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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended September 30, 1999
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
Commission File Number: 1-4034
TOTAL RENAL CARE HOLDINGS, INC.
(Exact name of registrant as specified in its charter)
FOR THE QUARTER ENDED SEPTEMBER 30, 1999
Delaware 51-0354549
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
21250 Hawthorne Blvd., Suite 800
Torrance, California 90503-5517
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (310) 792-2600
Not Applicable
(Former name or former address, if changed since last report)
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [_]
APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY
PROCEEDINGS DURING THE PRECEDING FIVE YEARS:
Indicate by check mark whether the Registrant has filed all documents and
reports required to be filed by Sections 12, 13 or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court. Yes [_] No [_]
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes of
common stock as of the latest practicable date.
Outstanding at
Class October 31, 1999
----- -----------------
Common Stock, Par Value $0.001.......................... 81,188,843 shares
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TOTAL RENAL CARE HOLDINGS, INC.
Unless otherwise indicated in this Form 10-Q, "we," "us," "our" and similar
terms refer to Total Renal Care Holdings, Inc. and its subsidiaries.
INDEX
Page
No.
----
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements:
Condensed Consolidated Balance Sheets as of September 30, 1999 and
December 31, 1998................................................... 1
Condensed Consolidated Statements of Income and Comprehensive Income
for the three months and nine months ended September 30, 1999 and
September 30, 1998.................................................. 2
Condensed Consolidated Statements of Cash Flows for the nine months
ended September 30, 1999 and September 30, 1998..................... 3
Notes to Condensed Consolidated Financial Statements................. 4
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations.......................................... 11
Item 3. Quantitative and Qualitative Disclosures About Market Risk..... 20
Risk Factors............................................................ 22
PART II. OTHER INFORMATON
Item 1. Legal Proceedings.............................................. 28
Item 6. Exhibits and Reports on Form 8-K............................... 28
Signatures.............................................................. 29
- ---------------------
Note: Items 2, 3, 4 and 5 of Part II are omitted because they are not
applicable.
i
TOTAL RENAL CARE HOLDINGS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
September 30, December 31,
1999 1998
-------------- --------------
ASSETS
------
Current assets:
Cash and cash equivalents.................... $ 70,741,000 $ 41,487,000
Patient accounts receivable, less allowance
for doubtful accounts of $113,416,000 and
$61,848,000, respectively................... 457,780,000 416,472,000
Deferred income taxes........................ 55,177,000 31,917,000
Other current assets......................... 74,175,000 50,395,000
-------------- --------------
Total current assets....................... 657,873,000 540,271,000
Property and equipment, net.................... 285,821,000 233,337,000
Notes receivable and other long-term assets.... 76,521,000 57,578,000
Intangible assets, net of accumulated
amortization of $162,255,000 and $114,982,000,
respectively.................................. 1,176,766,000 1,084,395,000
-------------- --------------
Total assets............................... $2,196,981,000 $1,915,581,000
============== ==============
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
Current liabilities:
Current portion of long-term obligations..... $ 23,702,000 $ 21,847,000
Other current liabilities.................... 216,484,000 152,617,000
-------------- --------------
Total current liabilities.................. 240,186,000 174,464,000
Long term debt and other....................... 1,434,166,000 1,227,671,000
Deferred income taxes.......................... 14,403,000 8,212,000
Minority interests............................. 26,607,000 23,422,000
Stockholders' equity:
Preferred stock, ($0.001 par value; 5,000,000
shares authorized; none outstanding)........
Common stock, voting, ($0.001 par value;
195,000,000 shares authorized; 81,189,000
and 81,030,000 shares issued and
outstanding, respectively).................. 81,000 81,000
Additional paid-in capital................... 416,633,000 413,095,000
Notes receivable from stockholders........... (188,000) (356,000)
Accumulated other comprehensive loss......... (4,718,000)
Retained earnings............................ 69,811,000 68,992,000
-------------- --------------
Total stockholders' equity................. 481,619,000 481,812,000
-------------- --------------
Total liabilities and stockholders'
equity.................................... $2,196,981,000 $1,915,581,000
============== ==============
See accompanying Notes to Condensed Consolidated Financial Statements and
Management's Discussion and Analysis of Financial Condition and Results of
Operations.
1
TOTAL RENAL CARE HOLDINGS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
Three months and nine months ended September 30, 1999 and 1998
Three months Nine months
-------------------------- ----------------------------
1999 1998 1999 1998
------------ ------------ -------------- ------------
STATEMENTS OF INCOME
Net operating revenues.. $366,968,000 $318,585,000 $1,072,405,000 $865,684,000
Operating expenses:
Facilities............ 250,765,000 200,925,000 734,528,000 551,244,000
General and
administrative....... 32,725,000 18,274,000 86,003,000 52,789,000
Provision for doubtful
accounts............. 17,002,000 8,997,000 63,187,000 23,539,000
Depreciation and
amortization......... 29,750,000 24,205,000 84,167,000 66,604,000
Write-off of
investments and
loans................ 16,600,000
Merger and related
costs................ 79,435,000
------------ ------------ -------------- ------------
Total operating
expenses............ 330,242,000 252,401,000 984,485,000 773,611,000
Operating income...... 36,726,000 66,184,000 87,920,000 92,073,000
Interest expense, net of
capitalized interest... (28,862,000) (19,805,000) (75,999,000) (50,866,000)
Other financing costs... (629,000) (629,000) (9,823,000)
Interest income and
other.................. 1,241,000 963,000 4,505,000 3,627,000
Other losses............ (2,745,000) (2,945,000)
------------ ------------ -------------- ------------
Income before income
taxes, minority
interests,
extraordinary item
and cumulative effect
of change in
accounting
principle............ 5,731,000 47,342,000 12,852,000 35,011,000
Income taxes............ 2,285,000 18,102,000 5,608,000 31,062,000
------------ ------------ -------------- ------------
Income before minority
interests,
extraordinary item
and cumulative effect
of change in
accounting principle
of change in
accounting
principle............ 3,446,000 29,240,000 7,244,000 3,949,000
Minority interests in
income of consolidated
subsidiaries........... 1,586,000 1,859,000 6,425,000 4,817,000
------------ ------------ -------------- ------------
Income (loss) before
extraordinary item
and cumulative effect
of change in
accounting
principle............ 1,860,000 27,381,000 819,000 (868,000)
Extraordinary loss, net
of tax of $ 7,668,000.. (12,744,000)
Cumulative effect of
change in accounting
principle, net of tax
of $4,300,000.......... (6,896,000)
------------ ------------ -------------- ------------
Net income (loss)....... $ 1,860,000 $ 27,381,000 $ 819,000 $(20,508,000)
============ ============ ============== ============
Earnings (loss) per
common share:
Income (loss) before
extraordinary item
and cumulative effect
of change in
accounting
principle............ $ 0.02 $ 0.34 $ 0.01 $ (0.01)
Extraordinary loss,
net of tax........... (0.16)
Cumulative effect of
change in accounting
principle, net of
tax.................. (0.09)
------------ ------------ -------------- ------------
Net income (loss)..... $ 0.02 $ 0.34 $ 0.01 $ (0.26)
============ ============ ============== ============
Weighted average number
of common shares
outstanding............ 81,165,000 80,858,000 81,148,000 79,982,000
============ ============ ============== ============
Earnings (loss) per
common share--assuming
dilution:
Income (loss) before
extraordinary item
and cumulative effect
of change in
accounting
principle............ $ 0.02 $ 0.33 $ 0.01 $ (0.01)
Extraordinary loss,
net of tax........... (0.16)
Cumulative effect of
change in accounting
principle, net of
tax.................. (0.09)
------------ ------------ -------------- ------------
Net income (loss)..... $ 0.02 $ 0.33 $ 0.01 $ (0.26)
============ ============ ============== ============
Weighted average number
of common shares and
equivalents
outstanding--assuming
dilution............... 81,561,000 87,052,000 81,600,000 79,982,000
============ ============ ============== ============
STATEMENTS OF
COMPREHENSIVE INCOME
Net income (loss)..... $ 1,860,000 $ 27,381,000 $ 819,000 $(20,508,000)
Other comprehensive
income:
Foreign currency
translation......... (659,000) (4,718,000)
------------ ------------ -------------- ------------
Comprehensive income
(loss)............... $ 1,201,000 $ 27,381,000 $ (3,899,000) $(20,508,000)
============ ============ ============== ============
See accompanying Notes to Condensed Consolidated Financial Statements and
Management's Discussion and Analysis of Financial Condition and Results of
Operations.
2
TOTAL RENAL CARE HOLDINGS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Nine months ended September 30, 1999 and 1998
Nine months
------------------------------
1999 1998
------------- ---------------
Cash flows from operating activities:
Net income (loss)............................ $ 819,000 $ (20,508,000)
Adjustments to reconcile net income (loss) to
net cash provided by operating activities:
Depreciation and amortization.............. 84,167,000 66,604,000
Extraordinary item, net of tax............. 12,744,000
Provision for doubtful accounts............ 63,187,000 23,539,000
Write-off of investments and loans......... 16,600,000
Other losses............................... 2,577,000
Change in accounting principle, net of
tax....................................... 6,896,000
Stock-based compensation................... 1,155,000 16,000,000
Changes in working capital................. (67,583,000) (98,423,000)
------------- ---------------
Total adjustments........................ 100,103,000 27,360,000
------------- ---------------
Net cash provided by operating
activities............................ 100,922,000 6,852,000
------------- ---------------
Cash flows from investing activities:
Purchases of property and equipment.......... (85,245,000) (64,767,000)
Cash paid for acquisitions, net of cash
acquired.................................... (152,619,000) (276,075,000)
Other........................................ (35,238,000) (42,388,000)
------------- ---------------
Net cash used in investing activities.. (273,102,000) (383,230,000)
------------- ---------------
Cash flows from financing activities:
Borrowings from bank credit facility......... 209,289,000 1,499,825,000
Principal payments on long-term obligations.. (10,174,000) (1,122,180,000)
Net proceeds from sale of common stock....... 2,033,000 20,347,000
Other........................................ 3,113,000 5,092,000
------------- ---------------
Net cash provided by financing
activities............................ 204,261,000 403,084,000
Effect of exchange rate changes on cash........ (2,827,000)
------------- ---------------
Net increase in cash........................... 29,254,000 26,706,000
Cash at beginning of period.................... 41,487,000 6,143,000
------------- ---------------
Cash at end of period.......................... $ 70,741,000 $ 32,849,000
============= ===============
See accompanying Notes to Condensed Consolidated Financial Statements and
Management's Discussion and Analysis of Financial Condition and Results of
Operations.
