convertible notes are issued by the Company's wholly- owned subsidiary, Renal Treatment Centers, Inc. and is guaranteed by the Company. The following is summarized financial information of RTC: DECEMBER 31, ------------------------- 1996 1997 ------------ ------------ Cash and cash equivalents............................ $ 1,446,000 $ 743,000 Accounts receivable, net............................. 65,198,000 95,927,000 Other current assets................................. 54,273,000 19,484,000 ------------ ------------ Total current assets............................... 120,917,000 116,154,000 Property and equipment, net.......................... 39,578,000 72,777,000 Intangible assets, net............................... 130,646,000 384,529,000 Other assets......................................... 2,807,000 12,034,000 ------------ ------------ Total assets....................................... $293,948,000 $585,494,000 ============ ============ Current liabilities.................................. $ 35,240,000 $ 62,673,000 Long-term debt....................................... 130,574,000 367,219,000 Other long-term liabilities.......................... -- 444,000 Stockholder's equity................................. 128,134,000 155,158,000 ------------ ------------ $293,948,000 $585,494,000 ============ ============ YEAR ENDED DECEMBER 31, -------------------------------------- 1995 1996 1997 ------------ ------------ ------------ Net operating revenues.................. $164,568,000 $225,077,000 $322,792,000 Total operating expenses................ 139,748,000 203,402,000 277,869,000 ------------ ------------ ------------ Operating income........................ 24,820,000 21,675,000 44,923,000 Interest expense, net................... 2,557,000 4,384,000 11,802,000 ------------ ------------ ------------ Income (loss) before income taxes....... 22,263,000 17,291,000 33,121,000 Income taxes............................ 7,632,000 6,609,000 15,071,000 ------------ ------------ ------------ Net income.............................. $ 14,631,000 $ 10,682,000 $ 18,050,000 ============ ============ ============ Acquisition Obligations--In 1994, pursuant to a business acquisition, RTC entered into an agreement to pay $7,364,100 in annual installments commencing June 1995 through June 1998. Interest on the unpaid principal amount of the note accrued at an annual rate of 6.50%, payable in arrears each June 1 from 1995 from 1998. The note allowed the seller to convert the principal amount of the note into that number of shares of Common Stock of RTC based upon the average daily closing sale price of RTC stock during December 1994. During 1997, the note payable was paid in full through the issuance of Common Stock. F-16 TOTAL RENAL CARE HOLDINGS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) In 1996, pursuant to a business acquisition, RTC entered into an agreement to pay a total of $8,050,000 in one installment in January 1997. During 1997, pursuant to several business acquisitions, RTC entered into several other agreements to pay the various Sellers a total of $24,468,000 in one installment in January 1998. In conjunction with certain facility acquisitions, the Company issued three letters of credit. Two of these were released on April 1, 1997. The remaining letter of credit of $3,000,000 is being 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. As of December 31, 1996 and December 31, 1997 the aggregate amount outstanding, including accrued interest, was $15,886,000 and $2,183,000 respectively. Interest Rate Swap Agreements--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, 1997 the total notional principal amount of this interest rate swap agreement was $100,000,000 and the effective interest rate thereon was 7.57%. On July 24, 1997, the Company entered into a ten-year interest rate swap agreement. At December 31, 1997 the total notional principal amount of this interest rate swap agreement was $200,000,000 and the effective interest rate thereon was 7.77%. NOTE 9--LEASES The Company leases the majority of its facilities under noncancelable operating leases expiring in various years through 2021. 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: 1998........................................................ $ 28,282,000 1999........................................................ 25,461,000 2000........................................................ 23,350,000 2001........................................................ 20,740,000 2002........................................................ 19,588,000 Thereafter.................................................. 74,233,000 ------------ Total minimum lease payments................................ $191,654,000 ============ Rental expense under all operating leases for the year ended May 31, 1995, the seven months ended December 31, 1995 and the years ended December 31, 1996 and 1997 amounted to $7,425,000, $5,851,000, $15,901,000 and $24,589,000, respectively. F-17 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: 1998......................................................... $2,473,000 1999......................................................... 2,091,000 2000......................................................... 801,000 2001......................................................... 245,000 2002......................................................... 28,000 Thereafter................................................... 176,000 ---------- 5,814,000 Less--Portion representing interest.......................... 634,000 ---------- Total capital lease obligation, including current portion of $782,000.................................................... $5,180,000 ========== The net book value of fixed assets under capital lease was $5,932,000 and $5,649,000 at December 31, 1996 and 1997, respectively. Capital lease obligations are included in long-term debt (Note 8). NOTE 10--STOCKHOLDERS' EQUITY Public offerings of Common Stock--On March 1, 1994, RTC completed a public offering whereby it issued 6,393,315 shares of Common Stock. The stock offering resulted in net proceeds to RTC in the amount of $51,101,000 after the deduction of certain expenses. On November 3, 1995, the Company completed an initial public offering of its Common Stock at an offering price of $9.30 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 $62,912,000 to redeem outstanding notes and to repay outstanding borrowings. The remainder of the net 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 its 13,416,667 and 4,166,667 shares of Common Stock, respectively; 5,833,333 and 833,334, respectively, of which were sold for the Company's account and 7,583,333 and 3,333,333 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 Company's Credit Facilities in connection with acquisitions, to repurchase and subsequently retire its 12% senior subordinated debt, to finance other acquisitions and de novo developments and for working capital and other corporate purposes. Change in shares, stock splits and dividends--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 4,888,890 shares of Common Stock for $4,400. Immediately following the public debt offering of 12% senior subordinated debt in August 1994, 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. 