<Page>
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON NOVEMBER 13, 2001
REGISTRATION NO. 333-72338
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------------
AMENDMENT NO. 3
TO
FORM S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
------------------------------
DYNACARE INC.
(Exact Name of Registrant as Specified in its Charter)
<Table>
ONTARIO, CANADA 8071 98-0337653
(State or Other Jurisdiction (Primary Standard (I.R.S. Employer
of Industrial Identification Number)
Incorporation or Organization) Classification Code Number)
</Table>
------------------------------
14900 LANDMARK BOULEVARD
DALLAS, TEXAS 75254
(972) 387-3200
------------------------------
(Address, Including Zip Code, and Telephone Number,
Including Area Code, of Registrant's Principal Executive Offices)
------------------------------
ZBIG S. BISKUP
CHIEF FINANCIAL OFFICER
DYNACARE INC.
14900 LANDMARK BOULEVARD
DALLAS, TEXAS 75254
(972) 387-3200
------------------------------
(Name, Address, Including Zip Code, and Telephone Number,
Including Area Code, of Agent for Service)
------------------------------
COPIES TO:
<Table>
DAVID P. STONE, ESQ. FREDERICK W. KANNER, ESQ.
WEIL, GOTSHAL & MANGES LLP DEV R. SEN, ESQ.
767 FIFTH AVENUE DEWEY BALLANTINE LLP
NEW YORK, NEW YORK 10153 1301 AVENUE OF THE AMERICAS
(212) 310-8000 NEW YORK, NEW YORK 10019
(212) 259-8000
</Table>
------------------------
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: As soon as
practicable after the effective date of this Registration Statement.
If any of the securities being registered on this Form are to be offered on a
delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, check the following box. / /
If this Form is filed to register additional securities for an offering pursuant
to Rule 462(b) under the Securities Act, check the following box and list the
Securities Act registration statement number of the earlier effective
registration statement for the same offering. / /
If this Form is a post-effective amendment filed pursuant to Rule 462(c) under
the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. / /
If this Form is a post-effective amendment filed pursuant to Rule 462(d) under
the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. / /
If delivery of the prospectus is expected to be made pursuant to Rule 434, check
the following box. / /
------------------------------
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR DATES
AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF
THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SECTION 8(A), MAY
DETERMINE.
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<Page>
The information in this preliminary prospectus is not complete and may be
changed. We may not sell these securities until the registration statement filed
with the Securities and Exchange Commission is effective. This preliminary
prospectus is not an offer to sell these securities and it is not soliciting an
offer to buy these securities in any state where the offer or sale is not
permitted.
<Page>
PRELIMINARY PROSPECTUS Subject to Completion November 13, 2001
- --------------------------------------------------------------------------------
5,000,000 Shares
[LOGO]
Common Shares
- ----------------------------------------------------------------------
Of the 5,000,000 common shares offered by this prospectus, we are selling
2,700,000 shares and selling shareholders are selling 2,300,000 shares. We will
not receive any proceeds from the sale of any common shares sold by the selling
shareholders.
Our common shares are traded on the Nasdaq National Market under the symbol
"DNCR" and on the Toronto Stock Exchange under the symbol "DNA". On October 31,
2001, the last reported sales price of our common shares was $13.10 on the
Nasdaq National Market and Cdn$20.25 on the Toronto Stock Exchange.
Investing in our common shares involves a high degree of risk. Before buying any
shares, you should read the discussion of material risks of investing in our
common shares in "Risk factors" beginning on page 8 of this prospectus.
Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved of these securities or passed upon the
accuracy or adequacy of this prospectus. Any representation to the contrary is a
criminal offense.
<Table>
<Caption>
Per Share Total
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Public offering price $ $
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Underwriting discounts and commissions $ $
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Proceeds, before expenses, to us $ $
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Proceeds, before expenses, to the selling shareholders $ $
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</Table>
The underwriters may also purchase up to an additional 750,000 common shares
from us at the public offering price, less the underwriting discounts and
commissions, to cover over-allotments, if any, within 30 days from the date of
this prospectus. If the underwriters exercise the option in full, the total
underwriting discounts and commissions will be $ and our total
proceeds before expenses will be $ .
The underwriters are offering the common shares as set forth under
"Underwriting." Delivery of the shares will be made on or about November ,
2001.
UBS Warburg
Banc of America Securities LLC
U.S. Bancorp Piper Jaffray
McDonald Investments Inc.
<Page>
DESCRIPTION OF GRAPHIC ON INSIDE FRONT COVER OF PROSPECTUS:
Map of the United States and Canada indicating the states and provinces served
by Dynacare color-coded to indicate its regions of operations.
<Page>
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You should rely only on the information contained in this prospectus. We have
not authorized anyone to provide you with any other information. We are offering
to sell, and seeking offers to buy, our common shares only in jurisdictions
where these offers and sales are permitted. The information contained in this
prospectus is accurate only as of the date of this prospectus, regardless of the
time of delivery of this prospectus or of any sale of our common shares.
TABLE OF CONTENTS
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<Table>
Prospectus summary.................... 1
The offering.......................... 5
Summary consolidated financial and
operating information............... 6
Risk factors.......................... 8
Forward-looking information........... 20
Use of proceeds....................... 21
Market price of our common shares..... 22
Dividend policy....................... 23
Capitalization........................ 24
Dilution.............................. 25
Selected consolidated financial
data................................ 26
Management's discussion and analysis
of financial condition and results
of operations....................... 29
Business.............................. 43
Management............................ 66
Related party transactions............ 74
Principal and selling shareholders.... 75
Description of capital stock.......... 77
Material income tax considerations.... 78
Shares eligible for future sale....... 85
Description of indebtedness........... 87
Underwriting.......................... 89
Legal matters......................... 91
Experts............................... 91
Where you can find more information... 92
Exchange rate information............. 93
Index to consolidated financial
statements.......................... F-1
</Table>
In this prospectus, except where otherwise indicated, all dollar amounts are
expressed in U.S. dollars. References to "Cdn$" are to Canadian dollars. The
consolidated financial statements included in this prospectus are presented in
U.S. dollars. See note 1 "Summary of significant policies--Foreign currency
translation" to our consolidated financial statements found elsewhere in this
prospectus for more information about the U.S. dollar presentation of those
financial statements.
As used in this prospectus, references to "we," "our," "us" and "Dynacare" refer
to Dynacare Inc. and its subsidiaries, including subsidiaries we formed for the
purpose of making acquisitions or entering into joint venture partnerships,
unless the context requires otherwise.
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<Page>
[This page intentionally left blank]
<Page>
Prospectus summary
YOU SHOULD READ THE FOLLOWING SUMMARY TOGETHER WITH THE MORE DETAILED
INFORMATION REGARDING US AND THE COMMON SHARES BEING SOLD IN THIS OFFERING WHICH
IS SET FORTH ELSEWHERE IN THIS PROSPECTUS, INCLUDING UNDER THE HEADING "RISK
FACTORS" BEGINNING ON PAGE 8 AND IN OUR CONSOLIDATED FINANCIAL STATEMENTS.
ABOUT OUR COMPANY
We are the third largest independent provider of clinical laboratory testing
services in North America as measured by revenues. Through our integrated
network of regional laboratory operations, we provide clinical laboratory
testing services in 21 states in the United States and two provinces in Canada.
We believe we offer a comprehensive menu of tests, comprised of more than
1,000 different tests. We provide clinical laboratory testing, which is
performed on body fluids such as blood and urine and on tissues and other
specimens, including human cells. Through Dynagene, our center for esoteric
testing, we also provide a growing number of more complex esoteric tests,
including molecular diagnostic services. Our customers include physicians,
hospitals and other healthcare providers who utilize clinical laboratory testing
in diagnosing, evaluating, monitoring and treating diseases and other medical
conditions. We provide clinical laboratory testing services either directly
through our wholly-owned laboratories or through joint venture partnerships we
form with major local hospitals and academic medical centers.
Since entering the clinical laboratory testing market in the United States in
1993, we have grown to become a significant provider of clinical laboratory
testing services in a number of selected regions. Our U.S. revenues grew at a
compound annual rate of approximately 40% for the five-year period ended
June 30, 2001, as a result of strong internal growth combined with growth
generated by 20 acquisitions and the commencement of four joint venture
partnerships with hospitals. In the United States, we currently operate 22
central laboratories, 63 rapid response laboratories and 173 patient service
centers, which we own directly or through our joint venture partnerships. We are
positioned as a multi-regional provider with a major presence in four integrated
regions in the United States: the Southeast, which is comprised of Alabama,
Mississippi and Northern Florida; the Southwest, which is comprised of
Louisiana, Arkansas, Texas, Oklahoma and Missouri; the Northwest, which is
comprised of Oregon, Utah, Alaska, Wyoming, Colorado, Idaho, Montana and the
state of Washington; and the Midwest, which is comprised of Wisconsin and
Illinois. Additionally, we have operations in New York, Pennsylvania and
Tennessee.
In Canada, we operate in the provinces of Ontario and Alberta through two joint
venture partnerships. Our operations in these provinces include four central
laboratories, 18 rapid response laboratories and 143 patient service centers.
Through our joint venture partnership in Ontario, we have an estimated 31% share
of the Ontario independent clinical laboratory testing market. Through our joint
venture partnership in Alberta, we have an estimated 60% share of the Northern
Alberta market.
We processed approximately 7 million requisitions during the six months ended
June 30, 2001. For the six months ended June 30, 2001, we had net revenues of
$197.7 million and net earnings of $8.0 million.
1
<Page>
INDUSTRY OVERVIEW
According to industry sources, the U.S. clinical laboratory testing market in
1999 was approximately $31.8 billion, which includes an estimated $2.0 billion
derived from esoteric testing. The clinical laboratory testing industry can be
categorized into three broad types of laboratory providers:
- - hospital-based laboratories;
- - independent clinical laboratories; and
- - physician office laboratories.
According to industry information, in 1999 those three segments accounted for
approximately 63%, 26% and 11% of the clinical laboratory testing market in the
United States, respectively. We estimate the Canadian clinical laboratory
testing market was approximately $1.6 billion in 2000. The Canadian clinical
laboratory testing industry operates in a stable environment characterized by
limited competition and significant regulation under which a substantial
majority of laboratory procedures are paid for by government health plans.