3
TOTAL RENAL CARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. In our opinion the interim financial information reflects all normal
recurring adjustments which are necessary to state fairly our consolidated
financial position, results of operations, and cash flows as of and for the
periods indicated. We presume that users of the interim financial information
have read or have access to our audited consolidated financial statements and
Management's Discussion and Analysis of Financial Condition and Results of
Operations for the preceding fiscal year and that the adequacy of additional
disclosure needed for a fair presentation, except in regard to material
contingencies or recent significant events, may be determined in that context.
Accordingly, we have omitted footnote and other disclosures which would
substantially duplicate the disclosures contained in our Form 10-K/A for the
year ended December 31, 1998. We have made certain reclassifications of prior
period amounts to conform to current period classifications. The interim
financial information herein is not necessarily representative of a full year's
operations.
The information related to the activity for the three months and nine months
ended September 30, 1998 has been restated for certain reclassifications and
adjustments. The accrued merger and related costs initially reported by us in
the first nine months of 1998 amounted to $92,835,000. We have revised our
financial reporting relating to certain costs initially included in our merger
and related costs and accrual resulting in a decrease in merger and related
costs of $13,400,000, partially offset by an increase to facilities operating
costs of $1,700,000 and an increase to depreciation and amortization of
$590,000 for a net decrease to our first quarter 1998 operating expenses of
$11,110,000 and a net increase to each of our second and third quarter 1998
operating expenses of $2,870,000. These reclassifications and adjustments are
more fully described in our Form 10-K/A for the year ended December 31, 1998.
2. On February 27, 1998, we acquired Renal Treatment Centers, Inc., or RTC,
in a merger transaction. The merger was accounted for as a pooling of
interests. As a result, we restated our condensed consolidated financial
statements to include RTC for all periods presented. We had no transactions
with RTC prior to the combination and no adjustments were necessary to conform
RTC's accounting policies to ours.
Merger and related costs recorded during the first nine months of 1998 in
connection with our merger with RTC included costs associated with certain of
the integration activities, transaction costs and costs of employee severance
and amounts due under employment agreements and other compensation programs. A
summary of merger and related costs and accrual activity through September 30,
1999 is as follows:
Severance
Direct and Costs to
Transaction Employment Integrate
Costs Costs Operations Total
------------ ------------ ------------ ------------
Initial expense......... $ 21,580,000 $ 41,960,000 $ 15,895,000 $ 79,435,000
Amounts utilized in
1998................... (22,885,000) (37,401,000) (13,137,000) (73,423,000)
Adjustment of
estimates.............. 1,305,000 (959,000) (1,593,000) (1,247,000)
------------ ------------ ------------ ------------
Accrual, December 31,
1998................... $ 3,600,000 1,165,000 4,765,000
============
Amounts utilized--1st
quarter 1999........... (600,000) (90,000) (690,000)
------------ ------------ ------------
Accrual, March 31,
1999................... 3,000,000 1,075,000 4,075,000
Amounts utilized--2nd
quarter 1999........... (90,000) (90,000)
------------ ------------ ------------
Accrual, June 30, 1999.. 3,000,000 985,000 3,985,000
Amounts utilized--3rd
quarter 1999........... (99,000) (99,000)
------------ ------------ ------------
Accrual, September 30,
1999................... $ 3,000,000 $ 886,000 $ 3,886,000
============ ============ ============
The remaining balance of severance and employment costs represents tax gross-
up payments expected to be paid by the end of 1999. The remaining balance of
costs to integrate operations represents remaining lease payments on RTC's
vacant laboratory lease space.
4
TOTAL RENAL CARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
3. During the nine months ended September 30, 1999, we purchased 44 centers
and additional interests from minority partners in certain of our partnerships.
Total cash consideration for these transactions was approximately $152.6
million.
We accounted for these transactions under the purchase method. The cost of
these acquisitions has been allocated primarily to intangible assets such as
patient charts, noncompete agreements and goodwill to the extent the purchase
price exceeds the value of the tangible assets, primarily capital equipment.
The assets and liabilities of the acquired centers 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 have been included in our financial statements from their
respective effective acquisition dates.
The results of operations on a pro forma basis, as though the above
acquisitions had been combined with us at the beginning of each period
presented for the nine months ended September 30, are as follows:
1999 1998
-------------- ------------
Pro forma net operating revenues............... $1,097,101,000 $926,121,000
Pro forma income before extraordinary item and
cumulative effect of change in accounting
principle..................................... $ 2,668,000 $ 3,106,000
Pro forma net income (loss).................... $ 2,668,000 $(16,534,000)
Pro forma income per share before extraordinary
item and cumulative effect of change in
accounting principle:
Basic........................................ $ 0.03 $ 0.04
Assuming dilution............................ $ 0.03 $ 0.04
4. In March 1998, Statement of Position No. 98-1, Accounting for the Cost of
Computer Software Developed or Obtained for Internal Use, or SOP 98-1, was
issued. We adopted SOP 98-1 in the first quarter of 1999, effective January 1,
1999. SOP 98-1 defines internal-use software and identifies whether internal-
use software costs that we incur must be expensed or capitalized. Costs that
should be capitalized include external direct costs of materials and services,
payroll and payroll related costs for employees directly associated with the
internal-use software projects and certain interest costs incurred in the
application development stage. All other internal-use software costs are
expensed as incurred. The impact of the adoption of SOP 98-1 was not material
to our operations.
In April 1998, Statement of Position No. 98-5, Reporting on the Costs of
Start-up Activities, or SOP 98-5, was issued. We adopted SOP 98-5 effective
January 1, 1998. SOP 98-5 requires that pre-opening and organization costs,
incurred in conjunction with facility pre-opening activities, which previously
had been treated as deferred costs and amortized over five years, should be
expensed as incurred. As a result of the adoption of SOP 98-5, all remaining
unamortized pre-opening, development and organizational costs existing prior to
January 1, 1998 of $11,196,000 were recognized, net of tax of $4,300,000, as
the cumulative effect of a change in accounting principle in the first quarter
of 1998.
5
TOTAL RENAL CARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
5. The reconciliation of the numerators and denominators used to calculate
earnings (loss) per common share for all periods presented is as follows:
Three months ended Nine months ended
September 30, September 30,
------------------------ -------------------------
1999 1998 1999 1998
----------- ----------- ----------- ------------
Income (loss) before
extraordinary item and
cumulative effect of
change in accounting
principle............... $ 1,860,000 $27,381,000 $ 819,000 $ (868,000)
Interest, net of tax
resulting from dilutive
effect of convertible
debt.................... 1,055,000
----------- ----------- ----------- ------------
Adjusted income (loss)... 1,860,000 28,436,000 819,000 (868,000)
Extraordinary loss, net
of tax.................. (12,744,000)
Cumulative effect of
change in accounting
principle, net of tax (6,896,000)
----------- ----------- ----------- ------------
Income (loss)--assuming
dilution................ $ 1,860,000 $28,436,000 $ 819,000 $(20,508,000)
=========== =========== =========== ============
Applicable common shares
Average outstanding
during the period....... 81,185,000 80,871,000 81,162,000 79,994,000
Reduction in shares in
connection with notes
receivable from
employees............... (20,000) (13,000) (14,000) (12,000)
----------- ----------- ----------- ------------
Weighted average number
of shares outstanding
for use in computing
earnings per share...... 81,165,000 80,858,000 81,148,000 79,982,000
Dilutive effect of
outstanding stock
options................. 396,000 1,315,000 452,000
Dilutive effect of
convertible debt........ 4,879,000
----------- ----------- ----------- ------------
Weighted average number
of shares and
equivalents outstanding
for use in computing
earnings per share--
assuming dilution....... 81,561,000 87,052,000 81,600,000 79,982,000
=========== =========== =========== ============
Earnings (loss) per
common share:
Income (loss) per
common share before
extraordinary item and
cumulative effect of
change in accounting
principle............. $ 0.02 $ 0.34 $ 0.01 $ (0.01)
Extraordinary loss, net
of tax................ (0.16)
Cumulative effect of
change in accounting
principle, net of
tax................... (0.09)
----------- ----------- ----------- ------------
Net income (loss) per
common share............ $ 0.02 $ 0.34 $ 0.01 $ (0.26)
=========== =========== =========== ============
Earnings (loss) per
common share--assuming
dilution:
Income (loss) before
extraordinary item and
cumulative effect of
change in accounting
principle............. $ 0.02 $ 0.33 $ 0.01 $ (0.01)
Extraordinary loss, net
of tax................ (0.16)
Cumulative effect of
change in accounting
principle, net of
tax................... (0.09)
----------- ----------- ----------- ------------
Net income (loss) per
common share--assuming
dilution................ $ 0.02 $ 0.33 $ 0.01 $ (0.26)
=========== =========== =========== ============
Included in the above calculation for the three months ended September 30,
1998, is the effect of RTC's 5 5/8% convertible subordinated notes due 2006
treated on an "as converted" basis; however, the effect is not included for all
other periods presented because it was antidilutive. Our 7% convertible notes
due 2009 were also anti-dilutive for all periods presented.
6. In conjunction with the refinancing of our credit facilities, our two
existing forward interest rate swap agreements with notional amounts of
$100,000,000 and $200,000,000 were canceled in April 1998. The loss associated
with the early cancellation of these swaps was approximately $9,823,000 and is
presented as other financing costs in the accompanying statement of income for
the nine months ended September 30, 1998.
6
TOTAL RENAL CARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
During the quarter ended June 30, 1998, we entered into forward interest rate
cancelable swap agreements, with a combined notional amount of $800,000,000.
The lengths of the agreements are between three and ten years with cancelation
clauses at the counterparties' option from one to seven years. The underlying
blended rate is fixed at approximately 5.69% plus an applicable margin based
upon our current leverage ratio.
During the quarter ended June 30, 1999, we received notification from two of
our swap agreement counterparties that they had exercised their right to cancel
agreements in the aggregate notional amount of $100,000,000. The remaining
$700,000,000 of swap agreements with maturities from the years 2003 through
2008 and cancelation option dates from the years 2001 through 2005 are still in
effect. At September 30, 1999, the effective interest rate for borrowings under
the swap agreements was 9.30%.
In September 1999 we converted approximately $50.0 million of our outstanding
borrowings under our revolving credit facility from U.S. dollar denominated
borrowings to Euro denominated borrowings, primarily as a hedge of our net
investment in European operations.
Further, the amendment and waiver to our credit facilities described in Note
10 resulted in a write-off of $629,000 for the reduction of previously deferred
financing costs. This write-off is included in other financing costs.
