UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] quarterly report pursuant to section 13 or 15(d) of the securities
exchange act of 1934
FOR THE THREE MONTHS ENDED March 31, 2002
--------------
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 33-80127
Dynacare Inc.
------------------------------------------------------
(Exact name of registrant as specified in its charter)
Ontario, Canada 98-0337653
---------------------------- ------------------------------------
(State or other jurisdiction (I.R.S. Employer Identification No.)
of incorporation or organization)
14900 Landmark Boulevard, Dallas, Texas 75254
---------------------------------------------
(Address of principal executive offices)
(Zip Code)
(972) 387-3200
----------------------------------------------------
(Registrant's telephone number, including area code)
N/A
--------------------------------------------------------------------------
(Former name, former address and former fiscal year, 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 periods 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 __
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practical date.
As of April 15, 2002, there were 19,326,946 shares of the Company's common stock
outstanding.
INDEX
- --------------------------------------------------------------------------------
DYNACARE INC.
Page
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Consolidated statements of financial position as at March 31,
2002 and December 31, 2001 .................................................................. 1
Consolidated statements of operations for the three months ended
March 31, 2002 and 2001 ..................................................................... 2
Consolidated statements of deficit for the three months ended
March 31, 2002 and 2001 ..................................................................... 2
Condensed consolidated statements of cash flows for the three months ended March 31, 2002
and 2001 .................................................................................... 3
Notes to consolidated financial statements for the three months ended March 31, 2002 and
2001......................................................................................... 4
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations........ 11
Item 3. Quantitative and Qualitative Disclosure of Market Risk....................................... 18
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.......................................................................... 20
Item 2. Changes in Securities and Use of Proceeds.................................................. 20
Item 3. Defaults upon Senior Securities............................................................ 20
Item 4. Submission of Matters to a Vote of Security Holders........................................ 20
Item 5. Other Information.......................................................................... 20
Item 6. Exhibits and Reports on Form 8-K........................................................... 20
SIGNATURES ................................................................................................ 21
2
PART I. FINANCIAL INFORMATION
ITEM I. FINANCIAL STATEMENTS (UNAUDITED)
DYNACARE INC.
CONSOLIDATED STATEMENTS OF FINANCIAL POSITION
As at
- -------------------------------------------------------------------------------------------------------------------
(in thousands of U.S. dollars) March 31, December 31,
2002 2001
(Unaudited) (Audited)
- -------------------------------------------------------------------------------------------------------------------
ASSETS
Current assets:
Cash and cash equivalents $ 18,507 $ 30,002
Accounts receivable 76,852 72,895
Prepaid expenses 4,756 3,074
Inventory 11,532 11,314
Deferred income taxes 5,059 5,059
- -------------------------------------------------------------------------------------------------------------------
Total current assets 116,706 122,344
Capital assets 52,578 51,722
Goodwill 102,080 100,194
Intangible assets 80,720 81,037
Other assets 27,926 29,028
- -------------------------------------------------------------------------------------------------------------------
$ 380,010 $ 384,325
===================================================================================================================
LIABILITIES
Current liabilities:
Bank indebtedness $ 3,894 $ 3,890
Accounts payable and accrued liabilities 38,710 48,701
Current portion of deferred income taxes 12,799 12,799
Current portion of long term debt 2,082 2,265
- -------------------------------------------------------------------------------------------------------------------
Total current liabilities 57,485 67,655
Long term debt 203,109 201,811
Deferred income taxes 24,483 22,574
- -------------------------------------------------------------------------------------------------------------------
285,077 292,040
- -------------------------------------------------------------------------------------------------------------------
SHAREHOLDERS' EQUITY
Capital stock 123,172 122,855
Deficit (28,054) (32,368)
- -------------------------------------------------------------------------------------------------------------------
95,118 90,487
Foreign currency translation adjustment (185) 1,798
- -------------------------------------------------------------------------------------------------------------------
94,933 92,285
- -------------------------------------------------------------------------------------------------------------------
$ 380,010 $ 384,325
===================================================================================================================
Commitments and contingencies (Note 4)
DYNACARE INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
For the three months ended March 31, (Unaudited)
- ------------------------------------------------------------------------------------------------------------------
(in thousands of U.S. dollars, except per share data) 2002 2001
- ------------------------------------------------------------------------------------------------------------------
Revenues $ 107,748 $ 95,808
- ------------------------------------------------------------------------------------------------------------------
General and operating expenses 92,882 82,739
Depreciation 3,397 2,672
Amortization of customer lists and contracts 247 199
Amortization of licenses and goodwill - 1,187
- ------------------------------------------------------------------------------------------------------------------
96,526 86,797
- ------------------------------------------------------------------------------------------------------------------
Operating earnings 11,222 9,011
Interest expense 4,347 5,331
- ------------------------------------------------------------------------------------------------------------------
Earnings before income taxes 6,875 3,680
- ------------------------------------------------------------------------------------------------------------------
Income tax expense
Current 766 687
Deferred 1,795 904
- ------------------------------------------------------------------------------------------------------------------
2,561 1,591
- ------------------------------------------------------------------------------------------------------------------
Net earnings $ 4,314 $ 2,089
==================================================================================================================
Earnings Per Share - Basic $ 0.22 $ 0.12
Earnings Per Share - Diluted $ 0.21 $ 0.12