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 F-18 TOTAL RENAL CARE HOLDINGS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) 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. Dividend distributions paid during 1995 and 1996 were to the former shareholders of entities acquired by RTC in transactions accounted for as poolings of interests as described in Note 1. On September 30, 1997 the Company announced a Common Stock dividend to all shareholders of record as of October 7, 1997, to be paid on October 20, 1997. Each shareholder received two additional shares of Common Stock for each three shares held. Fractional shares calculated as a result of the stock dividend were paid out in cash in the amount of approximately $14,000. As such, all share and per share amounts presented in the financial statements and related notes thereto have been retroactively restated to reflect this dividend which was accounted for as a stock split. EARNINGS PER SHARE The reconciliation of the numerators and denominators used to calculate earnings per share for all periods presented is as follows: SEVEN MONTHS ENDED YEAR ENDED DECEMBER 31, YEAR ENDED DECEMBER 31, MAY 31, ------------------------ ------------------------------------- 1995 1994 1995 1995 1996 1997 ----------- ----------- ----------- ----------- ----------- ----------- (UNAUDITED) (UNAUDITED) Net Income: As reported............ $14,903,000 $8,537,000 $12,166,000 $20,745,000 $26,707,000 $55,027,000 =========== ========== =========== =========== =========== =========== Net Income--assuming dilution: As reported............ 14,903,000 8,537,000 12,166,000 20,745,000 26,707,000 55,027,000 Add back interest on RTC earnout note, tax effected.............. -- -- 136,000 283,000 233,000 34,000 ----------- ---------- ----------- ----------- ----------- ----------- $14,903,000 $8,537,000 $12,302,000 $21,028,000 $26,940,000 $55,061,000 =========== ========== =========== =========== =========== =========== Applicable common shares: Average outstanding during the period..... 45,376,000 42,812,000 57,237,000 54,058,000 74,172,000 77,649,000 Average mandatorily redeemable common shares outstanding during the period..... 110,000 -- -- -- -- -- Reduction in shares in connection with notes receivable from employees............. (185,000) (130,000) (128,000) (122,000) (130,000) (125,000) Weighted average number of shares outstanding for use in computing earnings per share..... 45,301,000 42,682,000 57,109,000 53,936,000 74,042,000 77,524,000 Outstanding stock options (based on the treasury stock method)............... 2,205,000 2,197,000 2,728,000 2,897,000 2,411,000 2,288,000 Dilutive effect of RTC earnout note.......... -- -- 856,000 911,000 772,000 163,000 ----------- ---------- ----------- ----------- ----------- ----------- Adjusted weighted average number of common and common share equivalent shares outstanding.... 47,506,000 44,879,000 60,693,000 57,744,000 77,225,000 79,975,000 =========== ========== =========== =========== =========== =========== Earnings per common share.................. $ 0.33 $ 0.20 $ 0.22 $ 0.38 $ 0.36 $ 0.71 Earnings per common share--assuming dilution............... $ 0.31 $ 0.19 $ 0.20 $ 0.36 $ 0.35 $ 0.69 F-19 TOTAL RENAL CARE HOLDINGS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) STOCK-BASED COMPENSATION PLANS At December 31, 1997, the Company has four 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 ("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 8,474,078 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 1,314,450 common shares for $.90-$3.60 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, 1996 and 1997 the outstanding notes plus accrued interest totaled $378,000, $227,000, and $212,000 respectively. During the year ended May 31, 1995, 1,477,778 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 President's vesting period and all of the options became 100% vested. Pursuant to this action, the 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 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 President. 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 the Company. There are 1,666,667 common shares reserved for issuance under the 1995 Stock Plan. Options granted generally vest over four years from the date of grant and an option's maximum term is ten years, subject to certain restrictions. The Company generally issues awards with the exercise prices equal to the market price of the Company's stock on the date of grant. 1997 Stock Plan. In July 1997, the Company established the Total Renal Care Holdings, Inc. 1997 Equity Compensation Plan ("1997 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 the Company. There are 4,166,667 common shares reserved for issuance under the 1997 Stock Plan. Options granted generally vest over four years from the date of grant and an option's maximum term is ten years. The Company generally issues awards with the exercise prices equal to the market price of the Company's stock on the date of grant. F-20 TOTAL RENAL CARE HOLDINGS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) 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, year ended December 31, 1996, and year ended December 31, 1997, respectively: dividend yield of 0 percent for all periods; weighted average expected volatility of 40.5%, 36.35% and 35.12%; risk-free interest rates of 5.92%, 6.56% and 6.40% and expected lives of six years for all periods. A combined summary of the status of the 1994 Stock Plan, 1995 Stock Plan, and 1997 Stock Plan as of and for the seven months ended December 31, 1995 and years ended December 31, 1996 and 1997, is presented below: SEVEN MONTHS ENDED YEAR ENDED YEAR ENDED DECEMBER 31, 1995 DECEMBER 31, 1996 DECEMBER 31, 1997 -------------------- ------------------- -------------------- WEIGHTED WEIGHTED WEIGHTED AVERAGE AVERAGE AVERAGE EXERCISE EXERCISE EXERCISE OPTIONS PRICE OPTIONS PRICE OPTIONS PRICE ---------- -------- --------- -------- ---------- -------- Outstanding at beginning of period.............. 