7. In June 1996, RTC issued $125,000,000 of 5 5/8% convertible subordinated
notes due 2006. These notes are convertible, at the option of the holder, at
any time after August 12, 1996 through maturity, unless previously redeemed or
repurchased, into our common stock at a conversion price of $25.62 principal
amount per share, subject to certain adjustments. All or any part of these
notes are redeemable at our 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. TRCH has guaranteed these notes.
The following is summarized financial information of RTC:
September 30, December 31,
1999 1998
------------- ------------
Cash and cash equivalents........................ $ 5,396,000
Accounts receivable, net......................... $132,960,000 130,129,000
Other current assets............................. 10,427,000 19,106,000
------------ ------------
Total current assets........................... 143,387,000 154,631,000
Property and equipment, net...................... 88,888,000 75,641,000
Intangible assets, net........................... 406,255,000 406,562,000
Other assets..................................... 7,853,000 9,249,000
------------ ------------
Total assets................................... $646,383,000 $646,083,000
============ ============
Current liabilities (includes intercompany
payable to TRCH of $207,966,000 and
$306,628,000, respectively)..................... $336,368,000 $352,753,000
Long-term debt................................... 128,830,000 125,199,000
Stockholder's equity............................. 181,185,000 168,131,000
------------ ------------
Total liabilities and stockholder's equity..... $646,383,000 $646,083,000
============ ============
7
TOTAL RENAL CARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Three months ended Nine months ended
September 30, September 30,
------------------------- -------------------------
1999 1998 1999 1998
------------ ------------ ------------ ------------
Net operating revenues... $129,295,000 $120,178,000 $375,597,000 $358,829,000
Total operating
expenses................ 117,038,000 98,924,000 343,433,000 335,205,000
------------ ------------ ------------ ------------
Operating income......... 12,257,000 21,254,000 32,164,000 23,624,000
Interest expense, net.... 2,194,000 2,074,000 5,741,000 6,863,000
------------ ------------ ------------ ------------
Income before income
taxes................... 10,063,000 19,180,000 26,423,000 16,761,000
Income taxes............. 4,528,000 (431,000) 13,369,000 6,671,000
------------ ------------ ------------ ------------
Income before
extraordinary item and
cumulative effect of
change in accounting
principle............. $ 5,535,000 $ 19,611,000 $ 13,054,000 $ 10,090,000
============ ============ ============ ============
8. In November 1998, we issued $345,000,000 of 7% convertible subordinated
notes due 2009, or the 7% notes, in a private placement offering. The 7% notes
are convertible, at the option of the holder, at any time into our common stock
at a conversion price of $32.81 per share. We may redeem the 7% notes on or
after November 15, 2001. The 7% notes are general, unsecured obligations junior
to all of our existing and future senior debt and, effectively, all existing
and future liabilities of us and our subsidiaries.
We subsequently filed a registration statement covering the resale of the 7%
notes which has not yet been declared effective by the SEC. As further
described in the registration statement, commencing May 18, 1999, we are
accruing certain monetary penalties on a weekly basis until the registration
statement is declared effective, as follows:
Days following Weekly Cumulative
180 days after closing Penalty Penalty
---------------------- ------- ----------
0-90..................... $17,250 $ 222,000
91-180................... 34,500 665,000
181-270.................. 51,750 1,331,000
271-360.................. 69,000 2,218,000
Thereafter............... 86,250
Payment of these accrued penalties is due upon the next interest due date.
The accrued penalty as of September 30, 1999 was $428,800.
9. Contingencies
Our Florida-based laboratory subsidiary is the subject of a third-party
carrier review relating to certain claims submitted by us for Medicare
reimbursement. We understand that similar reviews have been undertaken with
respect to other providers' laboratory activities in Florida and elsewhere. The
carrier has alleged that approximately 97% of the tests performed by this
laboratory for the review periods the carrier has identified, from January 1995
to April 1996, and May 1996 to March 1998, were not properly supported by the
prescribing physicians' medical justification. The carrier has issued formal
overpayment determinations in the amount of $5.6 million for the review period
from January 1995 to April 1996 and $14.2 million for the review period from
May 1996 to March 1998. The carrier also has suspended all payments of claims
related to this laboratory, regardless of when the laboratory performed the
tests. The carrier has withheld approximately $27 million as of September 30,
1999. In addition the carrier has informed the local offices of the Department
of Justice, or DOJ, and the Department of Health and Human Services, or HHS, of
this matter, and we are cooperating with DOJ and HHS.
8
TOTAL RENAL CARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
We have consulted with outside counsel, reviewed our records, are disputing
the overpayment determinations vigorously and have provided extensive
supporting documentation of our claims. We have cooperated with the carrier to
resolve this matter and have initiated the process of a formal review of the
carrier's determinations. The first step in this formal review process is a
hearing before a hearing officer at the carrier. The hearing regarding the
initial review period from January 1995 to April 1996 was held in late July
1999. We expect the hearing officer to render a decision by mid-December 1999.
We have received minimal responses from the carrier to our repeated requests
for clarification and information regarding the continuing payment suspension.
In February 1999, our Florida-based laboratory subsidiary filed a complaint
against the carrier and HHS seeking a court order to lift the payment
suspension. The court dismissed our complaint because we had not exhausted all
administrative remedies.
We are unable to determine at this time:
. When this matter will be resolved or when this laboratory's payment
suspension will be lifted;
. What, if any, of this laboratory's claims will be disallowed;
. What action the carrier, DOJ or HHS may take with respect to this matter;
. Whether additional periods may be reviewed by the carrier; or
. Any other outcome of this investigation.
No provisions or allowances have been recorded for this matter. Any
determination adverse to us could have an adverse impact on our business,
results of operations, financial condition, or cash flows.
Following the announcement on February 18, 1999 of our preliminary results
for the fourth quarter of 1998 and the full year 1998, several class action
lawsuits were filed against us and certain of our officers in the U.S. District
Court for the Central District of California. The complaints are similar and
allege violations of federal securities laws arising from allegedly false and
misleading statements primarily regarding our accounting for the integration of
RTC into TRCH and request unspecified monetary damages. The lawsuits have been
consolidated into a single action. A consolidated amended complaint was filed
on October 6, 1999. This complaint alleges violations of the federal securities
laws arising from allegedly false and misleading statements during a class
period of March 11, 1997 to July 18, 1999 and seeks unspecified monetary
damages. The primary allegations of this complaint are that we booked revenues
at inflated amounts, failed to disclose that a material portion of our accounts
receivable were uncollectible, reported excessive non-Medicare revenues, billed
for treatments that were never provided, failed to disclose accurately the
basis for suspension of payments to our Florida-based laboratory subsidiary on
Medicare claims, accounted for goodwill to overstate income, and manipulated
the value of intangible assets. We have not yet responded to this complaint,
but we believe that all of the claims are without merit and we intend to defend
ourselves vigorously. We anticipate that the attorney's fees and related costs
of defending this consolidated litigation should be covered primarily by our
directors and officers insurance policies and we believe that any additional
costs will not have a material impact on our financial condition, results of
operations or cash flows.
In addition, we are subject to claims and suits in the ordinary course of
business for which we believe most will be covered by insurance. We do not
believe that the ultimate resolution of these additional pending proceedings,
whether the underlying claims are covered by insurance or not, will have a
material adverse effect on our financial condition, results of operations or
cash flows.
9
TOTAL RENAL CARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
10. In August 1999 the lenders under our credit facilities waived compliance
with a financial covenant that established a maximum leverage ratio which we
could not exceed. Subsequent to September 30, 1999, this waiver was extended on
revised terms. The revision to the waiver was required because we have exceeded
the maximum leverage ratio allowable under the terms of the original waiver.
The revised waiver expires March 15, 2000. The lenders also waived our
violation of a covenant that placed a limit on our aggregate borrowings for
international acquisitions, which we had exceeded. The terms of the revised
waiver:
. Permanently reduce the revolving credit facility from $950,000,000 to
$700,000,000;
. Reduce our permitted borrowings under the revolving credit facility to
$650,000,000 during the waiver period;
. Limit the amounts we may spend for acquisitions, de novo developments and
expansion or relocation of existing dialysis centers;
. Accelerated the maturity dates on the term loan and revolving credit
facilities by two years, to March 31, 2006 and March 31, 2003,
respectively; and
. Increased the applicable margins used to determine the interest rates for
our borrowings under the credit facilities.
Other than the issues specifically addressed in the waiver agreement, all
other covenants and conditions of the credit facilities remain unchanged.
The outstanding balances on our term loan and revolving credit facilities at
September 30, 1999 were $392,000,000 and $560,942,000 respectively. As modified
by the most recent waiver agreement, borrowings under the credit facilities
generally bear interest at one of two floating rates selected by us:
. 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%, plus a margin ranging
from 1.75% to 2.25% for borrowings under the revolving credit facility
and a margin of 2.50% for borrowings under the term loan facility; or
. Adjusted LIBOR, defined as the 30-, 60-, 90- or 180-day London Interbank
Offered Rate, adjusted for statutory reserves, plus a margin ranging from
3.00% to 3.50% for borrowings under the revolving credit facility and a
margin of 3.75% for borrowings under the term loan facility.
The applicable margin used in determining the interest rate for borrowings
under the revolving credit facility is based on our leverage ratio. Currently,
the applicable margin is at the top of the ranges listed above. In addition,
the most recent waiver agreement fixed the applicable margin at 2.25% for
Alternate Base Rate loans and 3.50% for adjusted LIBOR loans for the period
September 30, 1999 through March 15, 2000. The applicable margin used in
determining the interest rate for borrowings under the term loan has been fixed
for the remainder of the loan period.
11. During the nine months ended September 30, 1999, we provided an allowance
of $16,600,000 against loans to, and investments in, several dialysis related
businesses which we are unlikely to recover as a result of recent deterioration
in the financial condition of these businesses.
10
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
As described in Note 2 to our condensed consolidated financial statements, we
acquired Renal Treatment Centers, Inc., or RTC, on February 27, 1998 in a
merger accounted for as a pooling of interests. Accordingly, our condensed
consolidated financial statements have been restated to include RTC for all
periods presented.
The information related to the activity for the three months and nine months
ended September 30, 1998 has been restated for certain reclassifications and
adjustments. The accrued merger and related costs initially reported by us in
the first and second quarters of 1998 amounted to $92,835,000. We have revised
our financial reporting relating to certain costs initially included in our
merger and related costs and accrual resulting in a decrease in merger and
related costs of $13,400,000, partially offset by an increase to facilities
operating costs of $1,700,000 and an increase to depreciation and amortization
of $590,000 for a net decrease to our first quarter 1998 operating expenses of
$11,110,000 and a net increase to each of our second and third quarter 1998
operating expenses of $2,870,000. These reclassifications and adjustments are
more fully described in our Form 10-K/A for the year ended December 31, 1998.