We believe that clinical laboratory testing is critical to the delivery of
quality healthcare to patients. We expect the demand and the volume of clinical
laboratory testing services to increase in the future as a result of several
trends, including:
- - the general aging of the North American population;
- - advances in specialized equipment and cost efficiencies that have made
clinical laboratory testing available to a broader market;
- - an expanded base of scientific knowledge which has led to the development of
more sophisticated clinical laboratory tests covering a wider array of
procedures;
- - greater awareness by physicians and patients of the value of clinical
laboratory testing as a cost- effective means of early detection of disease
and the monitoring of treatment;
- - increased testing for high risk diseases, such as HIV/AIDS and hepatitis;
and
- - advances in genomics facilitating the development of new and more
specialized testing.
OUR STRATEGY
Our objective is to be a leading provider of clinical laboratory testing
services in selected regional markets by focusing on the following key strategic
elements:
Enhance our Market Position in Existing Regions
We intend to further develop our position in the regional markets in which we
currently operate in three ways.
- - INCREASED SALES EFFORTS--We believe we have established a strong and
indentifiable brand in each region, where we offer state-of-the-art
diagnostic services, supported by cutting-edge information technology. This
allows us to promptly report results with minimum reliance on air transport.
With our local presence in the markets we service, we are able to provide
prompt support and information to physicians. We employ experienced sales
and marketing personnel who emphasize these attributes in marketing our
services. Without giving effect to any revenue growth attributable to
acquisitions and new joint venture partnerships and excluding revenues from
long-term hospital
2
<Page>
contracts, our revenues in the United States have grown 7.6% for the six
months ended June 30, 2001, primarily through the addition of new customers
and increased testing volumes.
- - PURSUE FOLD-IN ACQUISITIONS--We expect to continue to make selective
acquisitions of smaller laboratories and to improve laboratory efficiency
and profitability by combining the acquired operations with our existing
laboratory operations. This enables us to expand within existing regions and
to strengthen our position in the local markets that we serve. During the
five years ended June 30, 2001, we made 16 fold-in acquisitions.
- - REALIZE OPERATING EFFICIENCIES--As we grow and establish our regional
operations, we seek to continue to realize operating efficiencies by
consolidating certain of our laboratory operations and by implementing cost
management initiatives. For example, we are currently in the process of
consolidating laboratory operations in our Southwest Region and have
undertaken materials management initiatives on a company-wide basis with a
view to decreasing our materials cost per requisition.
Expand into New Attractive Regional Markets
We target expansion opportunities in new regions where we believe that market
size, demographics, payor mix, competition and other factors will allow us to
become a significant and profitable regional provider of laboratory services. We
enter into selected new regional markets through either strategic acquisitions
or joint venture partnerships. We prefer to enter markets adjacent to our
existing regions as this allows us to leverage our existing infrastructure. Due
to the fragmented nature of the clinical laboratory testing industry, we believe
opportunities exist to selectively acquire additional clinical laboratories and
enter into joint venture partnerships on terms favorable to us.
Pursue the Hospital Market
The hospital market constitutes 63% of the $31.8 billion U.S. clinical
laboratory business. We intend to continue to pursue this segment of the market
by establishing relationships with leading hospitals as follows:
- - FORM JOINT VENTURE PARTNERSHIPS WITH HOSPITALS--We believe that our joint
venture partnership model is a cost-effective means of expanding into new
markets. We gain access to an existing, fully equipped and staffed clinical
laboratory within our partner hospital for a small initial investment. By
marketing our services in the local community, we expand the volume of
testing performed in the hospital laboratory and leverage its fixed costs,
thereby maximizing profit on incremental testing volume.
We are able to compete effectively for community based testing business by
marketing clinical laboratory testing services to physicians, clinics and
other healthcare providers in the community, capitalizing on the hospital's
reputation and relationships with its network of affiliated physicians. We
believe the desire of hospitals to control costs and participate in the
revenue and profitability of community-based business will lead other
hospitals to consider our joint venture partnership model.
- - OBTAIN LONG-TERM EXCLUSIVE LABORATORY SERVICES CONTRACTS WITH HOSPITALS--An
integral component of our growth strategy is to secure, through our joint
venture partnerships and wholly-owned operations, long-term exclusive
contracts to provide all of a hospital's clinical laboratory testing
requirements. These contracts provide us with a stable base of revenues and
cash flows upon which we build our regional operations. For the six months
ended June 30, 2001, long-term hospital contracts accounted for
approximately 20% of our total revenues in the United States.
3
<Page>
Grow Esoteric Testing Capability
Esoteric tests are generally more complex tests that are performed less
frequently than routine tests and require more sophisticated instruments and/or
highly skilled personnel. We believe that esoteric testing is the fastest
growing segment of the clinical laboratory market. In November 2000, we launched
Dynagene, our center for esoteric testing. We will continue to expand our
esoteric testing capabilities to enhance our services to our existing clients,
to attract new clients and to internalize and reduce testing currently
out-sourced to other esoteric laboratories.
RECENT DEVELOPMENTS
On October 11, 2001 we issued a press release in which we stated, among other
things, that we expect to report earnings for fiscal year 2001 in line with the
then current consensus estimates. We also reported that we expect revenues for
2002 to be approximately $420 million; earnings before interest, taxes,
depreciation and amortization to be approximately $58 million; and net earnings
to be approximately $12 million, or $0.67 per diluted share (without giving
effect to any future acquisitions and/or joint venture partnerships and to the
shares to be issued pursuant to this offering). Additionally, we anticipated
that in 2002 the discontinuance, in accordance with new accounting rules adopted
in both Canada and the United States, of amortization for goodwill and
intangible assets with an indefinite life is expected to add approximately
$4 million in net earnings, or $0.23 per diluted share (without giving effect to
any future acquisitions and/or joint venture partnerships and to the shares to
be issued pursuant to this offering) for total expected net earnings of
approximately $16 million, or $0.90 per diluted share. See "Management's
discussion and analysis of financial condition and results of
operations--Accounting Pronouncements" regarding the new accounting rules and
required tests of impairment of goodwill and intangible assets which we are
subject to beginning January 1, 2002. Our achievement of the results anticipated
in the press release and in this paragraph is and will continue to be subject to
all of the risks and uncertainties described below under "Risk factors" and
"Forward-looking information."
For the three months ended September 30, 2001, our revenues and net earnings
increased to $102.0 million and $2.0 million, respectively, as compared to
$93.9 million and $1.0 million, respectively, for the three months ended
September 30, 2000. U.S. revenues for the three months ended September 30, 2001
were $76.4 million, an increase of 12% from the comparable 2000 period. Earnings
per diluted share for the three months ended September 30, 2001 were $0.11,
compared to $0.08 for the three months ended September 30, 2000 based on
5.4 million additional shares outstanding. For the nine months ended
September 30, 2001, our revenues and net earnings increased to $299.7 million
and $10.0 million, respectively, as compared to $265.7 million and
$5.5 million, respectively, for the nine months ended September 30, 2000. U.S.
revenues for the nine months ended September 30, 2001 were $221.3 million, an
increase of 17% from the comparable 2000 period. Earnings per diluted share for
the nine months ended September 30, 2001 were $0.57, compared to $0.44 for the
nine months ended September 30, 2000. During the nine months ended
September 30, 2001 and 2000, we recorded tax benefits of $3.0 million and
$2.0 million, respectively. Excluding these tax benefits, net earnings for the
nine months ended September 30, 2001 doubled to $7.0 million, or $0.40 per
diluted share, from $3.5 million, or $0.28 per diluted share, in the comparable
2000 period. EBITDA for the three months ended September 30, 2001 was
$12.5 million, as compared to $11.3 million for the three months ended
September 30, 2000. EBITDA for the nine months ended September 30, 2001 was
$39.2 million, as compared to $36.4 million in the comparable 2000 period.
Please see Note (2) on page 7 for information with respect to EBITDA. At
September 30, 2001 our days sales outstanding were 62 days, compared to 61 days
at June 30, 2001 and 65 days at December 31, 2000.
4
<Page>
The offering
<Table>
Common shares offered by:
Dynacare..................................... 2,700,000 shares
Selling shareholders......................... 2,300,000 shares
Total...................................... 5,000,000 shares
Common shares to be outstanding after this
offering................................... 19,628,937 shares
Nasdaq National Market Symbol................ DNCR
Toronto Stock Exchange Symbol................ DNA
Use of proceeds.............................. We intend to use the net proceeds from this
offering for working capital and general
corporate purposes, including a pay-down of
our outstanding revolving credit borrowings,
which totaled approximately $3.9 million as
of June 30, 2001, and for funding potential
acquisitions and joint venture partnerships.
See "Use of proceeds." We will not receive
any of the proceeds from the sale of shares
by the selling shareholders.
Risk factors................................. Investing in our common shares involves
significant risks. See "Risk factors."
</Table>
Unless we indicate otherwise, the information in this prospectus does not assume
the exercise of the underwriters' over-allotment option.
Unless we indicate otherwise, the number of common shares to be outstanding
after this offering in this prospectus is based on the number of shares
outstanding as of June 30, 2001 and excludes:
- - 2,176,774 shares issuable upon the exercise of stock options outstanding as
of June 30, 2001 under our stock option plans, of which 1,695,374 have a
weighted average exercise price of Cdn$9.62 per share and 481,400 have a
weighted average exercise price of $9.125 per share; and
- - an aggregate of 687,543 shares available for future issuance under our stock
option plans.
We have agreed to sell an aggregate of 750,000 additional common shares if the
underwriters exercise in full their over-allotment option, which we describe in
"Underwriting." If the underwriters exercise this option in full, 20,378,937
common shares will be outstanding after this offering.
HOW TO CONTACT US
Our principal executive office is located at 14900 Landmark Boulevard, Dallas,
Texas 75254 and our telephone number is (972) 387-3200.