2,863,890 $0.90 1,441,685 $ 1.91 3,118,394 $13.82 Granted................. 322,238 5.41 1,818,913 22.28 3,931,080 19.74 Exercised............... (1,744,443) 0.90 (111,647) .92 (275,620) 3.96 Forfeited............... (30,557) 2.43 (1,734,016) 22.46 ---------- ----- --------- ------ ---------- ------ Outstanding at end of year................... 1,441,685 $1.91 3,118,394 $13.82 5,039,838 $16.01 ========== ===== ========= ====== ========== ====== Options exercisable at year end............... 351,855 663,007 797,474 Weighted-average fair value of options granted during the year................... $3.17 $10.52 $ 9.15 Forfeitures and grants include the effects of modifications to the terms of awards as if the original award was repurchased and exchanged for a new award of greater value. On April 24, 1997, 1,649,735 shares were cancelled and reawarded at the market price as of that date. The new awards vest annually over 3 years on the anniversary date of the new award. The following table summarizes information about fixed stock options outstanding at December 31, 1997: OPTIONS OUTSTANDING OPTIONS EXERCISABLE ----------------------------------------- ------------------------ WEIGHTED AVERAGE WEIGHTED WEIGHTED REMAINING AVERAGE AVERAGE EXERCISE OPTIONS CONTRACTUAL LIFE EXERCISE PRICE OPTIONS PRICE RANGE OF EXERCISE PRICES --------- ---------------- -------------- ------- ---------------- $ 0.01-$ 5.00........... 950,917 6.8 years $ 1.15 666,411 $ 1.08 $ 5.01-$10.00........... 19,735 7.0 years 5.44 10,531 5.47 $10.01-$15.00........... 13,890 7.8 years 11.82 7,230 11.82 $15.01-$20.00........... 3,561,952 8.8 years 18.64 99,969 17.49 $20.01-$25.00........... 100,002 9.3 years 22.07 2,083 20.73 $25.01-$30.00........... 300,283 9.6 years 26.20 11,250 28.43 $30.01-$35.00........... 93,059 9.8 years 30.79 0 0 --------- --------- ------ ------- ------ 5,039,838 8.5 years $16.01 797,474 $ 3.73 ========= ========= ====== ======= ====== RTC Stock Plan. In September 1990, RTC established a stock plan, which provided for awards of incentive and nonqualified stock options to certain directors, officers, employees and other individuals. In 1995 and 1996, the stock plan was amended to increase the number of RTC common shares available for grant to 3,253,395 and 4,321,395 respectively. In addition, in 1996, RTC established an option plan for outside directors pursuant to which nonqualified stock options to purchase up to 80,100 shares of RTC Common Stock were reserved for issuance. F-21 TOTAL RENAL CARE HOLDINGS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) Options granted generally vest from three to five years and an option's maximum term is ten years, subject to certain restrictions. Incentive stock options were granted at an exercise price not less than the fair market value of RTC's Common Stock on the date of grant. Nonqualified stock options were permitted to be granted as low as 50% of market value, subject to certain floor restrictions. Accordingly, compensation expense for the difference between the fair market value and the exercise price for nonqualified stock options is recorded over the vesting period of such options. In May 1995, RTC granted 559,557 incentive stock options to certain directors, officers and employees of RTC. These options were granted at an exercise price equal to the fair market value of RTC's Common Stock on the date of the grant. These options vest over three years. Certain options totaling 407,175 vest upon the earlier of attainment of predetermined earnings per share targets or nine years. In March 1996, RTC granted 821,495 incentive stock options to certain directors, officers and employees of RTC. These options were granted at an exercise price equal to the fair market value of RTC's Common Stock on the date of the grant and vest over four years. Certain options aggregating 231,398 vest upon the earlier of attainment of predetermined earnings per share targets or nine years. In December 1996, RTC granted 133,500 incentive stock options to an officer of the Company. These options were granted at an exercise price equal to the fair market value of RTC's Common Stock on the date of the grant and were fully vested on the grant date. Also in December 1996, RTC granted 40,050 non-qualified stock options in connection with the release of RTC from certain obligations. The options were granted at an exercise price equal to the fair market value of RTC's Common Stock on the date of grant and were fully vested as of December 31, 1997. During 1997, RTC granted 1,182,543 incentive stock options to certain directors, officers and employees. These options were granted at an exercise price equal to the fair market value of RTC's Common Stock on the dates of the grants and vest in two to five years. In 1997 RTC granted 26,700 options to acquisition consultants for covenants not to compete. These options were granted at a price equal to the fair market values of RTC's Common Stock on the date of the grant and were valued at $235,000. Upon consummation of the Merger, all outstanding options were converted to The Total Renal Care Holdings Inc. Special Purpose Plan ("Special Purpose Plan") options. The Special Purpose Plan provides for awards of incentive and nonqualified stock options in exchange for outstanding RTC stock plan options. The Special Purpose Plan options have the same provisions and terms as the RTC stock plan, including acceleration provisions upon certain sale of assets, mergers and consolidations. On the Merger date, there was a conversion of 2,156,426 of the Company's options. Further, options for 1,305,738 shares became fully vested due to change in control accelerated vesting provisions which were contained in the original grants. Options for 1,662,356 shares were exercised subsequent to the Merger date. The Stock Plan Committee has the option of accelerating the remaining options upon certain sale of assets, mergers and consolidations. 