==================================================================================================================
CONSOLIDATED STATEMENTS OF DEFICIT
For the three months ended March 31, (Unaudited)
- ------------------------------------------------------------------------------------------------------------------
(in thousands of U.S. dollars) 2002 2001
- ------------------------------------------------------------------------------------------------------------------
Deficit, beginning of period $ (32,368) $ (44,085)
Net earnings 4,314 2,089
- ------------------------------------------------------------------------------------------------------------------
Deficit, end of period $ (28,054) $ (41,996)
==================================================================================================================
2
DYNACARE INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
For the three months ended March 31, (Unaudited)
- -------------------------------------------------------------------------------------------------------------------
(in thousands of U.S. dollars) 2002 2001
- -------------------------------------------------------------------------------------------------------------------
CASH FLOW USED IN OPERATING ACTIVITIES
Net Earnings $ 4,314 $ 2,089
Items not affecting cash and cash equivalents
Depreciation 3,397 2,672
Amortization of customer lists and contracts 247 199
Amortization of licenses and goodwill - 1,187
Deferred income taxes 1,795 904
Net change in non-cash working capital items (15,842) (16,219)
- -------------------------------------------------------------------------------------------------------------------
(6,089) (9,168)
- -------------------------------------------------------------------------------------------------------------------
CASH FLOW USED IN INVESTING ACTIVITIES
Acquisition of businesses (1,886) (7,982)
Purchase of capital assets (2,392) (2,318)
Decrease (increase) in other assets - net 169 (1,254)
- -------------------------------------------------------------------------------------------------------------------
(4,109) (11,554)
- -------------------------------------------------------------------------------------------------------------------
CASH FLOW PROVIDED BY FINANCING ACTIVITIES
Increase in bank indebtedness 3 7,340
Repayment of long term debt (283) (717)
Issuance of capital stock 317 -
- -------------------------------------------------------------------------------------------------------------------
37 6,623
- -------------------------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------------------
Foreign exchange translation adjustments (1,334) 728
- -------------------------------------------------------------------------------------------------------------------
Decrease in cash and cash equivalents during the period (11,495) (13,371)
Cash and cash equivalents, beginning of period 30,002 18,099
- -------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents, end of period $ 18,507 $ 4,728
===================================================================================================================
3
DYNACARE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(in thousands of U.S. dollars, except for share and per share amounts)
1. Basis of Presentation
The Company's unaudited interim consolidated financial statements have
been prepared in accordance with Canadian Generally Accepted Accounting
Principles ("GAAP") and the instructions of Form 10-Q and Article 10 of
Regulation S-X.
In the opinion of management, the unaudited interim consolidated
financial statements of the Company reflect all adjustments, which
consist only of normal and recurring adjustments, necessary to present
fairly the financial position as at March 31, 2002 and results of
operations and cash flows for the three months ended March 31, 2002 and
2001. These unaudited interim consolidated financial statements follow
the same accounting policies and methods of their application as the
most recent annual consolidated financial statements of the Company,
except as disclosed in note 5. Operating results for the three months
ended March 31, 2002, are not necessarily indicative of the operating
results that may be expected for the year ending December 31, 2002.
2. Earnings Per Share
The Company's earnings per share data was computed as follows:
Three months ended March 31, 2002 2001
----------------------------------------------------------------------------------------------------------
Basic earnings per share
----------------------------------------------------------------------------------------------------------
Net earnings $ 4,314 $ 2,089
----------------------------------------------------------------------------------------------------------
Weighted average number of common shares outstanding
during the period
19,312,326 16,883,914
----------------------------------------------------------------------------------------------------------
Basic earnings per share $ 0.22 $ 0.12
==========================================================================================================
Diluted earnings per share
----------------------------------------------------------------------------------------------------------
Net earnings $ 4,314 $ 2,089
----------------------------------------------------------------------------------------------------------
Weighted average number of common shares outstanding
during the period
19,312,326 16,883,914
Stock options 1,184,273 242,495
----------------------------------------------------------------------------------------------------------
20,496,599 17,126,409
----------------------------------------------------------------------------------------------------------
Diluted earnings per share $ 0.21 $ 0.12
==========================================================================================================
4
DYNACARE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(in thousands of U.S. dollars, except for share and per share amounts)
3. Segment Information
Management of the Company has determined that the Company operates in
two geographic segments, the provision of clinical laboratory services
in the United States and Canada.
As at and for the three
months ended March 31, 2002 2001
-----------------------------------------------------------------------------------------------------------
U.S Canada Total U.S. Canada Total
--- ------ ----- ---- ------ -----
Revenues $ 81,803 $ 25,945 $ 107,748 $ 70,021 $ 25,787 $ 95,808
Net earnings (loss) $ 1,013 $ 3,301 $ 4,314 $ (216) $ 2,305 $ 2,089
Total assets $ 236,838 $ 143,172 $ 380,010 $ 219,587 $ 128,155 $ 347,742
-----------------------------------------------------------------------------------------------------------
4. Commitments and Contingencies
In January 2002, one of the Company's partnerships entered into a new
lease, which has resulted in the early termination of its existing
lease. The Company expects to remain in its existing leased premises
until October 31, 2002. The lease termination cost has been estimated
at $0.4 million, and will be recorded by the Company in its
consolidated financial statements in the fourth quarter of 2002.
In 1995 the Company sold its retirement homes division. On the sale of
one of the retirement homes, the purchaser assumed two mortgages with a
total balance of $11.3 million at March 31, 2002 and $11.7 million at
December 31, 2001. The Company has not been formally discharged from
the mortgages, however, the Company has been indemnified by the
purchaser and does not expect non-performance. The mortgages bear
interest at 10.0% per annum and are repayable in 2003 and 2004.