5
<Page>
Summary consolidated financial and operating information
The following table sets forth a summary of our consolidated financial and
operating information for the periods indicated and should be read in
conjunction with our audited consolidated financial statements for the years
ended December 31, 1998, 1999 and 2000 and the related notes; our unaudited
consolidated financial statements for the six months ended June 30, 2000 and
2001; "Management's discussion and analysis of financial condition and results
of operations;" and "Business," included elsewhere in this prospectus. The
summary consolidated statement of operations data set forth below for the years
ended December 31, 1996 and 1997 are derived from our financial statements that
have been audited by Ernst & Young LLP, which financial statements are not
included in this prospectus. We prepared our consolidated financial statements
in accordance with Canadian GAAP. These principles conform in all material
respects with U.S. GAAP except as described in note 20 of our consolidated
financial statements, included elsewhere in this prospectus.
In the opinion of management, the unaudited consolidated financial statements
for the six months ended June 30, 2000 and 2001 contain all adjustments,
consisting only of normal recurring adjustments, necessary to present fairly the
historical consolidated financial position and our consolidated results of
operations for those periods. Results of operations for the six months ended
June 30, 2001 are not necessarily indicative of results for the full year.
<Table>
<Caption>
Six months ended
Years ended December 31, June 30,
--------------------------------------------------------- ---------------------
Income statement information: 1996 1997 1998 1999 2000 2000 2001
- ------------------------------------------------------------------------------------------------------------------------------
(in thousands of U.S. dollars, except per share amounts)
Revenues:
U.S. operations.......................... $ 66,861 $ 80,365 $133,552 $173,566 $250,747 $120,631 $144,914
Canadian operations...................... 98,737 95,450 91,359 99,111 102,172 51,202 52,767
-------- -------- -------- -------- -------- -------- --------
Total revenues......................... 165,598 175,815 224,911 272,677 352,919 171,833 197,681
General and operating expenses............. 141,004 152,353 189,643 230,795 306,105 146,734 170,954
Depreciation............................... 4,094 4,819 6,433 8,351 11,368 5,192 5,775
Amortization of licenses and goodwill...... 5,822 5,650 4,112 4,707 5,279 2,575 2,788
Non-recurring charges...................... 608 82,554 -- -- 6,750 -- --
-------- -------- -------- -------- -------- -------- --------
Operating earnings (loss).................. 14,070 (69,561) 24,723 28,824 23,417 17,332 18,164
Interest expense........................... 13,383 13,713 15,486 19,457 22,477 11,087 10,645
Gain on sale of home healthcare
operations............................... -- (720) -- -- -- -- --
-------- -------- -------- -------- -------- -------- --------
Earnings (loss) before income taxes........ 687 (82,554) 9,237 9,367 940 6,245 7,519
Income taxes (benefit)..................... (265) (27,417) 3,048 3,726 (5,085)(1) 1,741 (1) (435)(1)
-------- -------- -------- -------- -------- -------- --------
Net earnings (loss)........................ $ 952 $(55,137) $ 6,189 $ 5,641 $ 6,025 $ 4,504 $ 7,954
======== ======== ======== ======== ======== ======== ========
Earnings (loss) per share-basic............ $ 0.10 $ (5.19) $ 0.52 $ 0.47 $ 0.48 $ 0.38 $ 0.47
======== ======== ======== ======== ======== ======== ========
Earnings (loss) per share-diluted.......... $ 0.09 $ (5.19) $ 0.52 $ 0.45 $ 0.46 $ 0.36 $ 0.46
======== ======== ======== ======== ======== ======== ========
</Table>
6
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<Table>
<Caption>
Six months ended
Years ended December 31, June 30,
--------------------------------------------------------- ---------------------
Other information: 1996 1997 1998 1999 2000 2000 2001
- ----------------------------------------------------------------------------------------------------------------------------
(in thousands of U.S. dollars, except for non-financial information)
EBITDA (2)............................... $ 24,594 $ 23,462 $ 35,268 $ 41,882 $ 46,814 $ 25,099 $ 26,727
Cash flow from operating activities...... 4,768 9,093 8,601 4,764 23,918 13,448 6,269
Cash flow used in investing activities... (9,225) (28,392) (4,717) (37,536) (61,707) (35,949) (18,104)
Cash flow provided by (used in) financing
activities............................. 4,731 20,329 (901) 46,133 38,792 10,937 3,851
Facilities:
Central laboratories................... 9 12 13 20 25 23 26
Rapid response laboratories............ 38 66 54 78 74 87 81
Patient service centers................ 150 221 236 264 292 288 316
Requisitions (in thousands).............. 5,103 5,738 7,976 9,557 12,407 6,162 6,908
Laboratory revenue by payor type:
Canadian government agencies........... 50.8% 46.8% 36.8% 32.3% 25.6% 26.4% 24.2%
Long-term hospital contracts........... 19.2% 21.1% 22.2% 18.8% 15.3% 16.3% 14.4%
Community (non-hospital) and other
(3).................................. 25.9% 26.9% 33.4% 39.5% 46.3% 45.7% 47.9%
Medicare/Medicaid...................... 4.1% 5.2% 7.6% 9.4% 12.8% 11.6% 13.5%
</Table>
<Table>
<Caption>
As of
December 31,
2000 As of June 30, 2001
Balance sheet information: Actual Actual As adjusted
- -------------------------------------------------------------------------------------------------------
<Caption>
(in thousands of U.S. dollars)
Cash and cash equivalents................................... $ 18,099 $ 10,170 $ 42,883(4)
Total assets................................................ 348,976 359,395 392,108(4)
Long-term debt (5).......................................... 202,287 202,091 202,091
Total shareholders' equity.................................. 55,251 63,861 96,574(4)
</Table>
- ------------
(1) For the year ended December 31, 2000 and during the six months ended
June 30, 2000 and 2001, we reduced the provision for deferred income taxes
by $6.1 million, $2.0 million and $3.0 million, respectively, due to tax
rate reductions announced by the Canadian federal and provincial
governments. As of June 30, 2001, all of the tax rate reductions previously
announced by the Canadian federal and provincial governments have been
legislated.
(2) EBITDA represents earnings from operations, before deducting amounts for
interest, income taxes, depreciation, amortization of licenses and goodwill,
non-recurring charges and the gain on the sale of our home healthcare
operation in July 1997. We believe that EDITDA is a standard measure
commonly reported and widely used by analysts, investors and other
interested parties. EBITDA is presented here in addition to net earnings,
and does not represent cash flows from operations as defined by Canadian
GAAP. EBITDA should not be considered as an alternative to, or more
meaningful than, net earnings or cash flow as an indicator of our operating
performance, or to cash flow as a measure of liquidity. See "Management's
discussion and analysis of financial condition and results of operations"
for a discussion of other measures of liquidity and operations that are
included in our consolidated financial statements.
(3) Community (non-hospital) and other revenue includes revenues generated from
all other sources including patients, physicians, clinics, third party
insurance and managed care plans, but excludes amounts billed to Medicare
and Medicaid.
(4) Adjusted to give effect to the net proceeds to us of the sale of 2,700,000
common shares pursuant to this offering at an assumed public offering price
of $13.10 per share (the last sale price of our common shares on the Nasdaq
National Market on October 31, 2001), without giving effect to our use of
the proceeds.
(5) Excludes current portion of long-term debt.
7
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Risk factors
INVESTING IN OUR COMMON SHARES INVOLVES RISKS. YOU SHOULD CAREFULLY CONSIDER
EACH OF THE FOLLOWING RISK FACTORS BELOW AND ALL OTHER INFORMATION SET FORTH IN
THIS PROSPECTUS BEFORE MAKING A DECISION TO INVEST IN OUR COMMON SHARES. THE
RISKS AND UNCERTAINTIES DESCRIBED BELOW ARE NOT THE ONLY ONES FACING US.
ADDITIONAL RISKS NOT PRESENTLY KNOWN TO US OR THAT WE CURRENTLY DEEM IMMATERIAL
MAY ALSO IMPAIR OUR BUSINESS, OPERATIONS, OR FINANCIAL RESULTS. THIS COULD CAUSE
THE TRADING PRICE OF OUR COMMON SHARES TO DECLINE, AND YOU MAY LOSE ALL OR PART
OF YOUR INVESTMENT.
RISKS RELATED TO OUR BUSINESS
We are subject to extensive, complex and changing government regulation.
The clinical laboratory testing industry is subject to significant governmental
regulations at the federal, state or provincial, and local levels in the United
States and Canada, including regulations with respect to:
- - billing matters including prohibitions on fraud and abuse, kickbacks,
rebates and fee splitting;
- - licensing and certification requirements;
- - handling, transportation and disposal of medical specimens and hazardous
waste;
- - quality assurance for clinical laboratories; and
- - occupational safety.
A large number of laboratories have been forced by the U.S. federal and state
governments, as well as by private payors, to enter into substantial settlements
under laws prohibiting fraudulent billing and providing for the recoupment of
non-fraudulent overpayments. Government investigations of clinical laboratories
have been ongoing for a number of years and are expected to continue in the
future.
Existing U.S. federal laws governing Medicare and Medicaid and other similar
state laws impose a variety of broadly described restrictions on financial
relationships among healthcare providers, including clinical laboratories. These
laws include federal anti-kickback laws which prohibit clinical laboratories
from, among other things, making payments or furnishing other benefits intended
to induce the referral of patients for tests billed to Medicare, Medicaid or
other federally funded programs. They also include self-referral prohibitions
which prevent us from accepting referrals from physicians who have non-exempt
ownership or compensation relationships with us as well as anti-markup and
direct billing rules that may apply to our relationships with customers. Many
states have similar laws. Furthermore, many state laws prohibit physicians from
sharing professional fees with non-physicians and prohibit non-physician
entities, such as us, from practicing medicine and from employing physicians to
practice medicine.
The operations of our clinical laboratories in the United States are subject to
a stringent level of regulation under the U.S. Clinical Laboratory Improvement
Act of 1988 and subsequent amendments, or CLIA. For certification under CLIA,
laboratories, such as ours in the United States and Canada, must meet various
requirements, including requirements relating to quality assurance and personnel
standards. Our laboratories are also subject to strict regulation by various
states. Most of our clinical laboratories in the United States and Canada are
accredited by the College of American Pathologists and are therefore subject to
the College's requirements and evaluation. Compliance with such standards is
verified by periodic inspections and requires participation in proficiency
testing programs.