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 the six months ended December 31, 1995, the year ended December 31, 1996 and the year ended December 31, 1997, respectively: dividend yield of 0 percent for all periods; weighted average expected volatility of 29.3%, 29.3% and 43%; risk free interest rates of 6.39%, 6.18% and 6.55%; and expected lives of 6.00, 5.63, and 4.29 years. F-22 TOTAL RENAL CARE HOLDINGS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) A summary of the status of the RTC Stock Plan as of and for the six months ended December 31, 1995, and the years ended December 31, 1996 and 1997, is presented below: SIX MONTHS ENDED YEAR ENDED YEAR ENDED DECEMBER 31, 1995 DECEMBER 31, 1996 DECEMBER 31, 1997 ------------------- ------------------- ------------------- WEIGHTED WEIGHTED WEIGHTED AVERAGE AVERAGE AVERAGE EXERCISE EXERCISE EXERCISE OPTIONS PRICE OPTIONS PRICE OPTIONS PRICE --------- -------- --------- -------- --------- -------- Outstanding at beginning of period.............. 1,985,756 $ 6.62 1,658,601 $ 7.33 2,293,483 $11.09 Granted................. 4,197 12.55 997,376 16.50 1,182,543 16.84 Exercised............... (326,012) 3.08 (351,814) 8.73 (171,830) 7.60 Forfeited............... (5,340) 8.43 (10,680) 9.09 (19,004) 13.09 --------- ------ --------- ------ --------- ------ Outstanding at end of year................... 1,658,601 $ 7.33 2,293,483 $11.09 3,285,192 $13.33 ========= ====== ========= ====== ========= ====== Options exercisable at year end............... 995,018 966,903 1,785,169 ========= ========= ========= Weighted-average fair value of options granted during the year................... $ 4.90 $ 7.35 $ 9.70 ========= ========= ========= The following table summarizes information about RTC fixed stock options outstanding at December 31, 1997: OPTIONS OUTSTANDING OPTIONS EXERCISABLE ------------------------------------------- -------------------------- WEIGHTED AVERAGE REMAINING WEIGHTED AVERAGE WEIGHTED AVERAGE OPTIONS CONTRACTUAL LIFE EXERCISE PRICE OPTIONS EXERCISE PRICE RANGE OF EXERCISE PRICES --------- ---------------- ---------------- --------- ---------------- $ 3.75-$ 7.49........... 703,307 4.87 $ 6.49 614,100 $ 6.58 $ 7.50-$11.24........... 516,430 7.61 8.58 274,262 8.58 $11.25-$14.99........... 4,197 7.89 12.55 4,197 12.55 $15.00-$18.74........... 1,995,843 9.09 16.59 868,580 16.70 $18.75-$22.50........... 65,415 9.33 20.13 24,030 20.37 --------- ---- ------ --------- ------ 3,285,192 7.96 $13.33 1,785,169 $12.01 ========= ==== ====== ========= ====== 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, $1,790,000 and $1,120,307 at December 31, 1995, 1996, and 1997 respectively. Subsequent to December 31, 1996, and December 31, 1997, 174,775 and 49,060 shares, respectively were issued to satisfy the Company's obligations under the Plan. For the November 1995 and July 1996 purchase right periods the fair value of the employees' purchase rights were estimated on the beginning date of the purchase right period 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 F-23 TOTAL RENAL CARE HOLDINGS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) 6.6 percent and expected lives of 1.2 and 0.5 years. Using these assumptions, the weighted-average fair value of purchase rights granted on November 3, 1995 and July 1, 1996 is $2.86 and $7.37, respectively. The fair value of the January 1, 1997 and July 1, 1997 purchase right period were not estimated at December 31, 1997 because of the employee's ability to withdraw from participation through December 31. 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 YEAR ENDED DEC. 31, DECEMBER DECEMBER 1995 31, 1996 31, 1997 ----------- ----------- ----------- Income before extraordinary item......... $14,038,000 $28,830,000 $43,282,000 Extraordinary loss related to early extinguishment of debt, net of tax...... 2,555,000 7,700,000 0 ----------- ----------- ----------- Net income............................. $11,483,000 $21,130,000 $43,282,000 =========== =========== =========== Earnings per common share: Income before extraordinary item....... $ 0.25 $ 0.39 $ 0.56 Extraordinary loss..................... (0.05) (0.10) 0 ----------- ----------- ----------- Net income............................. $ 0.20 $ 0.29 $ 0.56 =========== =========== =========== Weighted average number of common shares and equivalents outstanding............. 56,465,000 74,042,000 77,524,000 =========== =========== =========== Earnings per common share--assuming dilution: Income before extraordinary item....... $ 0.20 $ 0.25 $ 0.55 Extraordinary loss..................... (0.05) (0.09) 0 ----------- ----------- ----------- Net income............................... $ 0.15 $ 0.16 $ 0.55 =========== =========== =========== Weighted average number of common shares and equivalents outstanding--assuming dilution................................ 58,220,000 83,477,000 78,982,000 =========== =========== =========== STOCK ISSUED TO EMPLOYEES OUTSIDE OF PLANS In connection with the change in control in August 1994, the Company awarded its Chief Executive Officer and Chief Operating Officer rights to purchase 1,855,555 and 222,222 common shares, respectively, at a purchase price of $.90 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. 11. TRANSACTIONS WITH RELATED PARTIES The Company 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 $347,000 and $534,000 at December 31, 1996 and 1997, respectively. Net operating revenues received from Tenet for these services were $2,130,000, $1,332,000, $2,260,000 and $2,640,000 for the year ended May 31, 1995, the seven months ended December 31, 1995, and the years ended December 31, 1996 and 1997, respectively. F-24 TOTAL RENAL CARE HOLDINGS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) 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 year ended May 31, 1995 amounted to $152,000. 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 $1,409,000 for year ended May 31, 1995. 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 seven months ended December 31, 1995 and the year ended December 31, 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 11,500,000, 11,666,667 and 833,334 shares, respectively. Fees for these transactions to DLJMB or its affiliates were $7,245,000, $5,075,000, and $780,000, respectively. Effective with the August 1997 public offering of Common Stock, DLJMB and it's affiliates are no longer considered a related party. 