The Company is contingently liable with respect to litigation and
claims which arise from time to time. Litigation is subject to many
uncertainties, and the outcome of individual matters is not
predictable. It is reasonably possible that the final resolution of
some of these matters may require the Company to make expenditures in
excess of estimates, over an extended period of time and in a range of
amounts that cannot be reasonably estimated at this time. However, in
the opinion of management, any liabilities that may arise from these
contingencies would not have a material adverse affect on the financial
position and results of operations of the Company.
5. Accounting Pronouncements
(a) Goodwill and Intangible Assets
In June 2001, the Financial Accounting Standards Board issued
Statements of Financial Accounting Standards No 141-Business
Combinations (FASB 141), and No 142-Goodwill and Other Intangible
Assets (FASB 142), effective for fiscal years beginning after December
15, 2001. Similarly, in August 2001, the Canadian Institute of
Chartered Accountants issued handbook sections 1581-Business
Combinations (CICA 1581) and 3062-Goodwill and Other Intangible Assets
(CICA 3062) effective for fiscal years beginning January 1, 2002. Under
the new U.S. and Canadian accounting rules, goodwill and intangible
assets deemed to have an indefinite life are no longer being amortized
5
DYNACARE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(in thousands of U.S. dollars, except for share and per share amounts)
but are subject to annual impairment tests. Other intangible assets
continue to be amortized over their useful life.
The Company has performed the required impairment tests of goodwill and
intangible assets with an indefinite life effective as of January 1,
2002, and has determined that there are no impairment charges that
impact the Company's licenses and goodwill, and therefore its net
earnings and financial position for the three months ended March 31,
2002. The Company may incur impairment charges for licenses and
goodwill in the future, which could adversely impact its profitability
and financial position.
The Company's goodwill and intangible assets are presented below. The
Company's goodwill arises on the acquisition of clinical laboratory
services in the United States.
Intangible Assets
March 31, 2002
----------------------------------------------------------------------------------------------------------
Gross Carrying Accumulated
Amount Amortization
----------------------------------------------------------------------------------------------------------
Amortized intangible assets
Customer lists $ 3,535 $ 637
Contracts 8,133 3,425
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Subtotal $ 11,668 $ 4,062
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Unamortized intangible assets
Licenses $ 89,750 $ 16,636
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Subtotal $ 89,750 $ 16,636
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Total $ 101,418 $ 20,698
==========================================================================================================
The amortization expense for intangible assets for the three months
ended March 31, 2002 was $0.2 million.
The estimated amortization expense for intangible assets for the
remainder of 2002 and in each of 2003 to 2006 is as follows:
2002 $ 0.8 million
2003 $ 1.0 million
2004 $ 1.0 million
2005 $ 0.8 million
2006 $ 0.4 million
6
DYNACARE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(in thousands of U.S. dollars, except for share and per share amounts)
Goodwill
The change in the carrying amount of the Company's goodwill for the
three months ended March 31, 2002 is as follows:
---------------------------------------------------------------------------------------------------------
Goodwill, beginning of period $ 100,194
Goodwill acquired during the period 1,886
---------------------------------------------------------------------------------------------------------
Goodwill, end of period $ 102,080
=========================================================================================================
Goodwill and Other Intangible Assets - Adoption of CICA 3062
As a result of the Company's adoption of CICA 3062, adjusted net
earnings and earnings per share for the three months ended March 31,
2002 and 2001 related to the Company's goodwill and intangible assets
that are no longer being amortized (including any related income tax
effects) are as follows:
For the Three Months Ended March 31, 2002 2001
----------------------------------------------------------------------------------------------------------
Reported net earnings $ 4,314 $ 2,089
Addback: Goodwill amortization - 421
Addback: Licenses amortization - 455
----------------------------------------------------------------------------------------------------------
Adjusted net earnings $ 4,314 $ 2,965
==========================================================================================================
Basic earnings per share
----------------------------------------------------------------------------------------------------------
Reported net earnings $ 0.22 $ 0.12
Goodwill amortization - 0.03
Licenses amortization - 0.03
----------------------------------------------------------------------------------------------------------
Adjusted net earnings $ 0.22 $ 0.18
==========================================================================================================
Diluted earning per share
----------------------------------------------------------------------------------------------------------
Reported net earnings $ 0.21 $ 0.12
Goodwill amortization - 0.02
Licenses amortization - 0.03
----------------------------------------------------------------------------------------------------------
Adjusted net earnings $ 0.21 $ 0.17
==========================================================================================================
The Company's licenses and goodwill based on the requirements of CICA
3062 are deemed to have an indefinite useful life and accordingly
effective January 1, 2002, the Company no longer amortizes its licenses
and goodwill. The Company's remaining intangible assets continue to be
amortized over their estimated useful life.
7
DYNACARE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(in thousands of U.S. dollars, except for share and per share amounts)
(b) Stock Compensation
Effective January 1, 2002 the Company adopted the newly issued Canadian
Institute of Chartered Accountants Handbook Section 3870 - Stock-Based
Compensation and Other Stock-Based Payments (CICA 3870), on a
prospective basis without restatement of prior periods.
Under the executive and employee stock option plans, the Company may
grant stock options to its executives and employees for up to 2,909,340
common shares.