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Our facilities may not pass all future inspections conducted to ensure
compliance with federal or any other applicable licensing or certification laws.
Some of these statutes and regulations, principally in the area of billing, have
not been interpreted by the courts and may be interpreted or applied in a manner
that might adversely affect us. Substantial time and expense are required on an
ongoing basis to ensure that we comply with existing regulations. Although we
believe that we are in compliance with the applicable fraud and abuse laws and
regulations, we may become the subject of a regulatory or other investigation or
proceeding. Furthermore, changes in existing regulations or new regulations
could have a material adverse effect on our profitability and financial
condition.
Healthcare providers in Canada are subject to significant governmental
regulation and licensing requirements, primarily at the provincial level but
also at the federal and municipal levels. Laboratory licenses authorize clinical
diagnostic laboratories to perform specific tests. The licensing and regulatory
requirements relate to, among other matters, the conduct of testing and
reporting of results, the handling and disposal of medical specimens and
infectious and hazardous waste and other materials, the safety and health of
laboratory employees and the proficiency of staff. The clinical laboratory
testing industry in Canada is subject to periodic inspections by regulatory
agencies.
Any failure to comply with licensing requirements or violation of other statutes
and regulations may result in civil or criminal sanctions, and/or may also
include:
- - the revocation of licenses, certifications and authorizations;
- - the denial of the right to conduct business;
- - exclusion from participation in government healthcare programs such as
Medicare and Medicaid;
- - significant fines; and
- - criminal penalties.
The imposition of any of these sanctions could have a material adverse effect on
our profitability and financial condition.
See "Business--Regulation" for additional information regarding government
regulations to which we are subject.
The complexities of billing for laboratory services in the United States may
adversely affect our revenues, profitability and cash flows.
Billing for laboratory services in the United States is a complex process.
Laboratories (including our laboratories) generally bill many different payors,
including physicians, patients, insurance companies, Medicare, Medicaid and
others. All of these payors have different billing requirements. In order to
bill and receive payment for laboratory services, the physician and the patient
must provide appropriate billing information, including medical necessity and
diagnosis codes. Following up on incorrect or missing information generally
slows down the billing process and increases the aging of accounts receivable.
We assume the financial risk related to collection, including the potential
uncollectibility of accounts from delays due to incorrect and missing
information. Failure to meet the billing requirements of the different payors or
to manage these collection risks could have a material adverse impact on our
revenues, profitability, cash flows and financial condition.
"Business--Billing--United States" discusses this topic in greater detail.
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Our growth strategy depends upon our ability to acquire clinical laboratories
and enter into new joint venture partnerships. However, we may not be able to
make acquisitions or enter into new joint venture partnerships that meet our
target criteria.
A key element of our growth strategy is expansion through the acquisition of
clinical laboratories and the creation of joint venture partnerships in new
markets. We may not be able to acquire clinical laboratories or enter into joint
venture partnerships that meet our target criteria on satisfactory terms, if at
all.
Our acquisition program requires substantial capital resources, and the
operation of our clinical laboratories requires ongoing capital expenditures. We
may need to obtain additional capital or financing, from time to time, to fund
these activities. Sufficient capital or financing may not be available to us on
satisfactory terms, if at all. If we are unable to continue to grow through
acquisitions and new joint venture partnerships, our growth may not meet
investor expectations, and our share price may decline.
We may not be able to integrate acquired operations and joint venture
partnerships successfully. This would adversely affect our profitability and
financial condition.
Since the beginning of 1999, we made 18 acquisitions and entered into two new
joint venture partnerships. Our growth strategy contemplates further
acquisitions and joint venture partnerships. See "Business--Acquisitions and
Joint Venture Partnerships" for additional details. Continued rapid growth may
impair our ability to provide our laboratory services effectively and to manage
our employees adequately. While we are taking steps to manage rapid growth,
future profitability could be materially adversely affected if we are unable to
do so effectively. The successful integration and management of acquired
businesses involves numerous risks that could adversely affect our growth and
profitability, including the risks that:
- - our management may not be able to manage the acquired operations
successfully and the integration may place significant demands on our
management, diverting attention from our existing operations;
- - our operational, financial and management systems may be incompatible with
or inadequate to effectively integrate and manage acquired systems. For
example, during 1999, we installed three new billing systems and upgraded
three existing systems. As a result, the billing workflow was interrupted,
causing an increase in our "days sales outstanding," a common measurement of
the aging of accounts receivable. Further, any steps taken to implement
changes in our systems may not be sufficient and may result in substantial
costs, delays or other operational or financial problems;
- - acquisitions may require substantial financial resources that otherwise
could be used in the development of other aspects of our business;
- - acquisitions may result in liabilities and contingencies, which could be
significant to our operations; and
- - personnel from our acquisitions and our existing businesses may not be able
to work together successfully, which would adversely affect the operation of
our businesses.
We may not be able to successfully integrate our acquisitions. Our failure to do
so could adversely affect our business, profitability and financial condition.
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We have received and may continue to receive reduced payments for our services
in the United States due to efforts by governmental payors, other third-party
payors and managed care plans to control their costs.
We expect to continue to be subject to pricing pressures. We may lose business
and we may be compelled to lower our prices due to increased pricing pressures.
This may reduce our revenues and, since a significant portion of our costs are
fixed, this could have a material adverse impact on our profitability.
Third party payors, including Medicare, Medicaid and health insurers, have
increased their efforts to control the cost of providing healthcare services. As
a result of these cost-control efforts, the reimbursement amounts we receive for
testing services have been reduced from time to time.
For the six months ended June 30, 2001, approximately 18% of our U.S. revenues
(14% of our total revenues) were from services provided under the Medicare and
Medicaid programs. Legislative and regulatory changes continue to be introduced
with an objective of reducing amounts paid for laboratory services under the
Medicare and Medicaid programs. Examples of measures already adopted include:
- - federal legislation that reduced ceilings on Medicare reimbursement to the
clinical laboratory testing industry;
- - reductions in the number of tests which may be concurrently ordered and
billed for; and
- - limits on our ability to bill for tests unless they are considered to be
medically necessary and properly documented by a physician.
Due to these legislative and regulatory changes, we may not be reimbursed for a
portion of our Medicare- and Medicaid-related testing. Further, in those cases
where we are unable to bill Medicare or Medicaid, we might be able to bill
patients directly. In these cases, however, we must rely on the patients to
properly complete and sign forms approving the billing.
The law generally requires clinical laboratories to accept Medicare and Medicaid
reimbursement amounts as payment in full. Therefore, when these payors
unilaterally reduce the fees they are willing to pay, we must accept the reduced
payments. Future reductions in payments could have a material adverse effect on
our revenues, profitability and financial condition.
Due to their size, many third party payors and certain clients in the United
States are able to negotiate favorable fee arrangements with healthcare
providers. Approximately 45%-50% of our revenues in the United States for the
six months ended June 30, 2001 were generated from third party payors and
clients, excluding Medicare/Medicaid and long-term hospital contracts.
A substantial portion of our Canadian revenues is subject to Canadian regulatory
limits that can prevent us from being paid for all of the testing services we
are required to provide. Future reductions in provincial government payments or
in our share of those payments, or the implementation of other measures, would
reduce our revenues and profitability.
Our laboratory operations in Ontario are subject to an agreement with the
Ontario government pursuant to which each laboratory service provider has been
allocated a fixed share (referred to as a corporate funding cap) of an overall
industry funding cap for government reimbursed services. For the six months
ended June 30, 2001, approximately 73% of our Canadian revenues (20% of our
total revenues) were for services that are subject to the corporate funding cap.
Under the agreement, we do
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not receive government payments in excess of our annual corporate funding cap,
even when we are required to provide testing services that would otherwise have
a value in excess of the cap. Having to provide testing services in excess of
our annual corporate funding cap could have a material adverse impact on our
profitability and financial condition. Should a laboratory service provider
perform testing valued below its corporate funding cap in any 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 service
providers as an increase to their share of the corporate funding cap. Although
we have continued to provide testing services in excess of our annual corporate
funding cap, we cannot assure you that we will continue to process adequate test
volumes to maintain our existing corporate funding cap in the future.
Through our joint venture partnership in Alberta, we have entered into a
long-term agreement with the Capital Health Authority in Alberta to provide
services in the Edmonton region. In addition, we have entered into agreements
with several other regional health authorities in Northern Alberta. In the
aggregate, these agreements accounted for approximately 17% of our Canadian
revenues for the six months ended June 30, 2001 (approximately 5% of our total
revenues). The loss or non-renewal of one or more of these contracts could have
a material adverse impact on us.
Healthcare providers in Canada are subject to pricing pressures as the
provincial governments attempt to control costs. In general, provincial
governments in Canada continue to examine funding methods and laboratory
delivery systems, with a longer-term view to improving the efficiency and cost
effectiveness of laboratory services provided by both independent and hospital
laboratories. Future changes which may be implemented by provincial governments
in Canada may have a material adverse effect on the funding received by us.
As a result of the use of partially capitated payment contracts, the
profitability of our long-term hospital contracts in the United States may be
adversely affected by a number of factors beyond our control.
Six of our long-term hospital contracts generally provide for a fixed price per
admission adjusted on a monthly basis for the hospital's acuity factor,
regardless of the number or cost of tests performed during the month (excluding
certain tests, such as esoteric tests and anatomic pathology services). Acuity
commonly refers to the degree of severity of ailment and the complexity of
treatment required. If the utilization per patient under these contracts
increases, the contracts will be more costly for us to perform. The utilization
per patient may not be directly related to acuity and may be affected by certain
factors out of our control, including changes in physician test ordering
patterns and other factors which affect test volume and mix of tests. Although
the acuity adjustment is an indirect means of adjusting for changes in volumes
and mix of tests, there is no direct adjustment for all factors affecting test
utilization. An increase in test utilization and/or a change in the mix of tests
per patient without a corresponding increase in acuity could lead to decreased
profitability of these contracts which could have a material adverse effect on
our profitability and cash flows.
The U.S. clinical laboratory testing market is intensely competitive. In the
United States, where we have a relatively limited operating history, the
clinical laboratory testing market is largely dominated by two large national
laboratory companies. We may not have the necessary resources to compete
effectively in that market.