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. RTC has a defined contribution savings plan covering substantially all of their employees. RTC's contributions under the plan were approximately $231,002, $462,004, $548,471, and $1,069,283 for the six months ended December 31, 1995 and for the years ended December 31, 1995, 1996 and 1997, respectively. Effective July 1, 1998, the plan will be terminated and merged into the Company's plan. 13. CONTINGENCIES The Company's laboratory subsidiary is presently the subject of a Medicare carrier review. The carrier has requested certain medical and billing records for certain patients and the Company has provided the requested records. The carrier has not informed the Company of the reason for or the exact nature or scope of this review. (See Note 18). 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-25 TOTAL RENAL CARE HOLDINGS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) 14. MERGERS AND ACQUISITIONS MERGERS During the fiscal years 1996 and 1995, RTC completed the following five mergers. There were no mergers in 1994 and 1997. MERGER WITH GROUP On July 23, 1996, RTC acquired the Group. The two dialysis facilities acquired are located in Florida and serviced a total of approximately 185 patients as of the acquisition date. The transaction was accounted for under the pooling of interest method of accounting. In the transaction, RTC issued 482,377 shares of its Common Stock in exchange for all of the outstanding stock of the Group. MERGER WITH MDU On February 29, 1996, RTC acquired MDU. The 11 dialysis facilities acquired are located in Oklahoma and serviced approximately 317 patients as of the acquisition date. The transaction was accounted for under the pooling of interests method of accounting. In the transaction, RTC issued 767,168 shares of its Common Stock in exchange for all of the outstanding stock of MDU. MERGER WITH IMS On February 20, 1996, RTC acquired IMS. The four dialysis facilities acquired are located in Hawaii and served a total of approximately 444 patients as of the acquisition date. The transaction was accounted for under the pooling of interests method of accounting. In the transaction, RTC issued 1,047,464 shares of its Common Stock in exchange for all of the outstanding stock of IMS. MERGER WITH THE WICHITA COMPANIES On August 1, 1995, RTC acquired Wichita Dialysis Center, P.A, Southeast Kansas Dialysis Center, P.A., Garden City Dialysis Center, P.A. and Wichita Dialysis Center, East, P.A. (the "Wichita Companies"). All of the facilities acquired are located in Kansas and serviced approximately 355 patients as of the acquisition date. The transaction was accounted for under the pooling of interest method of accounting. In the transaction, RTC issued 1,558,920 shares of its Common Stock in exchange for all of the outstanding stock of the Wichita Companies. MERGER WITH HCC On March 6, 1995, RTC completed its acquisition of Healthcare Corporation and its affiliates (collectively, "HCC"). The 13 facilities acquired from HCC are located in Missouri, Illinois, North Carolina, Florida and Washington, D.C. and serviced approximately 720 patients as of the acquisition date. The transaction was accounted for under the pooling of interests method of accounting. In the transaction, RTC issued 2,292,222 shares of its Common Stock in exchange for all of the outstanding stock of HCC. F-26 TOTAL RENAL CARE HOLDINGS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) The consolidated financial statements give retroactive effect to the mergers with the Group, the Wichita Companies and HCC and include the Group, the Wichita Companies, and HCC for all periods presented. The consolidated financial statements include the operations of IMS and MDU as of January 1, 1996. The following is a summary of the separate and combined results of operations for periods prior to the mergers (dollars in thousands): POOLING RTC RTC COMPANIES* COMBINED -------- ---------- -------- FOR THE YEAR ENDED DECEMBER 31, 1996: Net patient revenue............................ $217,529 $ 7,548 $225,077 Income from operations......................... 20,495 1,180 21,675 Net income..................................... 9,985 697 10,682 FOR THE YEAR ENDED DECEMBER 31, 1995: Net patient revenue............................ $150,467 $14,101 $164,568 Income from operations......................... 23,319 1,501 24,820 Net income..................................... 13,239 1,392 14,631 FOR THE SIX MONTHS ENDED DECEMBER 31, 1995: Net patient revenue............................ $ 83,685 $ 3,067 $ 86,752 Income from operations......................... 14,289 512 14,801 Net income..................................... 7,709 545 8,254 - --------------------- * Includes pooling transactions only for period prior to acquisition. Activity subsequent to acquisition dates is included in RTC. ACQUISITIONS Beginning in August 1994, the Company implemented an acquisition strategy which through the year ended December 31, 1997 has resulted in the acquisition of 231 facilities providing services to ESRD patients, more than 180 programs providing acute hospital in-patient dialysis services, two laboratories, a vascular access management company and a clinical research company specializing in renal and renal related services. In addition, during this period the Company developed forty-six 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 for all acquisitions that were accounted for as purchases. (See Note 18). SEVEN MONTHS YEAR ENDED ENDED YEAR ENDED DECEMBER 31, MAY 31, DECEMBER ------------------------- 1995 31, 1995 1996 1997 ----------- ----------- ------------ ------------ Number of facilities acquired................... 24 16 67 119 Number of common shares issued..................... 729,687 1,574,616 102,645 17,613 Numbers of mandatorily redeemable shares issued... 1,136,112 Number of Common Stock options issued............. 66,667 Estimated fair value of common shares issued....... $ 2,259,000 $ 8,403,000 $ 1,830,000 $ 273,000 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 8)................... 