A summary of the status of the Company's stock option plans for common
shares is presented below:
(i) Executive Stock Option Plan
March 31, 2002
-----------------------------------------------------------------------------------------------------------
Weighted-
average
Stock exercise
options price
-----------------------------------------------------------------------------------------------------------
Outstanding at beginning of period 1,454,669 Cdn$9.38
Granted 105,000 $17.92
Exercised - -
Cancelled - -
-----------------------------------------------------------------------------------------------------------
Outstanding at end of period 1,559,669 (1)
===========================================================================================================
-----------------------------------------------------------------------------------------------------------
Stock options exercisable
at period-end 1,454,669 Cdn$9.38
-----------------------------------------------------------------------------------------------------------
Weighted-average fair value
of stock options granted
during the period $12.32
-----------------------------------------------------------------------------------------------------------
- ----------
(1) Executive stock options outstanding as of March 31, 2002 have a
weighted average exercise price of $6.85 (Cdn$10.67).
The contractual remaining life of the stock options outstanding at
March 31, 2002 is approximately five years for 1,454,669 stock options
and approximately ten years for the balance of 105,000 stock options.
As of March 31, 2002, stock options outstanding of 1,454,669 are fully
vested, and the balance of 105,000 vest as to 20% each year on the
anniversary date of the stock option grant.
8
DYNACARE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(in thousands of U.S. dollars, except for share and per share amounts)
(ii) Employee Stock Option Plan
March 31, 2002
------------------------------------------------------------------------------------------------------------
Weighted-
average
Stock exercise
options price
------------------------------------------------------------------------------------------------------------
Outstanding at beginning of period 752,519 (2)
Granted 145,000 $15.50
Exercised (41,315) $6.91
Cancelled (52,463) $10.75
------------------------------------------------------------------------------------------------------------
Outstanding at end of period 803,741 (2)
============================================================================================================
------------------------------------------------------------------------------------------------------------
Stock options exercisable
at period-end 155,471 (2)
------------------------------------------------------------------------------------------------------------
Weighted-average fair value
of stock options granted
during the period $10.64
------------------------------------------------------------------------------------------------------------
- ----------
(2) Employee stock options outstanding as of January 1, 2002 and
March 31, 2002 have a weighted average exercise price of $9.34
(Cdn$14.47) and $10.49 (Cdn$16.32), respectively. Employee
stock options exercisable as of March 31, 2002 have a weighted
average exercise price of $8.22 (Cdn$13.10).
The contractual remaining life of the stock options outstanding at
March 31, 2002 is approximately four years for 142,121 stock options
and approximately six years for the balance of 661,620 stock options.
The stock options vest as to 20% each year on the anniversary date of
the stock option grant.
The Company accounts for stock options issued to executives and
employees based on the intrinsic method and follows the fair value
disclosure requirements as set out in CICA 3870. CICA 3870 is
substantially similar to the U.S. GAAP requirements of APB Opinion 25
and related Interpretations, in Accounting for Stock Issued to
Employees and the fair-value disclosure requirements as described in
Financial Accounting Standards Board Statement No. 123 - Accounting for
Stock-Based Compensation.
9
DYNACARE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(in thousands of U.S. dollars, except for share and per share amounts)
If the compensation cost for the Company's stock-based compensation
plan had been determined based on the fair value at the dates the
awards were granted under those plans consistent with the requirements
of CICA 3870 the pro forma net earnings and earnings per share would
have been as follows:
Three Months Ended March 31, 2002
----------------------------------------------------------------------
Pro forma net earnings $ 3,727
----------------------------------------------------------------------
Pro forma earnings per share - basic $ 0.19
----------------------------------------------------------------------
Pro forma earnings per share - diluted $ 0.18
----------------------------------------------------------------------
The fair value of each option grant of common shares for all options is
estimated using an option-pricing model for public companies with the
following assumptions for the three months ended March 31, 2002;
dividend yield of Nil%, risk-free interest rate range of 3.5% to 5.4%,
expected life of five years and a volatility factor of 0.822.
(c) Accounting for the Impairment of Long-Lived Assets
In August 2001, the Financial Accounting Standards Board issued
Statement No 144-Accounting for the Impairment or Disposal of
Long-Lived Assets (FASB 144) effective for fiscal years beginning after
December 15, 2001. This Statement supercedes (FASB 121) - Accounting
for the Impairment of Long-Lived Assets and for Long-Lived Assets to be
Disposed of. FASB 144 retains the fundamental provision of FASB 121 for
(a) recognition and measurement of the impairment of long-lived assets
to be held and used and (b) measurement of long-lived assets to be
disposed of by sale. The Company determined that for the three months
ended March 31, 2002 there is no effect of FASB 144 on the Company's
net earnings and financial position.
10
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Overview
Dynacare Inc. (the "Company") is one of the leading providers of
clinical laboratory testing services in North America, providing laboratory
services in 21 states and two Canadian provinces.
The Company's revenues for the three months ended March 31, 2002 were
$107.7 million compared to $95.8 million, an increase of $11.9 million, or
12.4%, from the comparable period in 2001. Approximately $81.8 million or 75.9%
of the Company's revenues were generated by its U.S. operations and $25.9
million or 24.1% by its Canadian operations. Of the total revenues generated by
the U.S. operations, approximately 18.0% of the revenues were from long-term
hospital contracts, 22.4% from Medicare and Medicaid and 59.6% from other payors
(including third-party insurance, physicians and clinics and patients). The
Company's community or non-hospital U.S. revenues grew by approximately 7.2%
during the three months ended March 31, 2002 on a "same store" basis.