Net operating revenues
Net operating revenues are derived primarily from five sources: (a)
outpatient facility hemodialysis services; (b) ancillary services, including
the administration of erythropoetin, or EPO, and other intravenous
pharmaceuticals, clinical laboratory services, oral pharmaceutical products and
other ancillary services; (c) home dialysis services and related products; (d)
inpatient hemodialysis services provided to hospitalized patients pursuant to
arrangements with hospitals; and (e) international operations. Additional
revenues are derived from the provision of dialysis facility management
services to certain subsidiaries and affiliated and unaffiliated dialysis
centers. Our outpatient dialysis and ancillary services are reimbursed
primarily under the Medicare ESRD program in accordance with rates established
by the Health Care Financing Administration, or HCFA. Payments are also
provided by other third party payors, generally at rates higher than those
reimbursed by Medicare for up to the first 33 months of treatment as mandated
by law. Rates paid for inpatient dialysis services provided to hospitalized
patients are negotiated with individual hospitals.
We maintain a usual and customary fee schedule for our dialysis treatment and
other patient services. We often do not realize our usual and customary rates,
however, because of negotiated limitations on the amounts we can bill to or
collect from the payors for our services. We generally bill the Medicare and
Medicaid programs at net realizable rates determined by applicable fee
schedules for these programs, which are established by statute or regulation.
We bill most non-governmental payors, including managed care payors with which
we have contracted, at our usual and customary rates. Since we bill most non-
governmental payors at our usual and customary rates, but often expect to
receive payments at the lower contracted rates, we also record a contractual
allowance in order to record expected net realizable revenue for services
provided. This process involves estimates and we record revisions to these
estimates in subsequent periods as they are determined to be necessary.
Results of operations
Three months ended September 30, 1999 compared to the three months ended
September 30, 1998
Net operating revenues. Net operating revenues increased $48,383,000 to
$366,968,000 in the third quarter of 1999 from $318,585,000 in the third
quarter of 1998, representing a 15% increase. Of this increase, $55,987,000 was
due to increased treatments, of which $44,125,000 was from acquisitions
consummated after the third quarter of 1998, $5,144,000 was from de novo
developments commencing operations after the third quarter of 1998 and the
remainder was from existing facilities as of September 30, 1998. The difference
between the $55,987,000 described above and the total change of $48,383,000
resulted from an overall decrease in net operating revenue per treatment which
decreased from $248.17 in the third quarter of 1998 to $243.13 in the third
quarter of 1999. This decrease in net operating revenue per treatment primarily
was attributable to a overall decline in the rates we receive for our dialysis
services. The decline in rates is the
11
result of increasing our contractual allowances, primarily related to billings
from our Tacoma office, to reflect recent trends in collection experience and
an additional allowance provision of $3,900,000 and an overall decrease of
$2,317,000, mainly attributable to a lower net revenue recognition per
treatment, for services provided by our dialysis laboratory in Minnesota. This
decline was partially offset by an increase in ancillary services intensity and
pricing of EPO of $9,433,000, and an increase in non-patient services revenue
of $2,273,000 resulting from an increase in dialysis facility management
services provided to facilities that we do not own or control.
Facility operating expenses. Facility operating expenses consist of costs and
expenses specifically attributable to the operation of dialysis facilities,
including operating and maintenance costs of such facilities, equipment, direct
labor, and supply and service costs relating to patient care. Facility
operating expenses increased $49,840,000 to $250,765,000 in the third quarter
of 1999 from $200,925,000 in the third quarter of 1998 and as a percentage of
net operating revenues, facility operating expenses increased to 68.3% in the
third quarter of 1999 from 63.1% in the third quarter of 1998. This increase
was primarily attributable to increased usage of EPO and other medical supplies
and the impact of a lower net revenue per treatment.
General and administrative expenses. General and administrative expenses
include headquarters expense and administrative, legal, quality assurance,
information systems and centralized accounting support functions. General and
administrative expenses increased $14,451,000 to $32,725,000 in the third
quarter of 1999 from $18,274,000 in the third quarter of 1998 and as a
percentage of net operating revenues, general and administrative expenses
increased to 8.9% in the third quarter of 1999 from 5.7% in the third quarter
of 1998. This increase was primarily attributable to increased staff at both
our business and corporate offices and the impact of a lower net revenue per
treatment. Additionally, general and administrative expense for the third
quarter of 1999 includes approximately $1,719,000 for executive severance, and
$1,081,000 for an employee retention program, primarily for amendments to stock
options extending the period in which the option holders can exercise the
options after their employment is terminated.
Provision for doubtful accounts. The provision for doubtful accounts is
influenced by the amount of net operating revenues generated from all payor
sources in addition to the relative percentage of accounts receivable by aging
category and collection trends. The provision for doubtful accounts increased
$8,005,000 to $17,002,000 in the third quarter of 1999 from $8,997,000 in the
third quarter of 1998. As a percentage of net operating revenues, the provision
for doubtful accounts increased to 4.6% in the third quarter of 1999 from 2.8%
in the third quarter of 1998. This is primarily a result of a $4,100,000
increase in the provision for doubtful accounts relating to patient accounts
receivable billed from our dialysis laboratory in Minnesota.
Depreciation and amortization. Depreciation and amortization increased
$5,545,000 to $29,750,000 in the third quarter of 1999 from $24,205,000 in the
third quarter of 1998. As a percentage of net operating revenues, depreciation
and amortization increased to 8.1% in the third quarter of 1999 from 7.6% in
the third quarter of 1998.
Operating income. Operating income decreased $29,458,000 to $36,726,000 in
the third quarter of 1999 from $66,184,000 in the third quarter of 1998. As a
percentage of net operating revenues, operating income decreased to 10.0% in
the third quarter of 1999 from 20.8% in the third quarter of 1998 primarily due
to the increases in both facility operating and general and administrative
expenses, additions to allowances for patient accounts receivable and a lower
overall net revenue per treatment as described above.
Interest expense, net of capitalized interest. Interest expense increased
$9,057,000 to $28,862,000 in the third quarter of 1999 from $19,805,000 in the
third quarter of 1998. The increase in interest expense primarily was due to an
increase in the interest rates on our credit facilities as a term of the bank
waiver as well as an increase in the overall borrowings made under our credit
facilities to fund acquisitions.
Other financing costs. Other financing costs represent the impact of various
debt-related transactions. In the third quarter of 1999, we recognized a write-
off of $629,000 for the reduction of deferred financing costs as a result of
the permanent reduction in our revolving credit facility in connection with the
bank waiver.
12
Interest income and other. Interest income is generated as a result of the
short-term investment of surplus cash from operations and excess proceeds from
borrowings under our credit facilities. Other income is income generated by
unconsolidated partnerships. Interest income and other increased by $278,000 to
$1,241,000 in the third quarter of 1999 from $963,000 in the third quarter of
1998.
Other losses. Other losses in the third quarter of 1999 were primarily a
result of a $2,577,000 loss on the disposition of our corporate jet.
Provision for income taxes. Provision for income taxes decreased to
$2,285,000 for the third quarter of 1999 from $18,102,000 in the third quarter
of 1998. The effective tax rate was 55.1% for the third quarter of 1999
compared to 40.4% in the third quarter of 1998, after minority interest. The
change in the effective tax rate primarily was due to $3.1 million from the
non-deductible amortization of intangible assets spread over a smaller pre-tax
base.
Minority interests. Minority interests represent the pretax income earned by
minority partners who directly or indirectly own minority interests in our
partnership affiliates and the net income in certain of our corporate
subsidiaries. Minority interests decreased $273,000 to $1,586,000 from
$1,859,000 in the third quarter of 1998. As a percentage of net operating
revenues, minority interest decreased to 0.4% in the third quarter of 1999 from
0.6% in the third quarter of 1998.
Nine months ended September 30, 1999 compared to the nine months ended
September 30, 1998
Net operating revenues. Net operating revenues increased $206,721,000 to
$1,072,405,000 in the nine months ended September 30, 1999 from $865,684,000 in
the nine months ended September 30, 1998, representing a 24% increase. Of this
increase, $193,756,000 was due to increased treatments, of which $84,931,000
was from acquisitions consummated after the nine months ended September 30,
1998, $11,250,000 was from de novo developments commencing operations after the
nine months ended September 30, 1998 and $97,575,000 was from existing
facilities as of September 30, 1998. The remaining increase of $12,965,000
resulted from an increase in net operating revenue per treatment which
increased from $242.49 in the nine months ended September 30, 1998 to $245.46
in the nine months ended September 30, 1999. The increase in net operating
revenue per treatment was mainly attributable to an increase in ancillary
services intensity and pricing of $38,064,000, primarily in the administration
of EPO of $35,371,000, an increase in corporate and ancillary program fees of
$1,865,000, primarily from the expansion of laboratory services to former RTC
facilities of $1,001,000, and an increase in non-patient services revenue of
$5,862,000 from the increase in dialysis facility management services to
facilities that we do not own or control, which were partially offset by a
decrease in our net operating revenue per treatment of $28,926,000, as a result
of increasing our contractual allowances primarily related to billings from our
Tacoma office to reflect recent trends in collection experience, and an
additional $3,900,000 in contractual allowances at our dialysis laboratory in
Minnesota.
Facility operating expenses. Facility operating expenses increased
$183,284,000 to $734,528,000 in the nine months ended September 30, 1999 from
$551,244,000 in the nine months ended September 30, 1998 and as a percentage of
net operating revenues, facility operating expenses increased to 68.5% in the
nine months ended September 30, 1999 from 63.7% in the nine months ended
September 30, 1998. This increase was primarily attributable to increased usage
in EPO and other medical supplies and the impact of a lower net revenue per
treatment. Additionally, during the second quarter of 1999, a provision of
$4,500,000 was recorded for the resolution of claims made by vendors during the
quarter for goods and services provided in earlier periods.
General and administrative expenses. General and administrative expenses
increased $33,214,000 to $86,003,000 in the nine months ended September 30,
1999 from $52,789,000 in the nine months ended September 30, 1998 and as a
percentage of net operating revenues, general and administrative expenses
increased to 8.0% in the nine months ended September 30, 1999 from 6.1% in the
nine months ended
13
September 30, 1998. This increase was primarily attributable to increased staff
at both our business and corporate offices and the impact of a lower net
revenue per treatment. Additionally, general and administrative expense for the
nine months ended September 30, 1999 includes approximately $3,230,000 of
expenses related to costs of business purchase transactions which we will not
consummate and operating costs associated with a corporate jet we are no longer
using, $1,719,000 related to executive severance and $1,081,000 for an employee
retention program.