The U.S. clinical laboratory testing business is highly competitive and we
expect this high level of competition to continue. In the United States, the
clinical laboratory testing market is dominated by two large independent
clinical laboratories, each of which has nationwide operations and greater
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financial and purchasing power than we do and is considerably larger than we
are. Accordingly, these competitors may:
- - be able to respond more effectively to changes in the clinical laboratory
testing and general financial markets;
- - benefit from greater economies of scale;
- - offer more aggressive pricing;
- - devote greater resources to the promotion of their services; and/or
- - have greater ability to contract with managed care and group purchasing
organizations.
In addition to competing with the two largest national laboratories, we also
compete with many smaller niche, independent regional laboratories and hospital
laboratories that provide community services in each of the local markets we
serve. We may not be able to compete effectively in the U.S. market or to
successfully implement our growth strategy in the United States. See "Business--
Competition" for additional information.
We are dependent upon a small number of hospital contracts for a significant
portion of our revenues in the United States.
The primary way we provide services to hospitals is through long-term contracts
pursuant to which we provide all of the hospital's laboratory testing. These
contracts accounted for an aggregate of approximately 20% of our revenues in the
United States (14% of our total revenues) for the six months ended June 30,
2001. One of these contracts is with an affiliate of Swedish Medical Center in
Seattle, Washington. This contract expires in February 2005 and accounted for
approximately 6% of our U.S. revenues (4% of our total revenues) for the six
months ended June 30, 2001. Our hospital contracts may be terminated without our
consent for our non-performance or in the event that changes in laws or
regulations make the arrangements unlawful. The loss or non-renewal of one or
more of these hospital contracts (the Swedish Medical contract in particular)
could have a material adverse impact on our profitability and financial
condition. Our contract with Memorial Hermann in Houston, Texas, which expired
on September 30, 2000, was not renewed by the hospital. See "Business--
Acquisitions and Joint Venture Partnerships" for additional details.
Our substantial leverage could adversely affect our ability to run our business.
We have, and will continue to have, a significant amount of indebtedness. As of
June 30, 2001, we had $207.5 million of long-term debt obligations outstanding.
This indebtedness could have important consequences on our ability to operate
our business effectively. For example, it could:
- - limit our ability to borrow additional funds or to obtain other financing in
the future for working capital, capital expenditures, acquisitions and
general corporate purposes;
- - require us to dedicate a substantial portion of our cash flow from
operations to pay down our indebtedness, thereby reducing the funds
available for working capital, capital expenditures, acquisitions and
general corporate purposes;
- - make us more vulnerable to economic downturns and reduce our flexibility in
responding to changing business and economic conditions;
- - limit our flexibility in planning for, or reacting to, changes in our
business or industry;
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- - place us at a competitive disadvantage to our competitors with less debt;
and
- - restrict our ability to pay dividends, repurchase or redeem our capital
stock or debt, merge or consolidate with another entity or issue capital
stock of our subsidiaries.
Our substantial leverage could adversely affect our ability to finance future
operations or other capital needs or to engage in other business activities that
may be in the best interests of our shareholders.
Any failure in our information technology systems could significantly increase
testing turn-around time, reduce our production capacity and otherwise disrupt
our operations. Any of these circumstances could reduce our customer base and
result in lost revenue and adversely affect our profitability.
Our laboratory operations depend, in part, on the continued and uninterrupted
performance of our information technology systems. The significant growth we
have experienced in the United States through our acquisitions and joint venture
partnerships has necessitated continued expansion and upgrading of our
information technology infrastructure. Sustained system failures or interruption
of our systems in one or more of our laboratory operations could disrupt our
ability to process laboratory requisitions, perform testing, provide test
results in a timely manner and/or bill the appropriate party.
Our computer systems are vulnerable to damage from a variety of sources,
including telecommunications failures, malicious human acts and natural
disasters. Moreover, despite network security measures, some of our servers are
potentially vulnerable to physical or electronic break-ins, computer viruses and
similar disruptive problems. Despite the precautions we have taken,
unanticipated problems affecting our systems could cause interruptions in our
information technology systems. Our insurance policies may not adequately
compensate us for any losses that may occur due to any failures in our systems.
Our business, profitability and financial condition could be adversely affected
by a system failure. See "Business--Information Technology" for additional
information about our information technology.
Any failure by us to consolidate certain of our laboratory operations and
implement cost management initiatives successfully could have a material adverse
impact on our profitability.
An important component of our strategy is to enhance the profitability of our
existing regional operations by consolidating certain of our laboratory
operations and implementing cost-management initiatives. We have commenced the
consolidation of certain of our operations in our Southwest Region and have
undertaken various measures to reduce our cost of materials. Our failure to
successfully implement these initiatives could adversely affect our
profitability and financial condition.
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Claims brought against us could have an adverse impact on us. We may not have
adequate insurance, and it may be more expensive or difficult for us to obtain
adequate insurance in the future.
As a provider of healthcare services we are exposed to the risk of litigation.
Plaintiffs have brought claims against clinical laboratories and other
healthcare providers, alleging a variety of complaints, including malpractice.
These actions may involve large claims and significant defense costs. We
maintain professional malpractice liability insurance and general liability
insurance in amounts that we believe are sufficient to cover claims arising out
of our operations. Some claims, however, could exceed the scope of our coverage,
or the coverage of particular claims could be denied. Our existing insurance may
not continue to be sufficient or, in the future, policies for adequate levels of
insurance may not be available to us at acceptable costs or at all. In addition,
such litigation could adversely affect our existing and potential customer
relationships, create adverse public relations and divert management's time and
resources from the operation of the business. See "Business--Insurance" and
"--Legal Proceedings" for additional details.
We depend significantly on key personnel. The loss of one or more of our key
senior management personnel or a significant portion of our local management
personnel would weaken our management team and our ability to deliver laboratory
services efficiently and profitably.
Our success largely depends on the skills, experience and effort of our senior
management. Our operations are also dependent on the efforts, ability and
experience of key members of our local management staff. The loss of services of
one or more members of our key senior management personnel or of a significant
portion of any of our local management personnel could significantly weaken our
management expertise and our ability to deliver laboratory services efficiently
and profitably. See "Management" for more information.
Our performance depends on our ability to recruit and retain experienced and
qualified personnel at our clinical laboratories. Shortages of qualified and
experienced laboratory personnel in our markets could negatively impact our
ability to operate our business efficiently and profitability.
The success of our laboratory operations depends on employing qualified and
experienced laboratory professionals who perform our clinical laboratory testing
or billing services. The healthcare industry is currently experiencing a
shortage of qualified personnel. Hiring and retaining healthcare professionals
in this tight labor market will be difficult due to intense competition for
their services, which has caused increased salary and wage rates. The loss of
healthcare professionals, the inability to recruit these individuals in our
markets or overall salary and wage rate increases could adversely affect our
ability to operate our business efficiently.
Any failure by us to comply with laws and regulations governing the
confidentiality of medical information could adversely affect our ability to do
business.
The disclosure and the use of confidential patient medical information are
subject to substantial regulation by state, provincial and federal governments.
Most states and provinces have laws that govern the use and disclosure of
patient medical information and the right to privacy. Similarly, many federal
laws also may apply to protect such information, including the Electronic
Communications
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Privacy Act of 1986, and federal laws relating to confidentiality of mental
health records and substance abuse treatment.
Legislation governing the dissemination and use of medical information is
continually being proposed at both the state and federal levels. For example,
the Health Insurance Portability and Accountability Act of 1996, also known as
HIPAA, requires us to comply with standards for the exchange of health
information within our company and with third parties, such as payors, business
associates and patients. These include standards for common healthcare
transactions (such as claims information, plan eligibility, payment information
and the use of electronic signatures); unique identifiers for providers,
employers, health plans and individuals; security; privacy and enforcement. To
date, the Department of Health and Human Services has released two standards,
one governing healthcare transactions and the second relating to the privacy of
individually identifiable health information (rules governing the security of
health information have been proposed but not finalized). We have until
October 2002 to comply with the transactions standards, and until February 2003
to comply with the privacy standards. In addition, many of these federal
provisions do not preempt more stringent state laws and regulations. Future
legislation may affect the dissemination of medical information that is not
individually identifiable. Physicians and other persons providing patient
information to us are also required to comply with these laws and regulations.
If a patient's privacy is violated, or if we are found to have violated any
state or federal statute or regulation with regard to the confidentiality,
dissemination or use of patient medical information, we could be liable for
damages or for civil or criminal fines or penalties.
The period of amortization for licenses and goodwill may be overestimated and
therefore the value of our intangible assets may be less than that reflected in
our financial statements.
Goodwill arises when an acquiror pays more for a business than the fair value of
the tangible assets and the measurable intangible assets acquired. Canadian
generally accepted accounting principles require that goodwill and other
unmeasurable intangible assets, such as our Ontario clinical laboratory
licenses, be amortized over a period which corresponds with the useful life of
such assets. We have estimated that the amortization period for the majority of
our goodwill and licenses is 40 years. However, if some of the goodwill or
licenses proves to have a useful life shorter than 40 years, earnings reported
in the periods following an acquisition would have been overstated. 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 (CICA) 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 will no
longer be amortized but will be subject to annual impairment tests. We may incur
impairment charges for licenses and goodwill in the future, which would
adversely impact our profitability and financial condition.
We may not be able to recover the value of our licenses and goodwill which make
up approximately half of our consolidated assets.
As of December 31, 2000 and June 30, 2001, $166.7 million (approximately 48%) of
our total consolidated assets of $349.0 million and $172.8 million
(approximately 48%) of our total consolidated assets of $359.4 million,
respectively, consisted of our Ontario clinical laboratory licenses
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and goodwill. Laboratory licenses are required to operate clinical laboratories
and to receive reimbursement in Ontario. In 1997, we recorded a $79.4 million
impairment charge against licenses and goodwill. The recently issued FASB 141
and 142 as well as CICA handbook sections 1581 and 3062 require the valuation of
our licenses and goodwill on an annual basis and it is possible we may incur an
additional impairment charge for licenses and goodwill in the future. Although
the licenses and goodwill are included in our total consolidated assets in
accordance with Canadian generally accepted accounting principles, we might not
receive the amount so included in the event of a sale, liquidation or bankruptcy
of any of the related businesses. For more information regarding our licenses
and goodwill you should read note 4 to our consolidated financial statements.