Net earnings for the three months ended March 31, 2002 were $4.3
million, or $0.21 per diluted share, compared to $2.1 million, or $0.12 per
diluted share, in the comparable period in 2001. Assuming FASB 142 and CICA 3062
had been in effect during the three months ended March 31, 2001, net income
would have been $3.0 million, or $0.17 per diluted share.
Critical Accounting Policies
Revenue Recognition. The Company recognizes revenues on the accrual
basis at the time it provides services, which approximates the time results are
reported. The Company's revenues are stated net of all contractual adjustments
and discounts.
In the United States, payments for laboratory services performed for
certain payors are subject to contractual adjustments, which are price discounts
negotiated with the various payors. Changes in contracts and government fee
schedules impact the contractual adjustments and discounts. Except for certain
revenues from long-term hospital contracts, the majority of the Company's
revenues are billed on a fee-for-service basis.
In arriving at net revenues in Canada, the Company recognizes revenues
on the accrual basis based upon its pro rata share of the industry funding cap
in Ontario and its contracts with regional health authorities in Alberta. Since
1997, the laboratory industry in Ontario has been subject to an agreement with
the Ontario provincial government pursuant to which each laboratory is allocated
a fixed share of the overall industry funding cap each year. Factors can arise
which can cause an individual laboratory to receive more than its pro rata share
of the cap, obligating it to reimburse the Ontario government for such excess.
An estimate of any excess payments may be made and withheld by the Ontario
government from the monthly payment to a laboratory, with any residual amounts
payable being settled subsequent to year-end. In addition, should an individual
laboratory perform testing valued below its pro rata share of the cap in a year,
its funding would be reduced to the value of testing actually completed, and the
amount of the shortfall would be permanently reallocated to other laboratory
providers. The Company monitors the value of testing on an ongoing basis to
ensure it does not fall below its funding cap.
Valuation of Accounts Receivable. The Company's calculation of
allowances and discounts and the resultant reserve on the statement of financial
position requires estimates and assumptions based on a number of different
factors, including the Company's past experiences. Despite the use of the
Company's best estimates, it is possible that these amounts could change as
billing for laboratory services in the United States is a complex process.
11
Billing for laboratory services and collection of amounts billed in the
United States are complicated by the following factors:
o many different payors (including patients, insurance
companies, Medicare, Medicaid and physicians);
o many different fee schedules for the different payors;
o the reliance on the physician to provide complete and correct
information necessary for billing purposes;
o uncertainty at times as to the party responsible for payment;
o complex compliance requirements such as medical necessity
documentation; and
o the existence of co-pays and deductibles.
A significant portion of the Company's bad debt expense with respect to
non-hospital revenues is the result of issues that are not credit related, but
is primarily due to missing or incorrect billing information on requisitions.
The Company performs the requested tests and reports test results regardless of
missing or incorrect billing information. Subsequent to performing the tests,
the Company attempts to obtain the required information. This missing or
incorrect information slows the billing process, creates backlogs of unbilled
requisitions and increases the aging of the Company's accounts receivable.
Differences between Canadian and U.S. Generally Accepted Accounting Principles
The Company reports its consolidated financial statements using
Canadian GAAP with a reconciliation to U.S. GAAP included in the notes to the
Company's audited financial statements. The Company's significant U.S. -
Canadian GAAP differences are noted below:
Accounting for Joint Ventures or Partnerships. Under Canadian GAAP, the
Company includes in its financial statements the pro rata share of revenues and
expenses, as well as assets and liabilities, of its partnerships. Under U.S.
GAAP, the Company would be required to account for these partnerships by the
equity method, with the earnings or losses of partnerships included as earnings
or losses from equity investments and the assets and liabilities of the
partnerships included in equity investments in the statement of financial
position. Although the use of the proportionate consolidation method as compared
to the equity method of accounting from a financial presentation perspective
impacts almost all areas of the Company's consolidated balance sheets,
statements of operations and cash flow statements, it does not impact the
Company's consolidated shareholders' equity or net earnings.
Accounting for Income Taxes. Under Canadian GAAP, the impact of changes
in income tax rates is recorded when the changes in tax rates have been
substantively enacted. Under U.S. GAAP, changes in income tax rates are recorded
when the change in rates has been legislated. All of the changes in the Canadian
income tax rates, including those previously described in the Company's
quarterly and annual filings with the Securities and Exchange Commission in the
United States and the Ontario Securities Commission in Canada, have been
legislated, and accordingly as of March 31, 2002 no differences exist between
U.S. and Canadian GAAP related to these tax benefits.
12
Accounting for Financial Instruments. Financial Accounting Standards
Board Statement No. 133 - Accounting for Derivative Instruments and Hedging
Activities (FASB 133) requires companies to recognize all of its derivative
instruments as either assets or liabilities in the statement of financial
position at fair value. FASB 133 was effective for the Company on January 1,
2001. The accounting for changes in fair value (i.e., gains or losses) of a
derivative instrument depends on whether it has been designated and qualifies as
part of a hedging relationship and further, on the type of hedging relationship.
For those derivative instruments that are designated and qualify as hedging
instruments, a company must designate the hedging instrument, based upon the
exposure being hedged, as either a fair value hedge, cash flow hedge or a hedge
of a net investment in a foreign operation.
Under U.S. GAAP the Company's main cross currency and interest rate
swap agreements are considered to be fair value hedges, which are reflected in
the statement of financial position at fair value. Under Canadian GAAP fair
value hedge accounting is not required.