Provision for doubtful accounts. The provision for doubtful accounts
increased $39,648,000 to $63,187,000 in the nine months ended September 30,
1999 from $23,539,000 in the nine months ended September 30, 1998. As a
percentage of net operating revenues, the provision for doubtful accounts
increased to 5.9% in the nine months ended September 30, 1999 from 2.7% in the
nine months ended September 30, 1998. This is primarily a result of a
$24,000,000 increase in the provision for doubtful accounts relating to
collectibility problems of patient accounts receivable billed from our Tacoma
business office. Our Tacoma office collection practices have not kept pace with
the growth of our business and receivables have aged, causing them to be more
difficult to collect. Additionally, we increased the provision for doubtful
accounts by $4,100,000 at our dialysis laboratory in Minnesota.
Depreciation and amortization. Depreciation and amortization increased
$17,563,000 to $84,167,000 in the nine months ended September 30, 1999 from
$66,604,000 in the nine months ended September 30, 1998. As a percentage of net
operating revenues, depreciation and amortization was 7.8% in the nine months
ended September 30, 1999 and 7.7% in the nine months ended September 30, 1998.
Write-off of investments. Write-off of investments and loans recorded in the
nine months ended September 30, 1999 of $16,600,000 represents allowances
provided for loans to, and investments in, several dialysis related businesses,
which we are unlikely to recover as a result of recent deterioration in the
financial condition of these businesses.
Merger and related costs.
Merger and related costs recorded during the nine months ended September 30,
1998 include costs associated with certain integration activities, transaction
costs and costs of employee severance and amounts due under employment
agreements and other compensation programs, in connection with our merger with
RTC.
A summary of merger and related costs and accrual activity through September
30, 1999 is as follows:
Severance
Direct and Costs to
Transaction Employment Integrate
Costs Costs Operations Total
------------ ------------ ------------ ------------
Initial expense......... $ 21,580,000 $ 41,960,000 $ 15,895,000 $ 79,435,000
Amounts utilized in
1998................... (22,885,000) (37,401,000) (13,137,000) (73,423,000)
Adjustment of
estimates.............. 1,305,000 (959,000) (1,593,000) (1,247,000)
------------ ------------ ------------ ------------
Accrual, December 31,
1998................... $ 3,600,000 1,165,000 4,765,000
============
Amounts utilized--1st
quarter 1999........... (600,000) (90,000) (690,000)
------------ ------------ ------------
Accrual, March 31,
1999................... 3,000,000 1,075,000 4,075,000
Amounts utilized--2nd
quarter 1999........... (90,000) (90,000)
------------ ------------ ------------
Accrual, June 30, 1999.. 3,000,000 985,000 3,985,000
Amounts utilized--3rd
quarter 1999........... (99,000) (99,000)
------------ ------------ ------------
Accrual, September 30,
1999................... $ 3,000,000 $ 886,000 $ 3,886,000
============ ============ ============
The remaining balance of severance and employment costs represents tax gross-
up payments expected to be paid by the end of the year. The remaining balance
of costs to integrate operations represents remaining lease payments on RTC's
vacant laboratory lease space.
14
Operating income. Operating income before merger and related costs and write-
off of investments decreased $66,988,000 to $104,520,000 in the nine months
ended September 30, 1999 from $171,508,000 in the nine months ended September
30, 1998. As a percentage of net operating revenues, operating income before
merger and related costs and write-off of investments decreased to 9.7% in the
nine months ended September 30, 1999 from 19.8% in the nine months ended
September 30, 1998. This decrease was primarily attributable to increases in
both facility operating and general and administrative expenses and the
additions to valuation allowances for patient accounts receivable as described
above.
Interest expense, net of capitalized interest. Interest expense increased
$25,133,000 to $75,999,000 in the nine months ended September 30, 1999 from
$50,866,000 in the nine months ended September 30, 1998. The increase in
interest expense primarily was due to an increase in borrowings made under our
credit facilities to fund acquisitions as well as an increase in the interest
rates on our credit facilities as a term of the bank waiver.
Other financing costs. In the third quarter of 1999 we recognized a write-off
of $629,000 as a result of the permanent reduction in our revolving credit
facility in connection with the bank waiver. In conjunction with the
refinancing of our credit facilities, two existing forward interest swap
agreements were canceled in April 1998. The early termination costs associated
with the cancelation of those swaps was $9,823,000.
Interest income and other. Interest income and other increased $878,000 to
$4,505,000 in the nine months ended September 30, 1999 from $3,627,000 in the
nine months ended September 30, 1998 and as a percentage of net operating
revenues, interest income and other was 0.4% for both periods.
Other losses. Other losses in the nine months ended September 30, 1999 were
primarily a result of a $2,577,000 loss on the disposition of our corporate
jet.
Provision for income taxes. Provision for income taxes decreased $25,454,000
to $5,608,000 for the nine months ended September 30, 1999 from $31,062,000 in
the nine months ended September 30, 1998. The effective tax rate was 87.3% for
the nine months ended September 30, 1999 compared to 40.4% in the nine months
ended September 30, 1998, after minority interest but before merger and related
costs. The change in the effective tax rate primarily was due to $8.9 million
from the non-deductible amortization of intangible assets spread over a smaller
pre-tax income base.
Minority interests. Minority interests increased $1,608,000 to $6,425,000 in
the nine months ended September 30, 1999 from $4,817,000 in the nine months
ended September 30, 1998. As a percentage of net operating revenues, minority
interest was 0.6% in both nine month periods.
Extraordinary loss. In February 1998, in conjunction with our merger with
RTC, we terminated the RTC revolving credit agreement, and recorded all of the
remaining related unamortized deferred financing costs as an extraordinary loss
of $2,812,000, net of income tax effect. In April 1998, in conjunction with
refinancing our credit facilities, we also recorded all of the remaining
related unamortized deferred financing costs as an extraordinary loss of
$9,932,000, net of income tax effect.
Cumulative effect of change in accounting principle. Effective January 1,
1998, we adopted Statement of Position No. 98-5, Reporting on the Costs of
Start-up Activities, or SOP 98-5. SOP 98-5 requires that pre-opening and
organizational costs, incurred in conjunction with our pre-opening activities
on our de novo facilities, which previously had been treated as deferred costs
and amortized over five years, should be expensed as incurred. In connection
with the adoption of SOP 98-5, we recorded a charge of $6,896,000, net of
income tax effect as a cumulative effect of a change in accounting principle in
the first quarter of 1998.
15
Liquidity and capital resources
Sources and uses of cash
Our primary capital requirements have been the funding of our growth through
acquisitions and de novo developments, and equipment purchases. Net cash
provided by operating activities was $100.9 million for the first nine months
of 1999 and $6.9 million for the first nine months of 1998. Net cash provided
by operating activities consists of our net income (loss), increased by non-
cash expenses such as depreciation, amortization and the provision for doubtful
accounts, and adjusted by changes in components of working capital, primarily
accounts receivable.
Accounts receivable, net of allowance for doubtful accounts, increased during
the first nine months of 1999 by $41.3 million, of which approximately $16.0
million was due to the payment suspension imposed on our Florida-based
laboratory by its Medicare carrier, which has caused additional working capital
needs, and the remainder mainly was due to an increase in our net operating
revenues.
Net cash used in investing activities was $273.1 million for the first nine
months of 1999 and $383.2 million for the first nine months of 1998. Our
principal uses of cash in investing activities have been related to
acquisitions, purchases of new equipment and leasehold improvements for our
facilities, as well as the development of new facilities. Net cash provided by
financing activities was $204.3 million for the first nine months of 1999 and
$403.1 million for the first nine months of 1998 primarily consisting of
borrowings from our credit facilities. The decreases in net cash used in
investing activities and in net cash provided by financing activities were due
to our completing fewer acquisitions in the first nine months of 1999 as
compared to the first nine months of 1998. As of September 30, 1999, we had
working capital of $417.7 million, including cash of $70.7 million.
We believe that we will have sufficient liquidity to fund our debt service
obligations over at least the next twelve months.
Expansion
In the nine months ended September 30, 1999, we developed 17 new facilities,
8 of which we do not own but we manage, and we expect to develop approximately
8 additional de novo facilities in the remainder of 1999. We anticipate that
our capital requirements for purchases of equipment and leasehold improvements
for facilities, including de novo facilities, will be approximately $20 to $25
million in aggregate for the remaining three months of 1999.
During the nine months ended September 30, 1999, we paid cash of
approximately $152.6 million to acquire 44 facilities and additional interests
from minority partners in certain of our partnerships.
Credit facilities
In August 1999 the lenders under our credit facilities waived compliance with
a financial covenant that established a maximum leverage ratio which we could
not exceed. Subsequent to September 30, 1999, this waiver was extended on
revised terms. The revision to the waiver was required because we have exceeded
the maximum leverage ratio allowable under the terms of the original waiver.
The revised waiver expires March 15, 2000. The lenders also waived our
violation of a covenant that placed a limit on our aggregate borrowings for
international acquisitions, which we had exceeded. The terms of the revised
waiver:
. Permanently reduce the revolving credit facility from $950.0 million to
$700.0 million;
. Reduce our permitted borrowings under the revolving credit facility to
$650.0 million during the waiver period;
. Limit the amounts we may spend for acquisitions, de novo developments and
expansion or relocation of existing dialysis centers;
16
. Accelerated the maturity dates on the term loan and revolving credit
facilities by two years, to March 31, 2006 and March 31, 2003,
respectively; and
. Increased the applicable margins used to determine the interest rates for
our borrowings under the credit facilities.
The applicable margin used in determining the interest rate for borrowings
under the revolving credit facility is based on our leverage ratio. In
addition, the most recent waiver agreement fixed the applicable margin at 2.25%
for Alternate Base Rate loans and 3.50% for adjusted LIBOR loans for the period
September 30, 1999 through March 15, 2000. The applicable margin used in
determining the interest rate for borrowings under the term loan has been fixed
for the remainder of the loan period.
Other than the issues specifically addressed in the waiver agreement, all
other covenants and conditions of the credit facilities remain unchanged.
As of September 30, 1999 the principal amount outstanding under our revolving
facility was $560.9 million and under our term facility was $392.0 million. The
term facility requires annual principal payments of $4.0 million, with the
$368.0 million balance due on maturity. As of September 30, 1999, we had $89.1
million available for borrowing under the revolving facility.
In September 1999 we converted approximately $50.0 million of our outstanding
borrowings under our revolving credit facility from U.S. dollar denominated
borrowings to Euro denominated borrowings, primarily as a hedge of our net
investment in European operations.
Further, the amendment and waiver to our credit facilities described in Note
10 resulted in a write-off of $629,000 for the reduction of previously deferred
financing costs. This write-off is included in other financing costs.