Changes in technology could adversely impact our testing volumes and revenues.
The clinical laboratory testing industry is faced with changing technology and
new product introductions. As an example, changes in technology may lead to the
development of more cost effective point-of-care testing equipment that can be
operated by physicians or other healthcare providers in their offices or by
patients themselves without requiring the services of clinical laboratories.
This could adversely impact our testing volumes, revenues and profitability.
Our operations may be adversely impacted by a catastrophic event, which could
prevent us from operating our business in the affected region.
A catastrophic event such as an earthquake or flood could adversely impact one
or more central laboratory facilities and could prevent us from operating our
business in the affected regions. Although we have property and business
interruption insurance, there is no assurance that these policies would
adequately compensate us for the losses that may occur. The occurrence of any
catastrophic event could impair our ability to operate our business.
On September 11, 2001, the United States was the target of terrorist attacks of
unprecedented scope. We were not significantly impacted because our regional
structure limits our reliance on air transportation of specimens and because we
do not have operations in the New York City and Washington D.C. markets.
However, those terrorist attacks and the U.S. government's response may lead to
further acts of terrorism, bio-terrorism and financial, economic and political
instability. While the precise effects of such instability on our industry and
our business are difficult to determine, it may have an adverse effect on our
business, profitability and financial condition.
Our quarterly operating results have varied and we expect them to continue to
vary.
Our results of operations have been and can be expected to continue to be
subject to quarterly fluctuations. We experience lower testing volumes during
the holiday and vacation seasons and, to a lesser extent, inclement weather. As
a result, because a significant portion of our expenses are relatively fixed
over the short term, our operating income as a percentage of revenue tends to
decrease during the third quarter due to the summer vacation period and the
fourth quarter due to the various holidays in that quarter. Our quarterly
results can also fluctuate as a result of a number of other factors including
the timing and transition of new acquisitions or joint venture partnerships and
the loss, non-renewal or commencement of significant hospital contracts.
As a result of these fluctuations, we may experience losses. We believe that
quarterly comparisons of our financial results should not be relied upon as an
indication of future performance. See "Management's discussion and analysis of
financial condition and results of operations--Overview" for additional details.
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As a result of our significant Canadian operations, our reported results may be
affected by fluctuations in the exchange rate between the U.S. and Canadian
dollars.
A significant portion of our revenues and expenses is derived from our
operations in Canada, which transacts business in Canadian dollars. Therefore,
our reported financial results from quarter-to-quarter may be adversely affected
by changes in the exchange rate between U.S. and Canadian dollars over the
relevant periods.
RISKS RELATED TO THIS OFFERING
Some of our existing shareholders can exert control over us and may not make
decisions that are in the best interests of all shareholders.
Immediately after the closing of this offering our officers, directors and
greater than 5% shareholders will beneficially own an aggregate of 10,527,773
common shares. This number represents approximately 48% of our shares to be
outstanding (including shares issuable upon exercise of outstanding options)
immediately after the closing of this offering (assuming no exercise by the
underwriters of their over-allotment option). As a result, these shareholders
will effectively control the outcome of our actions that require shareholder
approval. For example, these shareholders may be able to elect all of our
directors, delay or prevent a transaction in which shareholders might receive a
premium over the prevailing market price for their shares, delay or prevent the
approval of any merger or consolidation involving us and prevent changes in
control or management. These significant shareholders may have interests that
differ from those of other shareholders. See "Principal and selling
shareholders" for further information about our existing shareholders.
The price of our common shares may be volatile and this may adversely affect our
shareholders.
The market price for our common shares following this offering may be affected
by a number of factors, including the following:
- - seasonal fluctuations in operating results;
- - failure to achieve operating results projected by securities analysts;
- - changes in earnings estimates or recommendations by securities analysts;
- - developments in our industry;
- - variations in our or our competitors' operating results; and
- - general market conditions and other factors, including factors unrelated to
our operating performance or the operating performance of our competitors.
In the past, following periods of volatility in the market price of a particular
company's securities, securities class action litigation has often been brought
against that company. We may become involved in this type of litigation in the
future. Litigation of this type is often expensive and diverts management's
attention and resources.
- --------------------------------------------------------------------------------
18
<Page>
Risk factors
- --------------------------------------------------------------------------------
Existing shareholders may sell their common shares after this offering. This
could cause the market price of our common shares to decline significantly and
cause your shareholding to be diluted.
Upon completion of this offering, we will have outstanding 19,628,937 common
shares, and options to acquire 2,176,774 additional common shares. Of our
outstanding shares, 10,418,023 shares will be freely tradable, and 9,210,914
shares will be "restricted securities," as the term is defined in Rule 144 under
the Securities Act and for purposes of Canadian securities laws. Restricted
securities may be sold in the public market only if they are registered or if
they qualify for an exemption from registration under Rules 144 or 701 of the
Securities Act or are sold under a prospectus or a prospectus exemption in
Canada. See "Shares eligible for future sale" for a more detailed discussion of
these shares.
Of the 16,928,937 common shares outstanding prior to completion of this
offering, 11,510,914 shares, pursuant to lock-up agreements with our directors
and officers and the selling shareholders (and their affiliates), may not be
sold or otherwise disposed of for a period of 90 days after the date of this
prospectus without the prior written consent of UBS Warburg LLC, other than
2,300,000 common shares held by the selling shareholders which are being sold
pursuant to this offering.
As of June 30, 2001, we have options outstanding to acquire 2,176,774 of our
common shares which were issued in the past at prices significantly below the
offering price per share in this offering. If and when these options are
exercised there will be further dilution to investors in all common shares. See
"Dilution" for additional information.
In addition, some of our current shareholders have "demand" and/or "piggyback"
registration rights in connection with future offerings of our common shares.
Pursuant to these rights, it is contemplated that our selling shareholders will
sell 2,300,000 common shares in this offering. "Demand" rights generally permit
the holders to require us to register their shares under the Securities Act at
our expense. "Piggyback" rights provide for notice to the relevant holders of
our shares if we propose to register any of our securities under the Securities
Act and grant such holders the right to include their shares in the registration
statement. See "Principal and selling shareholders--Registration Rights
Agreement" for a more detailed discussion of these registration rights.
We will have broad discretion as to the use of proceeds of this offering and may
fail to use them effectively.
We expect to use a portion of the net proceeds of this offering to fund future
growth through acquisitions and joint venture partnerships. While we engage in
discussions on a regular basis regarding possible acquisitions and joint venture
partnerships, at present we have no current agreements for any material
acquisitions or joint venture partnerships. However, our management will have
broad discretion in utilizing the proceeds and may use them in ways with which
you and our other shareholders may disagree. We may not be able to invest these
funds effectively, which would adversely affect our profitability and financial
condition.
- --------------------------------------------------------------------------------
19
<Page>
- --------------------------------------------------------------------------------
Forward-looking information
Some of the statements that we make under "Prospectus summary," "Risk factors,"
"Management's discussion and analysis of financial condition and results of
operations," "Business" and elsewhere in this prospectus constitute
forward-looking statements as such term is defined in the Private Securities
Litigation Reform Act of 1995. These statements (which include in particular,
but are not limited to, those referred to under "Prospectus summary--Recent
Developments") relate to future events or our future financial performance and
involve known and unknown risks, uncertainties and other factors that may cause
our or our industry's actual results, levels of activity, performance or
achievements to be materially different from those expressed or implied by any
of our forward-looking statements. Some of these factors are listed under "Risk
factors". You should keep in mind these risk factors and other cautionary
statements in this prospectus, including those contained in "Management's
discussion and analysis of financial condition and results of operations" and
"Business." In some cases, you can identify forward-looking statements 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 events or results may differ materially. Although we
believe that the expectations reflected in the forward-looking statements are
reasonable, we cannot guarantee future results, levels of activity, performance
or achievement. Except as required by law, we undertake no obligation to update
publicly any forward-looking statements for any reason after the date of this
prospectus or to conform these statements to actual results or to changes in our
expectations.
- --------------------------------------------------------------------------------
20
<Page>
- --------------------------------------------------------------------------------
Use of proceeds
We estimate that the net proceeds to us from the sale of the 2,700,000 common
shares in this offering will be approximately $32.7 million ($42.0 million if
the underwriters' over-allotment option is exercised in full), at an assumed
public offering price of $13.10 per share (the last sale price of our common
shares on the Nasdaq National Market on October 31, 2001), after deducting
estimated underwriting discounts and commissions and estimated offering
expenses. We will not receive any proceeds from the sale of common shares by the
selling shareholders.
We expect to use the net proceeds from this offering for working capital and
general corporate purposes, including a pay-down of all our outstanding Canadian
and U.S. revolving working capital facilities which amounted to approximately
$3.9 million at June 30, 2001 as described under "Description of indebtedness,"
and to fund potential acquisitions and joint venture partnerships.
We have no current agreements for any potential material acquisitions or joint
venture partnerships. Further, we have not determined the amounts we plan to
spend on any of the areas listed above or the timing of these expenditures. As a
result, our management will have broad discretion to use the net proceeds from
this offering. Pending application of the net proceeds as described above, we
intend to invest the net proceeds of the offering in short-term,
investment-grade interest-bearing securities. We cannot predict whether the
proceeds invested will yield a favorable return.
- --------------------------------------------------------------------------------
21
<Page>
- --------------------------------------------------------------------------------
Market price of our common shares
On November 22, 2000, we completed an initial public offering of our common
shares in the United States and Canada. As a result of such issuance, we sold
5,003,000 common shares in the United States for proceeds of $50.0 million,
before costs of $3.6 million, and began trading on The Nasdaq National Market
and the Toronto Stock Exchange under the symbols "DNCR" and "DNA," respectively.
Additionally, one of the selling shareholders sold 375,000 common shares in that
offering to cover part of the exercised portion of the underwriters'
over-allotment option.
The following table sets forth for the periods indicated the high and low sales
prices for our common shares reported on The Nasdaq National Market composite
tape.