15,886,000 Cash paid................... 73,330,000 35,450,000 179,002,000 455,090,000 ----------- ----------- ------------ ------------ Aggregate purchase price.... $79,579,000 $45,147,000 $196,718,000 $455,363,000 =========== =========== ============ ============ F-27 TOTAL RENAL CARE HOLDINGS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) The assets and liabilities of the acquired entities in the preceding table were recorded at their estimated fair market values at the dates of acquisition. The initial allocations of fair market value are preliminary and 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 DECEMBER 31, MAY 31, DECEMBER -------------------------- 1995 31, 1995 1996 1997 ----------- ----------- ------------ ------------ Identified intangibles.... $16,277,000 $10,321,000 $ 34,682,000 $ 87,498,000 Goodwill.................. 57,520,000 32,144,000 135,456,000 366,121,000 Tangible assets........... 9,973,000 7,414,000 44,265,000 47,053,000 Liabilities assumed....... (4,191,000) (4,732,000) (17,685,000) (45,309,000) ----------- ----------- ------------ ------------ Total purchase price.... $79,579,000 $45,147,000 $196,718,000 $455,363,000 =========== =========== ============ ============ 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. YEAR ENDED YEAR ENDED DECEMBER 31, DECEMBER 31, 1996 1997 ------------ ------------ (UNAUDITED) Net operating revenues............................ $794,235,000 $930,960,000 Net income before extraordinary items............. 50,253,000 70,539,000 Pro forma net income per share before extraordinary items.............................. 0.68 0.91 Pro forma net income per share before extraordinary items, assuming dilution................................ 0.65 0.88 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. F-28 TOTAL RENAL CARE HOLDINGS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) NOTE 15--SUPPLEMENTAL CASH FLOW INFORMATION The table below provides supplemental cash flow information: SEVEN MONTHS YEAR ENDED YEAR ENDED YEAR ENDED ENDED DECEMBER DECEMBER MAY 31, DECEMBER 31, 31, 31, 1995 1995 1996 1997 ---------- ------------ ----------- ----------- Cash paid for: Income taxes................. $8,970,000 $3,599,000 $30,069,000 $37,402,000 Interest..................... 1,346,000 1,919,000 5,730,000 25,039,000 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................ 6,249,000 5,335,000 2,810,000 273,000 Fixed assets acquired under capital lease obligations... 542,000 2,021,000 3,670,000 829,000 Contribution to partnerships................ 1,111,000 943,000 2,318,000 Issuance of Common Stock in connection with earn out note........................ 7,364,000 523,000 1,474,000 5,148,000 Issuance of Common Stock in connection with IMS and MDU mergers..................... 3,204,000 Grant of stock options in connection with covenant not to compete.................. 235,000 NOTE 16--SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED) Summary unaudited quarterly financial data for the years ended December 31, 1996 and 1997 is as follows (in thousands, except per share amounts). MARCH 31, JUNE 30, SEPT. DEC. 31, MARCH JUNE 30, SEPT. DEC. 31, 1996 1996 30, 1996 1996 31, 1997 1997 30, 1997 1997 --------- -------- -------- -------- -------- -------- -------- -------- Net operating revenues.. $98,493 $117,719 $133,707 $148,105 $157,937 $179,715 $197,749 $225,596 Operating income........ 12,512 17,547 18,437 22,008 24,596 28,694 33,287 38,203 Income before extraordinary item..... 5,655 9,002 8,731 11,019 11,788 13,470 14,632 15,137 Net income.............. 5,655 9,002 1,031 11,019 11,788 13,470 14,632 15,137 Earnings per common share: Income before extraordinary item per share................. 0.08 0.12 0.12 0.14 0.15 0.17 0.19 0.19 Extraordinary loss..... 0.00 0.00 0.11 0.00 0.00 0.00 0.00 0.00 Net income per share... 0.08 0.12 0.01 0.14 0.15 0.17 0.19 0.19 Earnings per common share--assuming dilution: Income before extraordinary item per share................. 0.08 0.11 0.11 0.14 0.15 0.17 0.18 0.19 Extraordinary loss..... 0.00 0.00 0.10 0.00 0.00 0.00 0.00 0.00 Net income per share... 0.08 0.11 0.01 0.14 0.15 0.17 0.18 0.19 F-29 TOTAL RENAL CARE HOLDINGS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) NOTE 17--FEBRUARY 27, 1998 MERGER As described in Note 1, on February 27, 1998 the Company acquired Renal Treatment Centers, Inc. ("RTC") in a transaction accounted for as a pooling of interests. The results of operations for TRCH and the combined amounts presented in the consolidated financial statements follow: SEVEN MONTHS YEAR ENDED ENDED YEAR ENDED YEAR ENDED MAY 31, DECEMBER 31, DECEMBER 31, DECEMBER 31, 1995 1995 1996 1997 ------------ ------------ ------------ ------------ Net operating revenues TRCH.................. $ 98,968,000 $ 89,711,000 $272,947,000 $438,205,000 RTC................... 115,457,000 86,752,000 225,077,000 322,792,000 ------------ ------------ ------------ ------------ $214,425,000 $176,463,000 $498,024,000 $760,997,000 ============ ============ ============ ============ Net income before extraordinary item TRCH.................. $ 4,852,000 $ 6,467,000 $ 23,725,000 $ 36,977,000 RTC................... 10,051,000 8,254,000 10,682,000 18,050,000 ------------ ------------ ------------ ------------ $ 14,903,000 $ 14,721,000 $ 34,407,000 $ 55,027,000 ============ ============ ============ ============ Net income after extraordinary item TRCH.................. $ 4,852,000 $ 3,912,000 $ 16,025,000 $ 36,977,000 RTC................... 10,051,000 8,254,000 10,682,000 18,050,000 ------------ ------------ ------------ ------------ $ 14,903,000 $ 12,166,000 $ 26,707,000 $ 55,027,000 ============ ============ ============ ============ In connection with the Merger, fees and expenses incurred or anticipated which are relative to the Merger and to the integration of the combined companies will be expensed as required under the pooling of interests accounting method. Such fees and expenses amounted to $92,835,000 in the first quarter of 1998. The charge includes financial advisory, legal, accounting and other direct transaction costs, payments under severance and employment agreements and other costs associated with certain compensation plans and costs 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. Included in other long term assets at December 31, 1997 are $8,247,000 of deferred merger expenses. NOTE 18--SUBSEQUENT EVENTS (UNAUDITED) 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. The remaining net unamortized deferred financing costs in the amount of $4,392,000, less tax of $1,580,000, related to the RTC Credit Agreement were recognized as an extraordinary loss in the first quarter of 1998. 