The credit facilities contain financial and operating covenants including,
among other things, requirements that we maintain certain financial ratios and
satisfy certain financial tests, and impose limitations on our ability to make
capital expenditures, to incur other indebtedness and to pay dividends. As of
the date of this filing, including violations waived by the lenders as
described, we are in compliance with all such covenants.
Interest rate swaps
During the quarter ended June 30, 1998, we entered into forward interest rate
cancelable swap agreements with a combined notional amount of $800.0 million.
The lengths of the agreements are between three and ten years with cancelation
clauses at the counterparties' option from one to seven years. The underlying
blended interest rate is fixed at approximately 5.69% plus an applicable margin
based upon our current leverage ratio. Currently, the effective interest rate
for these swaps is 9.30%. During the second quarter of 1999, we received
notification from two of our swap agreement counterparties that they had
exercised their right to cancel agreements in the aggregate notional amount of
$100.0 million. The remaining $700.0 million of swap agreements with maturities
from the years 2003 through 2008 and cancelation option dates from the years
2000 through 2005 are still in effect.
In June 1998, the FASB issued Statement of Financial Accounting Standards No.
133, Accounting for Derivative Instruments and Hedging Activities, or SFAS 133.
SFAS 133 is effective for all fiscal quarters of all fiscal years beginning
after June 15, 2000. Accordingly, for us, SFAS 133 will become effective
January 1, 2001. SFAS 133 requires that all derivative instruments be recorded
on the balance sheet at their fair value. Changes in the fair value of
derivatives are recorded each period in current earnings or other comprehensive
income, depending on whether a derivative is designated as part of a hedge
transaction and, if it is, the type of hedge transaction. For fair-value hedge
transactions in which we are hedging changes in an asset's, liability's or firm
commitment's fair value, changes in the fair value of the derivative instrument
will generally be offset
17
in the income statement by changes in the hedged item's fair value. For cash-
flow hedge transactions, in which we are hedging the variability of cash flows
related to a variable-rate asset, liability, or a forecasted transaction,
changes in the fair value of the derivative instrument will be reported in
other comprehensive income. The gains and losses on the derivative instrument
that are reported in other comprehensive income will be reclassified as
earnings in the periods in which earnings are impacted by the variability of
the cash flows of the hedged item. The ineffective portion of all hedges will
be recognized in current-period earnings.
We have not yet determined the impact that the adoption of SFAS 133 will have
on our earnings or statement of financial position.
Subordinated notes
The $125.0 million outstanding 5 5/8% convertible subordinated notes due 2006
issued by RTC bear interest at the rate of 5 5/8%, payable semi-annually and
require no principal payments until 2006. The 5 5/8% notes are convertible into
shares of our common stock at an effective conversion price of $25.62 per share
and are redeemable by us at our 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. TRCH has guaranteed these notes.
In November 1998 we issued 7% convertible subordinated notes due 2009 in the
aggregate principal amount of $345.0 million. The 7% notes are convertible at
any time, in whole or in part, into shares of our common stock at a conversion
price of $32.81 and will be redeemable after November 16, 2001. We used the net
proceeds from the sale of the 7% notes to pay down debt under the revolving
facility, which may be re-borrowed, subject to the modified terms of our credit
facilities.
Year 2000 considerations
Since the summer of 1998, all of our departments have been meeting with our
information systems department to determine the extent of our Year 2000, or
Y2K, exposure. Project teams have been assembled to work on correcting Y2K
problems and to perform contingency planning to reduce our total exposure.
Corrective action and contingency plans are now in place.
Software applications and hardware. Each component of our software
application portfolio, or SAP, must be examined with respect to its ability to
handle dates properly in the next millennium. As part of our software
assessment plan, we have tested and will continue to validate the testing of
each component of our SAP. These tests are constructed to make sure each
component operates properly with the system date advanced to the next
millennium.
The major phases of our software assessment plan are as follows:
. Complete SAP inventory;
. Implement Y2K compliant software as necessary;
. Analyze which computers have Y2K problems and the cost to repair;
. Test all vendors' representations; and
. Fix any computer-specific problems.
Our billing and accounts receivable software was known to have a significant
Y2K problem. We have already addressed this issue by obtaining a new, Y2K
compliant version of this software. We completed conversion to this Y2K
compliant version in the third quarter of 1999. We will conduct additional
testing of this software in the fourth quarter of 1999.
18
Operating systems. We have also reviewed our operating systems to assess
possible Y2K exposure. We use several different network operating systems, or
NOS, for multi-user access to the software that resides on the respective
servers. Each NOS was examined with respect to its ability to properly handle
dates in the next millennium. We have tested each component of our SAP with a
compliant version of the NOS. One level beneath the NOS is a special piece of
software that comes into play when the computer is "booted" that potentially
has a Y2K problem and that is the basic input output system software, or BIOS.
The BIOS takes the date from the system clock and uses it in passing the date
to the NOS which in turn passes the date to the desktop operating system. The
system clock poses another problem in that some system clocks were only capable
of storing a two-digit year while other computer clocks stored a four-digit
year. This issue affects each and every computer we have purchased. To remedy
these problems, we are conducting an inventory of all computer hardware using a
Y2K utility program to determine whether we have a BIOS or a system clock
problem. Where necessary we performed a BIOS upgrade or performed a processor
upgrade to a Y2K compliant processor.
Dialysis centers, equipment and suppliers. The operations of our dialysis
centers can be affected by the Y2K problem so a contingency plan must be in
place to prevent the shutdown of these centers. Each center was responsible for
completing a survey of the possible consequences of a failure of the
information systems of our vendors and formulating a contingency plan by the
end of the third quarter of 1999. During the fourth quarter of 1999 each center
will continue to make preparations to minimize potential problems.
Substantially all of our biomedical devices, including dialysis machines that
have a computer chip in them, have been checked for Y2K compliance. We have
contacted each of the vendors of the equipment we use and asked them to provide
us with documentation regarding Y2K compliance. In a few cases we are
continuing to ask for and review additional documentation. A limited number of
vendors have performed Y2K tests on a random sample of our equipment by
advancing the clock to a date in the next millennium.
In general, we expect to have all of our biomedical devices Y2K compliant by
the fourth quarter of 1999. We have completed all necessary upgrades for our
dialysis machines. The only biomedical devices yet to be upgraded are two
models of dialyzer reprocessing equipment, with respect to which we are in the
process of securing and installing the necessary upgrades.
In addition to factors noted above which are directly within our control,
factors beyond our direct control may disrupt our operations. If our suppliers
are not Y2K compliant, we may experience inventory shortages and run short of
critical supplies. If the utilities companies, transportation carriers and
telecommunications companies which service us experience Y2K difficulties, our
operations will also be adversely affected and some of our facilities may need
to be closed. We are in the process of taking steps to reduce the impact on our
operations in such instances and implementing contingency plans to address any
possible unavoidable effect which these difficulties would have on our
operations.
To address the possibility of a physical plant failure, we have contacted the
landlords of each of our facilities to insure that they will provide access to
our staff and any other key service providers. We have also provided written
notification to our utilities companies of the locations, schedules and
emergency services required of each of our dialysis facilities. In case a
physical plant failure should result in an emergency closure of any of our
facilities, we are currently:
. Confirming that backup hospital affiliation agreements are up-to-date and
complete;
. Reviewing appropriate elements of our disaster preparedness plan with our
staff and patients;
. Adopting/modifying emergency treatment orders and rationing plans with
our medical directors to provide patient safety; and
. Conducting patient meetings with social workers and dieticians.
19
To minimize the effect of any Y2K non-compliance on the part of suppliers, we
have:
. Identified our critical suppliers and surveyed each of them to assess
their Y2K compliance status;
. Identified alternative supply sources where necessary;
. Identified Y2K compliant transportation/shipping companies to cover
situations where our current suppliers' delivery systems go down;
. Included language in contracts with new suppliers addressing Y2K
performance obligations, requirements and failures;
. Ordered one week of additional inventory for our dialysis facilities;
. Asked critical distributors to carry additional inventory earmarked for
us; and
. Prepared a critical supplier contact/pager list for Y2K emergency supply
problems and ensured that contact persons will be on call 24 hours a day.
Our financial exposure from all sources of SAP and operating system Y2K
issues as well as from dialysis center, equipment and supplier Y2K issues known
to date ranges from approximately $500,000 to $1,200,000, the majority of which
has been expended.
General. The extent and magnitude of the Y2K problem as it will affect us,
both before, and for some period after, January 1, 2000, are difficult to
predict or quantify for a number of reasons. Among the most important are our
lack of control over systems that are used by the third parties who are
critical to our operations, such as telecommunications and utilities companies,
the complexity of testing interconnected networks and applications that depend
on third-party networks and the uncertainty surrounding how others will deal
with liability issues raised by Y2K-related failures. Moreover, the estimated
costs of implementing our plans for fixing Y2K problems do not take into
account the costs, if any, that might be incurred as a result of Y2K-related
failures that occur despite our implementation of these plans.
With respect to third-party non-governmental payors, we are refining
contingency plans to prevent the interruption of cash flow. With respect to
Medicare payments, HCFA and the two primary fiscal intermediaries we utilize
have contingency plans in place. The HCFA mandated contingency plans have been
tested by HCFA to ensure that no interruption of Medicare payments results from
Y2K-related failures of their systems. During the fourth quarter of 1999 we
will conclude testing with our two primary fiscal intermediaries. With respect
to MediCal, the largest of our third-party state payors, we are already
submitting our claims with a four-digit numerical year in accordance with the
current system. We are currently working with our other state payors
individually to determine the extent of their Y2K compliance.
Although we currently are not aware of any material operational issues
associated with preparing our internal computer systems, facilities and
equipment for Y2K, we cannot assure you, due to the overall complexity of the
Y2K issues and the uncertainty surrounding third party responses to Y2K issues,
that we will not experience material unanticipated negative consequences and/or
material costs caused by undetected errors or defects in our or third party
systems or by our failure to adequately prepare for the results of such errors
or defects, including costs of related litigation, if any. The impact of such
consequences could have a material adverse effect on our business, financial
condition or results of operations.
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
Interest rate sensitivity
Due to the acceleration of the maturity of our credit facilities, our
repayment requirements have been modified. The table below has been revised
from the one disclosed in our Form 10-K/A for the fiscal year ended December
31, 1998, to reflect the modified principal repayments on our debt obligations
and the related variable weighted average interest rates by expected maturity
dates.
20
The table also reflects the cancellation of $100,000,000 of interest rate
swaps. For our interest rate swap agreements, the table presents the repayment
of the notional amounts of these swaps at maturity, the fixed weighted average
interest rates we must pay the swap holders according to the swap agreements,
and the weighted average interest rates we will receive from the swap holders,
based upon the current LIBOR. Notional amounts are used to calculate the
contracted payments we will exchange with the swap holders under the swap
agreements. The interest rates we will receive from the swap holders are
variable, and are based on the LIBOR.