<Table>
<Caption>
Fiscal year ended December 31, 2000 High Low
- ----------------------------------------------------------------------------------
Fourth Quarter.............................................. $ 11.00 $ 8.38
</Table>
<Table>
<Caption>
Fiscal year ended December 31, 2001 High Low
- ----------------------------------------------------------------------------------
First Quarter............................................... $ 10.94 $ 3.50
Second Quarter.............................................. $ 11.51 $ 4.00
Third Quarter............................................... $ 14.71 $ 8.10
Fourth Quarter (through October 31)......................... $ 14.63 $10.45
</Table>
As of October 31, 2001, 16,949,353 of our common shares were outstanding, which
were held by 23 registered holders.
- --------------------------------------------------------------------------------
22
<Page>
- --------------------------------------------------------------------------------
Dividend policy
We have not paid any cash dividends since 1993. We currently anticipate
retaining all of our future earnings, if any, to support operations and to
finance the growth and development of our business. Consequently, we do not
anticipate paying any dividends for the foreseeable future. Any future
determination relating to our dividend policy will be made at the discretion of
our board of directors and will depend on a number of factors, including future
earnings, capital requirements, financial conditions and future prospects and
other factors the board of directors may deem relevant. The indenture governing
our 10.75% senior unsecured notes contains covenants that among other things
limits our ability and the ability of our subsidiaries to pay dividends and
incur additional indebtedness.
- --------------------------------------------------------------------------------
23
<Page>
- --------------------------------------------------------------------------------
Capitalization
The following table sets forth our capitalization as of June 30, 2001:
- - on an actual basis;
- - on an adjusted basis to give effect to the sale by us of 2,700,000 common
shares in this offering at an assumed public offering price of $13.10 per
share (the last sale price of our common shares on the Nasdaq National
Market on October 31, 2001), less estimated underwriting discounts and
commissions and estimated offering expenses.
This table should be read with "Management's discussion and analysis of
financial condition and results of operations" and our consolidated financial
statements and related notes included elsewhere in this prospectus.
<Table>
<Caption>
As of June 30, 2001
-----------------------
Actual As adjusted
(Unaudited)
- -------------------------------------------------------------------------------------
<Caption>
(in thousands of U.S.
dollars, except share data)
Long-term debt, less current portion........................ $202,091 $202,091
-------- --------
Shareholders' equity:
Common shares; 16,928,937 shares issued and outstanding on
an actual basis and 19,628,937 shares issued and
outstanding on an as adjusted basis..................... 98,617 131,330
Foreign currency translation adjustment................... 1,375 1,375
Accumulated deficit....................................... (36,131) (36,131)
-------- --------
Total shareholders' equity.................................. 63,861 96,574
-------- --------
Total capitalization........................................ $265,952 $298,665
======== ========
</Table>
The number of common shares to be outstanding after this offering is based on
the number of shares outstanding as of June 30, 2001, assumes no exercise of the
underwriters' over-allotment option, and excludes:
- - 2,176,774 shares issuable upon the exercise of stock options outstanding as
of June 30, 2001 under our stock option plans of which 1,695,374 have a
weighted average exercise price of Cdn$9.62 per share and 481,400 have a
weighted average exercise price of $9.125 per share; and
- - at June 30, 2001, an aggregate of 687,543 shares available for future
issuance under our stock option plans.
- --------------------------------------------------------------------------------
24
<Page>
- --------------------------------------------------------------------------------
Dilution
If you invest in our common shares, your interest will be diluted to the extent
of the difference between the offering price per share and the adjusted net
tangible book value per share after giving effect to this offering. The net
tangible book value of our common shares as of June 30, 2001 was
($109.0) million, or approximately ($6.44) per share. Net tangible book value
per share represents the amount of our total tangible assets less total
liabilities, divided by the number of common shares outstanding. Dilution in net
tangible book value per share represents the difference between the amount per
share paid by purchasers of common shares in this offering and the net tangible
book value per share immediately after the completion of this offering. After
giving effect to our sale of 2,700,000 common shares in this offering at an
assumed public offering price of $13.10 per share (the last sale price of our
common shares on the Nasdaq National Market on October 31, 2001) (less estimated
underwriting discounts and commissions and estimated offering expenses), our
adjusted net tangible book value as of June 30, 2001 would be ($76.2) million,
or ($3.88) per share. This represents an immediate increase in net tangible book
value of $2.56 per share to existing shareholders and an immediate dilution in
net tangible book value of $16.98 per share to new investors. Investors
participating in this offering will incur immediate, substantial dilution. The
following table illustrates the per share dilution:
<Table>
Assumed public offering price per share..................... $13.10
Net tangible book value per share as of June 30, 2001..... ($ 6.44)
Increase attributable to existing investors............... 2.56
-------
Adjusted net tangible book value per share after this
offering.................................................. (3.88)
------
Dilution per share to new investors......................... $16.98
======
</Table>
The following table summarizes, as of June 30, 2001, the differences between the
total consideration paid and the average price per share paid by existing
shareholders and by new investors purchasing shares in this offering before
deducting the estimated underwriting discounts and commissions and our estimated
offering expenses.
<Table>
<Caption>
Shares purchased Total consideration Average price
Number Percent Amount Percent per share
- -----------------------------------------------------------------------------------------------------
Existing shareholders............. 16,928,937 86.2% $101,470,753 74.2% $ 5.99
New investors..................... 2,700,000 13.8% 35,370,000 25.8% $13.10
---------- ----- ------------ -----
Total........................... 19,628,937 100.0% $136,840,753 100.0% $ 6.97
========== ===== ============ =====
</Table>
The number of common shares to be outstanding after this offering is based on
the number of shares outstanding as of June 30, 2001, assumes no exercise of the
underwriters' over-allotment option, and excludes:
- - 2,176,774 shares issuable upon exercise of stock options outstanding as of
June 30, 2001 under our stock option plans of which 1,695,374 have a
weighted average exercise price of Cdn$9.62 per share and 481,400 have a
weighted average exercise price of $9.125 per share; and
- - an aggregate of 687,543 shares available for future issuance under our stock
option plans.
To the extent that any of these options are exercised, there will be further
dilution to new investors.
- --------------------------------------------------------------------------------
25
<Page>
- --------------------------------------------------------------------------------
Selected consolidated financial data
The following table sets forth our selected consolidated financial information
for the periods indicated and should be read in conjunction with our audited
consolidated financial statements for the years ended December 31, 1998, 1999
and 2000 and the related notes; our unaudited consolidated financial statements
for the six months ended June 30, 2000 and 2001; and "Management's discussion
and analysis of financial condition and results of operations," included
elsewhere in this prospectus. The selected consolidated statement of operations
data set forth below for the years ended December 31, 1996 and 1997 and the
balance sheet data at December 31, 1996, 1997 and 1998 are derived from our
financial statements that have been audited by Ernst & Young LLP, which
financial statements are not included in this prospectus. We prepare our
consolidated financial statements in accordance with Canadian GAAP. These
principles conform in all material respects with U.S. GAAP except as described
in note 20 of the consolidated financial statements included elsewhere in this
prospectus.
In the opinion of management, the unaudited consolidated financial statements
for the six months ended June 30, 2000 and 2001 contain all adjustments,
consisting only of normal recurring adjustments, necessary to present fairly the
historical consolidated financial position and our consolidated results of
operations for those periods. Results of operations for the six months ended
June 30, 2001 are not necessarily indicative of results for the full year.
<Table>
<Caption>
Six months ended
Years ended December 31, June 30,
Income statement --------------------------------------------------------------- ------------------------
information: 1996 1997 1998 1999 2000 2000 2001
- -------------------------------------------------------------------------------------------------------------------------
<Caption>
(in thousands of U.S. dollars, except for share and per share amounts)
Revenues:
U.S. operations............. $ 66,861 $ 80,365 $ 133,552 $ 173,566 $ 250,747 $ 120,631 $ 144,914
Canadian operations......... 98,737 95,450 91,359 99,111 102,172 51,202 52,767
----------- ----------- ----------- ----------- ----------- ----------- -----------
Total revenues............ 165,598 175,815 224,911 272,677 352,919 171,833 197,681
General and operating
expenses.................... 141,004 152,353 189,643 230,795 306,105 146,734 170,954
Depreciation.................. 4,094 4,819 6,433 8,351 11,368 5,192 5,775
Amortization of licenses and
goodwill.................... 5,822 5,650 4,112 4,707 5,279 2,575 2,788
Non-recurring charges......... 608 82,554 -- -- 6,750 -- --
----------- ----------- ----------- ----------- ----------- ----------- -----------
Operating earnings (loss)..... 14,070 (69,561) 24,723 28,824 23,417 17,332 18,164
Interest expense.............. 13,383 13,713 15,486 19,457 22,477 11,087 10,645
Gain on sale of home health-
care operation.............. -- (720) -- -- -- -- --
----------- ----------- ----------- ----------- ----------- ----------- -----------
Earnings (loss) before income
taxes....................... 687 (82,554) 9,237 9,367 940 6,245 7,519
Income taxes (benefit)........ (265) (27,417) 3,048 3,726 (5,085)(1) 1,741(1) (435)(1)
----------- ----------- ----------- ----------- ----------- ----------- -----------
Net earnings (loss)........... $ 952 $ (55,137) $ 6,189 $ 5,641 $ 6,025 $ 4,504 $ 7,954
=========== =========== =========== =========== =========== =========== ===========
Earnings (loss) per share--
basic....................... $ 0.10 $ (5.19) $ 0.52 $ 0.47 $ 0.48 $ 0.38 $ 0.47
Earnings (loss) per share--
diluted..................... $ 0.09 $ (5.19) $ 0.52 $ 0.45 $ 0.46 $ 0.36 $ 0.46
Weighted average number of
shares outstanding--basic... 9,982,839 10,631,650 11,880,914 11,880,914 12,482,368 11,880,914 16,891,418
Weighted average number of
shares
outstanding--diluted........ 10,161,038 10,631,650 11,880,914 12,464,105 13,143,971 12,443,119 17,146,611
</Table>
- ------------------------------
(1) For the year ended December 31, 2000 and during the six months ended June
30, 2000 and 2001, we reduced the provision for deferred income taxes by
$6.1 million, $2.0 million and $3.0 million, respectively, due to tax rate
reductions announced by the Canadian federal and provincial governments. As
of June 30, 2001, all of the tax rate reductions previously announced by the
Canadian federal and provincial governments have been legislated.