Accounting Pronouncements
In June 2001, the Financial Accounting Standards Board issued
Statements of Financial Accounting Standards No. 141 - Business Combinations
(FASB 141) and No. 142 - Goodwill and Other Intangible Assets (FASB 142),
effective for fiscal years beginning after December 15, 2001. Similarly, in
August 2001, the Canadian Institute of Chartered Accountants issued handbook
sections 1581 - Business Combinations and 3062 - Goodwill and Other Intangible
Assets effective for fiscal years beginning January 1, 2002. Under the new U.S.
and Canadian accounting rules, goodwill and intangible assets deemed to have an
indefinite life are no longer being amortized but are subject to annual
impairment tests. Other intangible assets continue to be amortized over their
useful life.
The Company has performed the required impairment tests of goodwill and
intangible assets with an indefinite life effective as of January 1, 2002, and
has determined that there are no impairment charges that impact the Company's
licenses and goodwill and therefore its net earnings and financial position for
the three months ended March 31, 2002. The Company may incur impairment charges
for licenses and goodwill in the future, which could adversely impact its
profitability and financial position.
In August 2001, the Financial Accounting Standards Board issued
Statement No. 144 - Accounting for the Impairment or Disposal of Long-Lived
Assets (FASB 144) effective for fiscal years beginning after December 15, 2001.
This statement supersedes Statement No. 121 - Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed of (FASB 121). FASB
144 retains the fundamental provision of FASB 121 for (a) recognition and
measurement of the impairment of long-lived assets to be held and used and (b)
measurement of long-lived assets to be disposed of by sale. The Company has
determined that for the three months ended March 31, 2002 there is no effect of
FASB 144 on the Company's net earnings and financial position.
Seasonality
The Company's results of operations have been and can be expected to be
subject to quarterly fluctuations. The Company experiences lower testing volumes
during the holiday and vacation seasons and, to a lesser extent, during
inclement weather. As a result, because a significant portion of the Company's
expenses is relatively fixed over the short-term, the Company's operating income
as a percentage of revenue tends to decrease during the third quarter due to the
summer vacation period and during the fourth quarter due to the various holidays
in that quarter. The Company's quarterly results can also fluctuate as a result
of a number of other factors, including the timing and transition of new
acquisitions and joint ventures or partnerships and completion, non-renewal or
commencement of significant hospital contracts.
13
The discussion that follows should be read in conjunction with the
Company's Consolidated Financial Statements for the three months ended March 31,
2002 and 2001 included elsewhere in this Form 10-Q.
Three Months Ended March 31, 2002 Compared to Three Months Ended March 31, 2001
Revenues. Revenues for the three months ended March 31, 2002 were
$107.7 million, an increase of $11.9 million, or 12.4%, from $95.8 million in
the comparable period in 2001. The increase in revenues resulted primarily from
the continuing growth in the Company's U.S. operations, where revenues increased
by $11.8 million to $81.8 million.
The increase in revenues from the Company's U.S. operations was due to:
o growth of 7.2% in community or non-hospital revenues in the
Company's existing operations; and
o additional revenues generated by the Company's 2002
acquisition of the assets and operations of Interwest
Endocrine Laboratory (Interwest) in Utah on January 2, and the
Company's acquisitions of Medical Arts Laboratory (Medical
Arts) in Oklahoma on March 1, 2001, the assets and operations
of the laboratories acquired in Illinois and Texas in June
2001, and the acquisition of Memorial Hermann's remaining 50%
partnership interest in the Texas Partnership on October 31,
2001.
The increase in revenues was offset in part by one less business day in
the three months ended March 31, 2002 relative to the comparable period in 2001.
Canadian revenues increased by $0.1 million to $25.9 million in 2002,
reflecting fee increases coupled with increases in non-government revenues,
offset in part by the decrease in the Canadian to U.S. dollar foreign exchange
rate and one less business day in the three months ended March 31, 2002 relative
to the comparable period in 2001.
General and Operating Expenses. General and operating expenses for the
three months ended March 31, 2002 were $92.9 million, an increase of $10.2
million, or 12.3%, from $82.7 million in the comparable 2001 period. This
increase in general and operating expenses resulted from costs associated with
processing additional volume generated by internal growth and the additional
operating expenses and costs associated with the Company's 2001 and 2002
acquisitions as noted above.
General and operating expenses as a percentage of revenues were 86.2%
for the three months ended March 31, 2002, compared to 86.4% in the comparable
2001 period, resulting in margins of 13.8% and 13.6%, respectively.
Depreciation and Amortization. Depreciation and amortization expense
for the three months ended March 31, 2002 was $3.6 million, a decrease of $0.5
million, or 12.2%, from $4.1 million in the comparable 2001 period. As a result
of the adoption of FASB 142 and CICA 3062, depreciation and amortization
decreased by $1.2 million during the three months ended March 31, 2002. The
decrease in depreciation and amortization was offset in part by the increase in
the Company's acquisitions and additional depreciation due to the capital
expenditures made during 2001 and the three months ended March 31, 2002.
Interest. Interest expense for the three months ended March 31, 2002
was $4.3 million, a decrease of $1.0 million, or 18.9%, from $5.3 million in the
comparable 2001 period. The decrease in interest expense is primarily due to a
lower effective interest rate in the three months ended March 31, 2002 relative
14
to the comparable 2001 period. The Company's average effective interest rate was
8.5% for the three months ended March 31, 2002 compared to 10.1% in the
comparable 2001 period.