Expected Maturity Date
---------------------------------------- Fair
2000 2001 2002 2003 2004 Thereafter Total Value
---- ---- ---- ---- ---- ---------- ----- -----
(in millions)
Liabilities
Long-term debt
Fixed rate.............. $470 $470 $469
Average interest
rate................. 6.64% 6.64%
Variable rate........... $ 24 $ 98 $153 $328 $ 4 $372 $979 $979
Average interest
rate................. 9.33% 9.33% 9.33% 9.33% 9.33% 9.33% 9.33%
Expected Maturity Date
---------------------------------------- Fair
2000 2001 2002 2003 2004 Thereafter Total Value
---- ---- ---- ---- ---- ---------- ----- -----
(in millions)
Interest rate derivatives
Interest rate swaps
Variable to fixed....... $100 $600 $700 $(29)
Average pay rate...... 5.51% 5.69% 5.66%
Average receive rate.. 5.53% 5.46% 5.47%
Our swaps have a one-time call provision for our counter-party at varying
times based upon the maturity of the underlying swaps as follows:
Notional
Swap Maturity Call Provision Amount
------------- -------------- --------
Ten-year swaps: Seven-year $200
Five-year 200
Seven-year swaps: Four-year 100
Three-year 100
Five-year swaps: Two-year 100
----
$700
====
Exchange rate sensitivity
In September 1999 we converted approximately $50.0 million of our outstanding
borrowings under our revolving credit facility from U.S. dollar denominated
borrowings to Euro denominated borrowings, primarily as a hedge of our net
investment in European operations and to assist in our management of foreign
exchange rate risk.
Other than as described above, there have been no material changes in our
market risk exposure from that reported in our Form 10-K/A for the fiscal year
ended December 31, 1998.
21
RISK FACTORS
In addition to the other information set forth in this Form 10-Q, you should
note the following risks related to our business.
If we fail to build adequate internal systems and controls then our revenue and
net income may be adversely affected.
We have experienced rapid growth in the last five years, and especially in
1998, as a result of our business strategy to acquire, develop and manage a
large number of dialysis centers. This historical growth and business strategy
subjects us to the following risks:
. Our billing and collection structures, systems and personnel may prove
inadequate to collect all amounts owed to us for services we have
rendered, resulting in a lack of sufficient cash flow;
. We may require additional management, administrative and clinical
personnel to manage and support our expanded operations, and we may not
be able to attract and retain sufficient personnel;
. Our assessment of the requirements of our growth on our information
systems may prove inaccurate, and we may have to spend substantial
amounts to enhance or replace our information systems;
. Our expanded operations may require cash expenditures in excess of the
cash available to us after paying our debt service obligations;
. We may inaccurately assess the historical and projected results of
operations of acquisition candidates, which may cause us to overpay for
acquisitions;
. We may inaccurately assess the historical and projected results of
operations of existing and recently acquired facilities, which may cause
us not to achieve the results of operations expected for these
facilities; and
. We may not be able to integrate acquired facilities as quickly or
smoothly as we expect, which may cause us not to achieve the results of
operations expected for these acquired facilities.
These risks are enhanced when we acquire entire regional networks or other
national dialysis providers, such as RTC, or enter into multi-facility
management agreements.
Future declines, or the lack of an increase, in Medicare reimbursement rates
could substantially decrease our net income.
We are reimbursed for dialysis services primarily at fixed rates established
in advance under the Medicare end stage renal disease, or ESRD, program. Unlike
many other Medicare programs, which receive periodic cost of living increases,
these rates have not increased since 1991. Increases in operating costs that
are subject to inflation, such as labor and supply costs, have occurred and
continue to occur without a compensating increase in reimbursement rates. In
addition, if Medicare should begin to include in its composite reimbursement
rate any ancillary services that it currently reimburses separately, our
revenue would decrease to the extent there was not a corresponding increase in
that composite rate. We cannot predict whether future rate changes will be
made. Approximately 50% of our net operating revenues in the first nine months
of 1999 was generated from patients who had Medicare as the primary payor.
The Department of Health and Human Services, or HHS, had recommended, and the
Clinton administration had included in its fiscal year 2000 budget proposal to
the Congress, a 10% reduction in Medicare reimbursement for erythropoietin, or
EPO. We cannot predict whether this proposal or other future rate or
reimbursement method changes will be made. Approximately 14% of our net
operating revenues in the first nine months of 1999 was generated from EPO
reimbursement through Medicare and Medicaid programs. Consequently, any
reduction in the rate of EPO reimbursement through Medicare and Medicaid
programs could materially reduce our revenues and net income.
22
Medicare separately reimburses us for other outpatient prescription drugs
that we administer to dialysis patients at the rate of 95% of the average
wholesale price of each drug. The Clinton administration had also included in
its fiscal year 2000 budget proposal to the Congress a reduction in the
reimbursement rate for outpatient prescription drugs to 83% of average
wholesale price. We cannot predict whether Congress will approve this rate
change, or whether other reductions in reimbursement rates for outpatient
prescription drugs will be made. If such changes are implemented, they could
have a material adverse effect on our revenues and net income.
Many Medicaid programs base their reimbursement rates for the services we
provide on the Medicare reimbursement rates. Any reductions in the Medicare
rates could also result in reductions in the Medicaid reimbursement rates.
Approximately 5% of our net operating revenues in the first nine months of 1999
was generated from patients who had Medicaid or comparable state programs as
the primary payer.
If Medicare changes its ESRD program to a capitated reimbursement system, our
revenues and profits could be materially reduced.
HCFA has initiated a pilot demonstration project, expected to end in 2001, to
test the feasibility of allowing managed care plans to participate in the
Medicare ESRD program on a capitated basis. Under a capitated plan we or
managed care plans would receive a fixed periodic payment for servicing all of
our Medicare-eligible ESRD patients regardless of certain fluctuations in the
number of services provided in that period or the number of patients treated.
Under the current demonstration project, Medicare is paying managed care plans
a capitated rate equal to 95% of Medicare's current average cost of treating
dialysis patients. If HCFA considers this pilot program successful, HCFA or
Congress could lower the average Medicare reimbursement for dialysis.
If we charge private payors at rates less than our current rates, then our
revenues and net income could be substantially reduced.
Approximately 39% of our net operating revenues in the first nine months of
1999 was generated from patients who had domestic private payors as the primary
payor. Domestic private payors, particularly managed care payors, have become
more aggressive in demanding contract rates approaching or at Medicare
reimbursement rates. We believe that the financial pressures on private payors
to decrease the rates at which they reimburse us will continue to increase and
could have a material impact on our revenues and net income.
If our assumptions regarding the beneficial life of our goodwill prove to be
inaccurate, or subsequently change, our current earnings may be overstated and
future earnings also may be affected.
Our balance sheet has an amount designated as "goodwill" that represents 45%
of our assets and 205% of our stockholders' equity at September 30, 1999.
Goodwill arises when an acquiror pays more for a business than the fair value
of the tangible and separately measurable intangible net assets. Generally
accepted accounting principles require the amortization of goodwill and all
other intangible assets over the period benefited. The current average useful
life is 34 years for our goodwill and 21 years for all of our intangible assets
that relate to business combinations. We have determined that most acquisitions
after December 31, 1996 will continue to provide a benefit to us for no less
than 40 years after the acquisition. In making this determination, we have
reviewed with our independent accountants the significant factors that we
considered in arriving at the consideration we paid for, and the expected
period of benefit from, acquired businesses.
We continuously review the appropriateness of the amortization periods we are
using and change them as necessary to reflect current expectations. This
information is also reviewed with our independent accountants. If the factors
we considered, and which give rise to a material portion of our goodwill,
result in an actual beneficial period shorter than our determined useful life,
earnings reported in periods immediately following some acquisitions would be
overstated. In addition, in later years, we would be burdened by a continuing
charge against earnings without the associated benefit to income. Earnings in
later years could also be affected significantly if we subsequently determine
that the remaining balance of goodwill has been impaired.
23
Interruption in the supply of, or cost increases in, EPO could materially
reduce our net income and affect our ability to care for our patients.
A single manufacturer, Amgen Corporation, produces EPO. In the future, Amgen
may be unwilling or unable to supply us with EPO. Additionally, shortages in
the raw materials or other resources necessary to manufacture EPO, or simply an
arbitrary decision on the part of this sole supplier, may increase the
wholesale price of EPO. Interruptions of the supply of EPO or increases in the
price we pay for EPO could have a material adverse effect on our financial
condition as well as our ability to provide appropriate care to our patients.
If we fail to identify, assess and respond successfully to the unique
attributes of each of our foreign operations, our net income could be adversely
affected.
We only recently commenced operations outside the U.S., and expect to enter
additional foreign markets in the next few years. Our failure to identify,
understand and respond to the unique attributes of any of the foreign markets
that we enter could cause us to:
. Overpay for acquisitions of foreign dialysis centers;
. Fail to integrate foreign acquisitions into our operations successfully;
and
. Assess the performance of our foreign operations incorrectly.
The unique attributes of our foreign operations include:
. Differences in payment and reimbursement rules and procedures, including
unanticipated slowdowns in payments from large payors in Argentina;
. Differences in accepted clinical standards and practices;
. Differences in management styles and practices;
. The unfamiliarity of foreign companies with U.S. financial reporting
standards; and
. Local laws that restrict or limit employee discharges and disciplinary
actions.
If we fail to adhere to all of the complex government regulations that apply to
our business, we could incur substantial fines or be excluded from
participating in government reimbursement programs.
Our dialysis operations are subject to extensive federal, state and local
government regulations in the U.S. and to extensive government regulation in
every foreign country in which we operate. Any of the following could adversely
impact our revenues:
. Loss of required government certifications;
. Loss of authorizations to participate in or exclusion from government
reimbursement programs, such as the Medicare ESRD Program and Medicaid
programs;
. Suspension of payments from government programs;
. Loss of licenses required to operate health care facilities in some of
the states in which we operate; and
. Any challenge to the relationships we have structured in some foreign
countries to comply with barriers to direct foreign ownership of
healthcare businesses.
The regulatory scrutiny of healthcare providers has increased significantly
in recent years. For example, the Office of Inspector General of HHS has
reported that it recovered $1.2 billion in fiscal year 1997 and $480 million in
fiscal year 1998 from health care fraud investigations.