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 organizational 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 consolidated statement of income for the six months ended June 30, 1998. F-30 TOTAL RENAL CARE HOLDINGS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) 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 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. In conjunction with the refinancing of the existing credit facilities the Company's two existing forward interest rate swap agreements with notional amounts of $100,000,000 and $200,000,000 were cancelled 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 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 5.65% plus an applicable margin based upon the Company's current leverage ratio. Currently, the effective interest rate for these swaps is 7.15%. 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 acquisition 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 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. 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 the 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. F-31 TOTAL RENAL CARE HOLDINGS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) The Company's Florida-based laboratory subsidiary is the subject of a third- party carrier review relating to certain claims submitted by the Company for Medicare reimbursement. The Company understands that similar reviews have been undertaken with respect to other providers' laboratory activities. The carrier has alleged that 99.3% of the tests performed by the Company's laboratory for the review period the carrier initially identified (from January 1995 to April 1996) were not properly supported by the prescribing physicians' medical justification. The carrier has issued a formal overpayment determination in the amount of $5.6 million and has suspended all payments of the Company's laboratory-related claims. In addition, the carrier has informed the local offices of the Departments of Justice ("DOJ") and Health and Human Services ("HHS") of this matter. The Company has consulted with outside counsel, reviewed the Company's records, is disputing the overpayment determination vigorously and has provided extensive supporting documentation of the Company's claims. The Company continues to cooperate with the carrier to resolve this matter and has initiated the process of a formal review of the carrier's determination. However, the Company is unable to determine at this time (1) when this matter will be resolved or when the laboratory's payment suspension will be lifted, (2) what, if any, of the laboratory claims will be disallowed; (3) what action DOJ or HHS may take with respect to this matter; (4) the outcome of the carrier's review of the additional periods from May 1996 through March 1998, including the initiation of another payment suspension; (5) whether additional periods may be reviewed by the carrier; or (6) any other outcome of this investigation. Determinations adverse to the Company could have an adverse impact on the Company's business, results of operations or financial condition. F-32 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 16, 1998, except as to the pooling of interests with Renal Treatment Centers, Inc. which is as of May 14, 1998, appearing on page F-2 of this Annual Report on Form 10-K/A also included audits of the information included in the Financial Statement Schedule listed in Item 14(a)(2) of this Form 10-K/A for the year ended May 31, 1995, the seven months ended December 31, 1995 and the years ended December 31, 1996 and 1997. 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 years ended December 31, 1996 and 1997 set forth therein when read in conjunction with the later consolidated financial statements. PricewaterhouseCoopers LLP Seattle, Washington February 16, 1998, except as to the pooling of interests with Renal Treatment Centers, Inc. which is as of May 14, 1998 S-1 TOTAL RENAL CARE HOLDINGS, INC. SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS ADDITIONS DEDUCTIONS -------------------- ---------- BALANCE AT BALANCES BEGINNING AMOUNTS OF AMOUNTS BALANCE AT OF CHARGED TO COMPANIES WRITTEN END DESCRIPTION YEAR INCOME ACQUIRED OFF OF YEAR Allowance for doubtful accounts: Year ended May 31, 1995................... $ 3,051,000 5,492,000 1,203,000 3,005,000 $ 6,741,000 Seven months ended December 31, 1995...... $ 6,741,000 4,552,000 541,000 2,662,000 $ 9,172,000 Year ended December 31, 1996................... $ 9,172,000 15,737,000 1,896,000 11,040,000 $15,765,000 Year ended December 31, 1997................... $15,765,000 20,525,000 2,962,000 8,557,000 $30,695,000 S-2 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 to be signed on its behalf by the undersigned, thereunto duly authorized. TOTAL RENAL CARE HOLDINGS, INC. /s/ John E. King By: _________________________________ John E. King Vice President, Finance and Chief Financial Officer Date: November 24, 1998 EXHIBIT INDEX SEQUENTIALLY EXHIBIT NUMBERED NUMBER DESCRIPTION PAGE 3.1 Amended and Restated Certificate of Incorporation of the Company, dated December 4, 1995.@@ 3.2 Certificate of Amendment of Certificate of Incorporation of the Company, dated February 26, 1998.+++ 3.3 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, 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 Subscription Agreement dated May 26, 1994 between DLJMB, DLJIP, DLJOP, DLJMBF, NME Properties, Tenet and the Company.# 10.2 Services Agreement dated August 11, 1994 between the Company and Tenet.## 10.3 Noncompetition Agreement dated August 11, 1994 between the Company and Tenet.## 10.4 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").##* 10.5 Amendment to Chaltiel Employment Agreement, dated as of August 11, 1994.##* 10.6 Employment Agreement dated as of September 1, 1994 by and between the Company and Barry C. Cosgrove.##* 10.7 Employment Agreement dated as of August 11, 1994 by and between the Company and Leonard W. Frie (the "Frie Employment Agreement").##* 10.8 Amendment to Frie Employment Agreement, dated as of October 11, 1994.##* 10.9 Employment Agreement dated as of September 1, 1994 by and between the Company and John E. King.##* 10.10 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.##* 10.11 Form of Stock Subscription Agreement relating to the 1994 Plan.##* 10.12 Form of Purchased Shares Award Agreement relating to the 1994 Plan.##* 10.13 Form of Nonqualified Stock Option relating to the 1994 Plan.