Income Taxes. Income tax expense for the three months ended March 31,
2002 was $2.6 million compared to $1.6 million in the comparable 2001 period.
The increase in income tax expense is primarily due to increased earnings before
income taxes.
Net Earnings. Net earnings for the three months ended March 31, 2002
were $4.3 million, or $0.21 per diluted share, compared to $2.1 million, or
$0.12 per diluted share, in the comparable 2001 period. Assuming FASB 142 and
CICA 3062 had been in effect during the three months ended March 31, 2001, net
income would have been $3.0 million, or $0.17 per diluted share.
Liquidity and Capital Resources
The Company's principal sources of liquidity are cash provided by
operating activities and borrowings under debt agreements, including the
Company's $35.0 million working capital facility in the United States. Because
approximately 89.8% of the Company's Canadian revenues are received from
government agencies, the Company's Canadian operations receive prompt payment
for their services on a monthly basis and have no significant bad debt expense.
In the United States, the Company receives monthly payments for the provision of
laboratory services under its long-term contracts with hospitals. These
long-term contracts represented approximately 18.0% of total U.S. revenues for
the three months ended March 31, 2002. The Canadian revenues from government
agencies, together with such U.S. revenues from hospitals, provide a relatively
reliable monthly cash flow and minimize the amount of working capital which is
required to finance these aspects of the Company's business. However, collecting
accounts receivable from the balance of the Company's business is a complex and
time-consuming process which the Company must finance.
In November 2001, the Company completed a public offering of common
shares for total proceeds to the Company of approximately $25.3 million (before
after tax costs of $1.4 million). Approximately $9.2 million of these proceeds
was used to temporarily pay down the Company's outstanding U.S. working capital
facilities. The Company expects to use the remaining proceeds from this offering
for working capital and general corporate purposes, and to fund potential
acquisitions and joint ventures or partnerships.
If additional capital is required for acquisitions, joint ventures,
partnerships or other expenditures or if the Company's operating results and
cash flow are significantly below expectations, the Company may require
additional debt or equity financing.
Operating Activities. Cash used in operations was $6.1 million and $9.2
million for the three months ended March 31, 2002 and 2001, respectively. The
cash used in non-cash working capital items was $15.8 million and $16.2 million
for the three months ended March 31, 2002 and 2001, respectively. The $15.8
million of cash used in non-cash working capital items reflects a reduction of
accounts payable partially related to the semi-annual interest payment relating
to the Company's $195.0 million Senior Notes in January 2002, and an increase in
working capital requirements resulting from the growth of the Company's United
States operations. The Company's accounts receivable days sales outstanding,
commonly referred to as DSOs, improved to 64 days at March 31, 2002 from 65 days
as at December 31, 2001.
The Company's available cash position, which originates both from the
Company's U.S. and Canadian operations, was $18.5 million as at March 31, 2002
(December 31, 2001 - $30.0 million). At March 31, 2002, the Company had
revolving credit facilities of approximately $47.0 million, with availability of
$39.6 million. Of the latter, $3.9 million was drawn. At March 31, 2002,
accounts receivable were $76.9 million (December 31, 2001 - $72.9 million) of
15
which $11.0 million (December 31, 2001 - $11.7 million) was derived from
Canadian government agencies, $4.3 million (December 31, 2001 - $3.9 million)
from U.S. long-term hospital contracts, $16.1 million (December 31, 2001 - $15.4
million) from the Medicare/Medicaid programs, and $45.5 million (December 31,
2001 - $41.9 million) from other payors. Cash, unused revolving credit
facilities and accounts receivable outstanding as at March 31, 2002 are
anticipated to meet short-term liabilities due in 2002.
Investing Activities. The net cash used in investing activities was
$4.1 million and $11.6 million for the three months ended March 31, 2002 and
2001, respectively. The major components of the investing activities are
outlined below:
Acquisitions and Joint Ventures or Partnerships - Consistent with the
Company's "fold-in" acquisition strategy, during the first quarter of 2002 the
Company acquired the laboratory assets and operations of Interwest for a
purchase price of $1.7 million. During the comparable period in 2001, the
Company acquired the laboratory assets and operations of Medical Arts for a
purchase price of $7.7 million.
Capital Expenditures - The Company's capital expenditures aggregated
$2.4 million and $2.3 million for the three months ended March 31, 2002 and
2001, respectively.
For the three months ended March 31, 2002 and 2001, capital assets of
$1.4 million and $0.3 million, respectively, were financed by means of capital
leases.
The Company's anticipated capital expenditures for the balance of 2002
are expected to remain at substantially the same levels as in 2001 and are
expected to be financed from cash flows from operations.
Other Assets - A decrease in other assets generated cash flow of $0.2
million for the three months ended March 31, 2002 compared to an investment in
other assets of $1.3 million in the comparable 2001 period.
Financing Activities. The net cash provided by financing activities was
$Nil and $6.6 million for the three months ended March 31, 2002 and 2001,
respectively.
The net cash provided by financing activities for the three months
ended March 31, 2002 reflect stock options exercised of $0.3 million, offset by
$0.3 million repayments of long-term debt. The net cash provided by financing
activities of $6.6 million for the three months ended March 31, 2001 reflects
increased bank indebtedness of $7.3 million offset in part by a repayment of
long-term debt of $0.7 million.