24
. We may never collect the revenues from the payments suspended as a result
of an investigation of our laboratory subsidiary
Our Florida-based laboratory subsidiary is the subject of a third-party
carrier review relating to claims the laboratory submitted for Medicare
reimbursement. In May 1998, the carrier suspended all further Medicare payments
to this laboratory. Medicare revenues from this laboratory represent
approximately 2% of our net revenues. For the review periods the carrier has
identified, January 1995 to April 1996, and May 1996 to March 1998, the carrier
has alleged that the prescribing physician's medical justification did not
properly support approximately 97% of the tests this laboratory performed. The
carrier has determined that it overpaid this laboratory $5.6 million for the
period from January 1995 to April 1996, and $14.2 million for the period from
May 1996 to March 1998. The suspension of payments relates to all payments due
after the suspension started, regardless of when this laboratory performed the
tests. The carrier has withheld approximately $27 million as of September 30,
1999, which has adversely affected our cash flow. We may never recover the
amounts withheld.
. Our failure to comply with federal and state fraud and abuse statutes
could result in sanctions
Neither our arrangements with the medical directors of our facilities nor the
minority ownership interests of referring physicians in some of our dialysis
facilities meet all of the requirements of published safe harbors to the anti-
kickback provisions of the Social Security Act and similar state laws. These
laws impose civil and criminal sanctions on anyone who receives or makes
payments for referring a patient for any service reimbursed by Medicare,
Medicaid or similar federal and state programs. Arrangements within published
safe harbors are deemed not to violate these provisions. Enforcement agencies
may subject arrangements that do not fall within a safe harbor to greater
scrutiny. If we are challenged under these statutes, we may have to change our
relationships with our medical directors and with referring physicians holding
minority ownership interests.
The laws of several states in which we do business prohibit a physician from
making referrals for laboratory services to entities with which the physician,
or an immediate family member, has a financial interest. We currently operate a
large number of facilities in these states, which account for a significant
percentage of our business. These state statutes could apply to laboratory
services incidental to dialysis services. If so, we may have to change our
relationships with referring physicians who serve as medical directors of our
facilities or hold minority interests in any of our facilities.
We may not have sufficient cash flow from our business to service our debt.
The amount of our outstanding debt is large compared to the net book value of
our assets, and we have substantial repayment obligations under our outstanding
debt. As of September 30, 1999 we had:
. Total consolidated debt of approximately $1.4 billion;
. Stockholders' equity of approximately $482 million; and
. A ratio of earnings to fixed charges of 1.07.
The following chart shows our aggregate interest and principal payments due
on all of our currently outstanding debt for each of the next five fiscal
years. Under interest swap agreements covering $700 million of debt, the
interest rate under our credit facilities varies based on the amount of debt we
incur relative to our assets and equity. Accordingly, the amount of these
interest payments could fluctuate in the future.
Interest Principal
Payments Payments
------------ ------------
For the year ending December 31:
2000.......................................... $119,833,000 $ 23,702,000
2001.......................................... 110,742,000 97,874,000
2002.......................................... 96,647,000 153,400,000
2003.......................................... 66,576,000 327,901,000
2004.......................................... 66,200,000 4,000,000
25
Due to the large amount of these principal and interest payments, we may not
have enough cash to pay the interest on our debt as it becomes due.
The large amount and terms of our outstanding debt may prevent us from taking
actions we would otherwise consider in our best interest.
Our credit facilities contain numerous financial and operating covenants that
limit our ability, and the ability of most of our subsidiaries, to engage in
activities such as incurring additional senior debt and disposing of our
assets. These covenants require that we meet interest coverage, net worth and
leverage tests.
Additionally, we are highly leveraged and, if we are not in compliance with
our covenants, we may be required to renegotiate the terms of our credit
facilities on terms that are more unfavorable to us, such as higher interest
rates, shorter maturities or more restrictive borrowing terms; all of which may
have an adverse impact on net income. Currently, as a result of the waivers
granted by our lenders, we are in compliance with our credit facility
covenants.
Our level of debt and the limitations our credit facilities impose on us
could have other important consequences to you, including:
. We will have to use a portion of our cash flow from operations,
approximately $143.5 million in 2000 and $208.6 million in 2001, for debt
service rather than for our operations;
. We may not be able to obtain additional debt financing for future working
capital, capital expenditures, acquisitions or other corporate purposes;
and
. We could be less able to take advantage of significant business
opportunities, including acquisitions, and react to changes in market or
industry conditions.
If a change of control occurs, we may not have sufficient funds to repurchase
our outstanding notes.
Upon a change of control, generally the sale or transfer of a majority of our
voting stock or almost all of our assets, our noteholders may require us to
repurchase all or a portion of their notes. If a change of control occurs, we
may not be able to pay the repurchase price for all of the notes submitted for
repurchase. In addition, the terms of our credit facilities generally prohibit
us from purchasing any notes until we have repaid all debt outstanding under
these credit facilities. Future credit agreements or other agreements relating
to debt may contain similar provisions. We may not be able to secure the
consent of our lenders to repurchase our outstanding notes or refinance the
borrowings that prohibit us from repurchasing our outstanding notes. If we do
not obtain a consent or repay the borrowings, we could not repurchase these
notes.
We may experience material unanticipated negative consequences beginning in the
year 2000 due to undetected computer defects.
The Y2K issue concerns the potential exposures related to the automated
generation of incorrect information from the use of computer programs which
have been written using two digits, rather than four, to define the applicable
year of business transactions. Due to the overall complexity of the Y2K issues
and the uncertainty surrounding third party responses to Y2K issues, we cannot
assure you that undetected errors or defects in our or third party systems or
our failure to prepare adequately for the results of those errors or defects
will not cause us material unanticipated problems or costs.
The extent and magnitude of the Y2K problem as it will affect us, both
before, and for some period after, January 1, 2000, are difficult to predict or
quantify for a number of reasons. Among the most important are:
. Our lack of control over third party systems that are critical to our
operations, including those of telecommunications and utilities companies
and governmental and non-governmental payors;
. The complexity of testing interconnected internal and external computer
networks, software applications and dialysis equipment; and
. The uncertainty surrounding how others will deal with liability issues
raised by Y2K-related failures.
26
Moreover, the estimated costs of implementing our plans for fixing Y2K
problems do not take into account the costs, if any, that we might incur as a
result of Y2K-related failures that occur despite our implementation of these
plans.
While we are developing contingency plans to address possible computer
failure scenarios, we recognize that there are "worst case" scenarios which may
occur. We may experience the extended failure of external and internal computer
networks and equipment that control
. Medicare, Medicaid and other third party payors' ability to reimburse us;
. Regional infrastructures, such as power, water and telecommunications
systems;
. Equipment and machines that are essential for the delivery of patient
care; and
. Computer software necessary to support our billing process.
If any one of these events occurs, our cash flow could be materially reduced.
Even in the absence of a failure of these networks and equipment, we will
likely continue to incur costs related to remediation efforts, the replacement
or upgrade of equipment, continued efforts regarding contingency planning,
increased staffing for the periods immediately preceding and after January 1,
2000 and the possible implementation of alternative payment schemes with our
payors.
Provisions in our charter documents may deter a change of control which our
stockholders may otherwise determine to be in their best interests.
Our certificate of incorporation and bylaws and the Delaware General
Corporation Law include provisions which may deter hostile takeovers, delay or
prevent changes in control or changes in our management, or limit the ability
of our stockholders to approve transactions that they may otherwise determine
to be in their best interests. These provisions include:
. A provision requiring that our stockholders may take action only at a
duly called annual or special meeting of our stockholders and not by
written consent;
. A provision requiring a stockholder to give at least 60 days' advance
notice of a proposal or director nomination that the stockholder desires
to present at any annual or special meeting of stockholders; and
. A provision granting our board of directors the authority to issue up to
five million shares of preferred stock and to determine the rights and
preferences of the preferred stock without the need for further
stockholder approval. The existence of this "blank-check" preferred stock
could discourage an attempt to obtain control of us by means of a tender
offer, merger, proxy contest or otherwise. Furthermore, this "blank-
check" preferred stock may have other rights, including economic rights,
senior to our common stock. Therefore, issuance of the preferred stock
could have an adverse effect on the market price of our common stock.
We may, in the future, adopt other measures that may have the effect of
delaying, deferring or preventing an unsolicited takeover, even if such a
change in control were at a premium price or favored by a majority of
unaffiliated stockholders. We may adopt certain of these measures without any
further vote or action by our stockholders.
Forward-looking statements
We believe that this Form 10-Q contains statements that are forward-looking
statements within the meaning of the federal securities laws. These include
statements about our expectations, beliefs, intentions or strategies for the
future, which we indicate by words or phrases such as "anticipate," "expect,"
"intend," "plan," "will," "believe" and similar language. These statements
involve known and unknown risks, including risks resulting from economic and
market conditions, the regulatory environment in which we operate, competitive
activities and other business conditions, and are subject to uncertainties and
assumptions set forth elsewhere in this Form 10-Q. Our actual results may
differ materially from results anticipated in these forward-looking statements.
We base our forward-looking statements on information currently available to
us, and we assume no obligation to update these statements.
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PART II
OTHER INFORMATION
Item 1. Legal Procedings
The information in Note 9 of the Notes to Condensed Consolidated Financial
Statements in Part I, Item 1 of this report is incorporated by this reference
in response to this item. Please see our quarterly report on Form 10-Q for the
quarter ended June 30, 1999 for additional information.
Items 2, 3, 4 and 5 are not applicable.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
10.1 Employment Agreement, dated as of October 18, 1999, by and between
TRCH and Kent J. Thiry.*
10.2 Agreement, dated as of October 6, 1999, by and between TRCH and Victor
M.G. Chaltiel.*
10.3 Agreement, dated as of October 18, 1999, by and between TRCH and John
E. King.*
10.4 Consulting Agreement, dated as of October 1, 1998, by and between
Total Renal Care, Inc. and Shaul G. Massry, M.D.*
10.5 Amendment No. 4 and Waiver, dated as of November 8, 1999, to and under
the Revolving Credit Agreement.
10.6 Limited Waiver and Third Amendment, dated as of November 8, 1999, to
the Term Loan Agreement.
12.1 Statement re computation of ratio of earnings to fixed charges.
27.1 Financial Data Schedule--three months ended September 30, 1999 and
1998.
27.2 Financial Data Schedule--nine months ended September 30, 1999 and nine
months ended September 30, 1998.
- ---------------------
* Management contract or executive compensation plan or arrangement.
(b) Reports on Form 8-K
None.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
TOTAL RENAL CARE HOLDINGS, INC.
/s/ John J. McDonough
By: _________________________________
John J. McDonough
Vice President and
Chief Accounting Officer
Date: November 15, 1999
John J. McDonough is signing in the dual capacities as the registrant's
principal accounting officer and a duly authorized officer of the registrant.
29