##* 10.14 1995 Equity Compensation Plan.+* 10.15 Employee Stock Purchase Plan.+* 10.16 Option Exercise and Bonus Agreement dated as of September 18, 1995 between the Company and Victor M.G. Chaltiel.+* 10.17 1997 Equity Compensation Plan.** SEQUENTIALLY EXHIBIT NUMBERED NUMBER DESCRIPTION PAGE 10.18 Subsidiary Guaranty (the "Subsidiary Guaranty") dated as of October 24, 1997 by Total Renal Care, Inc., TRC West, Inc. and Total Renal Care Acquisition Corp. in favor of and for the benefit of The Bank of New York, as Collateral Agent, the lenders to the Revolving Credit Agreement, the lenders to the Term Loan Agreement, the Term Agent (as defined therein), the Acknowledging Interest Rate Exchangers (as defined therein) and the Acknowledging Currency Exchangers (as defined therein). Renal Treatment Centers--Mid- Atlantic, Inc., Renal Treatment Centers--Northeast, Inc., Renal Treatment Centers--California, Inc., Renal Treatment Centers--West, Inc., and Renal Treatment Centers--Southeast, Inc. subsequently executed an agreement in this form on February 27, 1998.@@@ 10.19 Borrower Pledge Agreement dated as of October 24, 1997 and entered into by and between the Company, and The Bank of New York, as Collateral Agent, the lenders to the Revolving Credit Agreement, the lenders to the Term Loan Agreement, the Term Agent (as defined therein), the Acknowledging Interest Rate Exchangers (as defined therein) and the Acknowledging Currency Exchangers (as defined therein).@@@ 10.20 Form of Subsidiary Pledge Agreement dated as of October 24, 1997 by Total Renal Care, Inc., TRC West, Inc. and Total Renal Care Acquisition Corp., and The Bank of New York, as Collateral Agent, the lenders to the Revolving Credit Agreement, the lenders to the Term Loan Agreement, the Term Agent (as defined therein), the Acknowledging Interest Rate Exchangers (as defined therein) and the Acknowledging Currency Exchangers (as defined therein). RTC subsequently executed an agreement in this form on February 27, 1998.@@@ 10.21 Agreement and Plan of Merger dated as of November 18, 1997 by and among TRCH, Nevada Acquisition Corp., a Delaware corporation and wholly-owned subsidiary of TRCH, and RTC.### 10.22 Amendment No. 2 and Consent No. 2 to the Revolving Credit Agreement and First Amendment to the Subsidiary Guaranty dated February 17, 1998.+++ 10.23 Third Amendment to the Term Loan Agreement and First Amendment to the Subsidiary Guaranty dated February 17, 1998. (The provisions of this agreement amending the original term loan agreement have been superseded by exhibit no. 10.31 hereof.)+++ 10.24 Special Purpose Option Plan.++ 10.25 Indenture, dated June 12, 1996, by RTC to PNC Bank including form of RTC Note (the "Indenture").*** 10.26 First Supplemental Indenture, dated as of February 27, 1998, among RTC, TRCH and PNC Bank under the Indenture.+++ 10.27 Second Supplemental Indenture, dated as of March 31, 1998, among RTC, TRCH and PNC Bank under the Indenture.+++ 10.28 Guaranty, entered into as of March 31, 1998, by the Company in favor of and for the benefit of PNC Bank.+++ 10.29 Amended and Restated Term Loan Agreement, dated April 30, 1998, by and among the Company, the lenders party thereto, DLJ Capital Funding, Inc., as Syndication Agent, and The Bank of New York, as Administrative Agent (the "Term Loan Agreement").++++ 10.30 Amended and Restated Revolving Credit Agreement, dated April 30, 1998, by and among the Company, the lenders party thereto, DLJ Capital Funding, Inc., as Syndication Agent, First Union National Bank, as Documentation Agent, and The Bank of New York, as Administrative Agent (the "Revolving Credit Agreement").++++ EXHIBIT PAGE NUMBER DESCRIPTION NUMBER 10.31 Form of First Amendment to Borrower/Subsidiary Pledge Agreement, dated April 30, 1998, by and among the Company, RTC, Total Renal Care, Inc., and The Bank of New York, as Collateral Agent.++++ 10.32 Form of Acknowledgment and Confirmation, dated April 30, 1998, by the Company, RTC, TRC West, Inc., Total Renal Care, Inc., Total Renal Care Acquisition Corp., Renal Treatment Centers-- Mid-Atlantic, Inc., Renal Treatment Centers--Northeast, Inc., Renal Treatment Centers--California, Inc., Renal Treatment Centers--West, Inc., and Renal Treatment Centers--Southeast, Inc. for the benefit of The Bank of New York, as Collateral Agent and the lenders party to the Term Loan Agreement or the Revolving Credit Agreement.++++ 21 List of Subsidiaries of the Company.+++ 23.1 Consent of PricewaterhouseCoopers LLP.X 24 Powers of Attorney with respect to the Company.+++ 27 Financial Data Schedule.++++ - --------------------- 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 December 19, 1997 as an exhibit to the Company's Current Report on Form 8-K. + 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 February 25, 1998 as an exhibit to the Company's Registration Statement on Form S-8 (Registration Statement No. 333-46887). +++ Filed on March 31, 1998 as an exhibit to the Company's Form 10-K for the year ended December 31, 1997. ++++ Filed on May 18, 1998 as an exhibit to Amendment No. 1 on Form 10-K/A to the Company's Form 10-K for the year ended December 31, 1997. # 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. ### Filed on December 19, 1997 as Annex A to the Company's Registration Statement on Form S-4 (Registration No. 333-42653). * Management contract or executive compensation plan or arrangement. ** Filed on August 29, 1997 as an exhibit to the Company's Registration Statement on Form S-8 (Registration Statement No. 333-34695). *** Filed as an exhibit to RTC's Form 10-Q for the quarter ended June 30, 1996. (b) Reports on Form 8-K: Current Report on Form 8-K, dated November 21, 1997, reporting under Item 5 the issuance by TRCH of a press release in connection with the Merger. Current Report on Form 8-K, dated December 19, 1997, reporting under Item 7: (i) the Audited Financial Statements of the Nephrology Services Business of Caremark International, Inc., (ii) the Audited Financial Statements of New West Dialysis, Inc., (iii) the Audited Combined Financial Statements of Southfield Dialysis Facility, P.C., North Oakland Dialysis Facility, P.C., Macomb Kidney Center, P.C., and Novi Kidney Center, P.C., (iv) Audited Financial Statements of Dialysis Care of North Carolina, (v) Audited Financial Statements of the Renal Dialysis Business of the Rogosin Institute, Inc. and (vi) certain Unaudited Pro Forma Financial Statements.