The Company's interest expense on outstanding long-term debt for the
three months ended March 31, 2002 was $4.4 million. Based on the long-term debt
outstanding as of March 31, 2002 and assuming stable interest rates, the
Company's interest expense is expected to remain at substantially the same
levels for the balance of 2002.
16
As of March 31, 2002, the total scheduled repayments of long-term debt
due for the remainder of 2002 and in each of 2003 to 2006 and thereafter are as
follows:
2002 $ 1.7 million
2003 $ 3.2 million
2004 $ 1.8 million
2005 $ 1.2 million
2006 and thereafter $ 197.3 million
The Company's scheduled debt repayments and estimated interest
obligations due for the remainder of 2002 and in each of 2003 to 2005 are
anticipated to be funded by cash flows from operations and/or utilization of
credit facilities. The Company expects to refinance the Senior Notes of $195.0
million, which are scheduled to be repaid in 2006.
17
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
The Company does not hold or issue financial instruments for trading
purposes. A limited number of financial instruments are used to manage
well-defined risks associated with fluctuations in foreign currencies and to
manage interest costs.
Foreign Currency Risk
The Company has a cross currency swap agreement which effectively
converts a portion of the Company's U.S. dollar denominated borrowings to
Canadian dollar obligations to match the Company's Canadian dollar denominated
assets and cash flows. This swap agreement limits the Company's exposure to both
favorable and unfavorable currency fluctuations. As of March 31, 2002, a
sensitivity analysis to changes in the U.S. dollar on the Company's main
currency swap agreement indicates that if the U.S. dollar weakened by 10.0%
against the Canadian dollar, the fair value of this instrument would decrease by
Cdn$14.9 million ($9.3 million). Conversely, if the U.S. dollar strengthened by
10% against the Canadian dollar, the fair value of this instrument would
increase by Cdn$16.7 million ($10.5 million). Any resulting changes in fair
value would be offset by changes in the underlying hedged long-term debt
position. Pursuant to the terms of the currency swap agreement, the Company has
pledged shares of certain of its subsidiaries and partnership interests to
counterparties to those agreements.
Interest Rate Risk
The Company has entered into a number of interest rate swap agreements,
the net effect of which is to convert fixed rate senior notes due in 2006 to
fixed rate obligations with shorter maturity terms.
Based on the Company's interest rate swap agreements outstanding at
March 31, 2002, a 100 basis point increase in interest rates would result in a
decrease in the net aggregate market value of these instruments of Cdn$5.4
million ($3.4 million). Conversely, a 100 basis point decrease in interest rates
would result in a Cdn$5.6 million ($3.5 million) net increase in the net
aggregate market value of these instruments.
Cautionary Statement For Purposes of the "Safe Harbor" Provisions of the
Private Securities Litigation Reform Act of 1995
This Report contains forward-looking statements within the meaning of Section
27A of the Securities Act of 1933, as amended, and Section 21E of the Securities
Exchange Act of 1934, as amended. In addition, from time to time, the Company or
its representatives have made or may make forward-looking statements, orally or
in writing. Such forward-looking statements may be included in, but are not
limited to, various filings made by the Company with the Securities and Exchange
Commission, press releases or oral statements made by or with the approval of
authorized executive officers of the Company. The Private Securities Litigation
Reform Act of 1995 provides a "safe harbor" for forward-looking statements so
long as cautionary statements identifying important factors that could cause
actual results to differ materially from those projected in the statement are
provided. These statements relate to future events or future financial
performance and involve known and unknown risks, uncertainties and other factors
that may cause the Company or the Company's industry's actual results, levels of
activity, performance or achievements to be materially different from those
expressed or implied by any of the Company's forward-looking statements. In some
cases, forward-looking statements may be identified by terminology such as
"may," "will," "should," "expects," "plans," "anticipates," "intends,"
"believes," "estimates," "predicts," "potential" or "continue" or the negative
of these terms or other comparable terminology. These statements are only
predictions. Actual results could differ materially from those projected or
suggested in any forward-looking statements as a result of a wide variety of
factors, conditions, risks and uncertainties which include, but are not limited
18
to: (i) significant government regulation; (ii) efforts by various third-party
payors (including governmental agencies and insurers) to reduce reimbursements
and utilization and otherwise modify the delivery of healthcare services; (iii)
the inability to fully realize cost savings from the consolidation of certain
operations and other cost management initiatives; (iv) changes in interest rates
causing an increase in the Company's effective borrowing rates; (v) intensified
competition; and (vi) changes in market conditions. The Company undertakes no
obligation to update any forward-looking statements. For a more complete
discussion of risk factors, please see the Company's filings with the Securities
and Exchange Commission, and the Company's Annual Report on Form 10-K for the
year ended December 31, 2001.
19
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Not applicable
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
Not applicable
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Refer to the Company's Information Circular and Proxy Statement
filed with the Securities and Exchange Commission on April 30,
2002.
ITEM 5. OTHER INFORMATION
Not applicable
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
The Company did not file any reports on Form 8-K during the three
months ended March 31, 2002.
20
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.
DYNACARE INC.
Date: May 7, 2002 /s/ Harvey A. Shapiro
----------------- ---------------------------------------------
Harvey A. Shapiro
Chairman, President, Chief Executive Officer
and Director
(Principal Executive Officer)
Date: May 7, 2002 /s/ Zbig S. Biskup
------------------ ---------------------------------------------
Zbig S. Biskup
Executive Vice President and
Chief Financial Officer and Secretary
(Principal Financial Officer and
Principal Accounting Officer)
21