- --------------------------------------------------------------------------------
26
<Page>
Selected consolidated financial data
- --------------------------------------------------------------------------------
<Table>
<Caption>
As of December 31, As of June 30,
--------------------------------------------------------- ---------------------
Balance sheet information: 1996 1997 1998 1999 2000 2000 2001
- ----------------------------------------------------------------------------------------------------------------------
(in thousands of U.S. dollars)
Total assets....................... $262,358 $211,165 $231,130 $288,519 $348,976 $322,845 $359,395
Long-term debt(1) 124,763 143,689 152,731 198,788 202,287 204,050 202,091
Shareholders' equity (deficit)..... 41,635 (9,931) (3,968) 1,646 55,251 6,601 63,861
</Table>
- ------------------------------
(1) Excludes current portion of long-term debt.
U.S. GAAP:
<Table>
<Caption>
Six months ended
Years ended December 31, June 30,
--------------------------------------------------------- ---------------------
Income statement information: 1996 1997 1998 1999 2000 2000 2001
- ----------------------------------------------------------------------------------------------------------------------
(in thousands of U.S. dollars, except per share amounts)
Revenues........................... $147,030 $112,574 $125,310 $164,945 $233,487 $114,882 $130,608
Earnings (loss) from continuing
operations before extraordinary
item............................. $ 974 $(48,515) $ 5,943 $ 5,390 $ (794) $ 2,420 $ 13,664(1)
Net earnings (loss)................ $ (1,247) $(48,515) $ 5,943 $ 5,390 $ (794) $ 2,420 $ 13,664(1)
Earnings (loss) per share--basic $ (0.12) $ (4.56) $ 0.50 $ 0.45 $ (0.06) $ 0.20 $ 0.81
Earnings (loss) per share from
continuing operations before
extraordinary item--basic........ $ 0.10 $ (4.56) $ 0.50 $ 0.45 $ (0.06) $ 0.20 $ 0.81
</Table>
- ------------------------------
(1) For the six months ended June 30, 2001, earnings from continuing operations
and net earnings have increased as a result of a reduction in the provision
for deferred income taxes by $9.1 million due to tax rate reductions
legislated by the Canadian federal and provincial governments.
<Table>
<Caption>
As of December 31, As of June 30,
--------------------------------------------------------- ---------------------
Balance sheet information: 1996 1997 1998 1999 2000 2000 2001
- ----------------------------------------------------------------------------------------------------------------------
(in thousands of U.S. dollars)
Total assets....................... $264,330 $207,429 $210,662 $285,856 $339,663 $309,716 $344,587
Long-term debt(1).................. 131,443 145,381 144,647 202,296 199,404 201,253 198,959
Shareholders' equity (deficit)..... 40,009 (2,664) 3,038 8,755 56,571 12,102 72,149
</Table>
- ------------------------------
(1) Excludes current portion of long-term debt.
- --------------------------------------------------------------------------------
27
<Page>
Selected consolidated financial data
- --------------------------------------------------------------------------------
The following tables set forth our unaudited quarterly financial data for each
quarter within the years ended December 31, 1999 and 2000 and for the three
months ended March 31, 2001 and June 30, 2001. Our interim consolidated
financial statements are prepared in accordance with Canadian GAAP.
<Table>
<Caption>
Three months ended
March 31, June 30, September 30, December 31,
------------------------------------------------------------
Income statement information: 1999
- ---------------------------------------------------------------------------------------
<Caption>
(in thousands of U.S. dollars, except for share and per share
amounts)
Revenues:
U.S. operations.............. $ 38,637 $ 41,247 $ 47,714 $ 45,968
Canadian operations.......... 23,836 24,704 23,947 26,624
----------- ----------- ---------- ----------
Total revenues............. $ 62,473 $ 65,951 $ 71,661 $ 72,592
----------- ----------- ---------- ----------
General and operating
expenses..................... $ 52,118 $ 55,170 $ 61,456 $ 62,051
----------- ----------- ---------- ----------
Net earnings................... $ 1,925 $ 1,844 $ 1,044 $ 828
----------- ----------- ---------- ----------
Earnings per share--basic...... $ 0.16 $ 0.16 $ 0.09 $ 0.07
Earnings per share--diluted.... $ 0.16 $ 0.15 $ 0.08 $ 0.07
Weighted average number of
shares outstanding--basic.... 11,880,914 11,880,914 11,880,914 11,880,914
Weighted average number of
shares
outstanding--diluted......... 12,298,947 12,330,503 12,345,512 12,517,100
</Table>
<Table>
<Caption>
Three months ended Three months ended
March 31, June 30, September 30, December 31, March 31, June 30,
------------------------------------------------------------------------------------------
Income statement information: 2000 2001
- ---------------------------------------------------------------------------------------------------------------------------
<Caption>
(in thousands of U.S. dollars, except for share and per share amounts)
Revenues:
U.S. operations.............. $ 54,773 $ 65,858 $ 68,353 $ 61,757 $ 70,021 $ 74,893
Canadian operations.......... 25,162 26,040 25,553 25,423 25,787 26,980
----------- ----------- ----------- ----------- ----------- -----------
Total revenues............. $ 79,935 $ 91,898 $ 93,906 $ 87,180 $ 95,808 $ 101,873
----------- ----------- ----------- ----------- ----------- -----------
General and operating
expenses..................... $ 68,012 $ 78,721 $ 82,575 $ 76,796 $ 83,140 $ 87,814
----------- ----------- ----------- ----------- ----------- -----------
Net earnings(1)................ $ 2,619 $ 1,885 $ 962 $ 559 $ 2,089 $ 5,865
----------- ----------- ----------- ----------- ----------- -----------
Earnings per share--basic...... $ 0.22 $ 0.16 $ 0.08 $ 0.04 $ 0.12 $ 0.35
Earnings per share--diluted.... $ 0.21 $ 0.15 $ 0.08 $ 0.04 $ 0.12 $ 0.34
Weighted average number of
shares outstanding--basic.... 11,880,914 11,880,914 11,880,914 14,273,653 16,883,914 16,898,922
Weighted average number of
shares
outstanding--diluted......... 12,433,865 12,443,119 12,540,235 14,964,343 17,126,409 17,165,944
</Table>
(1) Net earnings for the three months ended March 31, June 30, September 30 and
December 31, 2000 and the three months ended March 31 and June 30, 2001,
include a reduction in the provision for deferred income taxes of
$0.9 million, $1.1 million, $Nil and $4.1 million and $Nil and
$3.0 million, respectively, due to tax rate reductions enacted by the
Canadian federal and provincial governments.
- --------------------------------------------------------------------------------
28
<Page>
- --------------------------------------------------------------------------------
Management's discussion and analysis of financial condition
and results of operations
THE FOLLOWING DISCUSSION OF OUR FINANCIAL CONDITION AND RESULTS OF OPERATIONS
SHOULD BE READ IN CONJUNCTION WITH THE FINANCIAL STATEMENTS AND THE NOTES TO
THOSE STATEMENTS INCLUDED ELSEWHERE IN THIS PROSPECTUS, WHICH ALSO INCLUDES
INFORMATION REGARDING OUR SIX MONTHS ENDED JUNE 30, 2001 AND 2000. THIS
DISCUSSION MAY CONTAIN FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND
UNCERTAINTIES. AS A RESULT OF THE RISKS SET FORTH UNDER "RISK FACTORS," OUR
ACTUAL RESULTS MAY DIFFER MATERIALLY FROM THOSE ANTICIPATED IN THESE
FORWARD-LOOKING STATEMENTS.
OVERVIEW
We are the third largest independent provider of clinical laboratory testing
services in North America as measured by revenues. Our growth in Canada occurred
through the acquisition of 12 laboratories during the period from 1987 through
1992, including our acquisition in 1992 of the Canadian laboratory operations of
SmithKline Beecham p.l.c., as well as internal growth. In 1992 we went public in
Canada on The Toronto Stock Exchange.
We entered the U.S. laboratory market in 1993 with the purchase of an 80%
interest in Clinical Laboratories Cheyenne. Since then we have made 23
acquisitions and entered into five joint venture partnerships.
In July 1995 we formed a joint venture partnership in Alberta, in which we hold
an approximate 43% interest, with our two major competitors in Northern Alberta.
The Alberta Partnership currently has an approximate 60% market share of the
clinical laboratory testing business in Northern Alberta. In June 1997 we formed
a joint venture partnership in Ontario, in which we hold an approximate 73%
interest, with two of our competitors in Ontario. The Ontario Partnership
currently has an approximate 31% share of the non-hospital clinical laboratory
testing market in Ontario.
In May 1997 we were "taken private" through a Cdn$45.2 million payment to our
shareholders, other than the Latner Group, which was financed primarily by
Golder, Thoma, Cressey, Rauner V, L.P. and its affiliates, a Chicago-based
equity investor group.
In February 1999 we issued $70.0 million aggregate principal amount of senior
notes upon the same terms and conditions as the $125.0 million of 10.75% senior
notes which we issued in January 1996. The proceeds of the $70.0 million note
offering were primarily used to fund our U.S. growth strategy and to repay bank
indebtedness that had been incurred for that purpose.
On November 22, 2000, we sold 5,003,000 common shares in an initial public
offering pursuant to a Form F-1 registration statement filed with the Securities
and Exchange Commission in the United States and a prospectus filed with the
Ontario Securities Commission in Canada. The net proceeds of the offering were
$46.4 million. Our common shares are listed on the Nasdaq National Market and
Toronto Stock Exchange under the symbols "DNCR" and "DNA" respectively.
Additionally, one of the selling shareholders sold 375,000 common shares in that
offering to cover part of the exercised portion of the underwriters'
over-allotment option.
Our revenues from our U.S. and Canadian operations for the six months ended
June 30, 2001 were $144.9 million and $52.8 million, respectively. Approximately
20% of the revenues from our U.S. operations for the six months ended June 30,
2001 was from long-term contracts with hospitals, 18% was from Medicare and
Medicaid, 62% was from various community related payors (including third party
insurance, physicians, clinics and patients). Approximately 90% of the revenues
from our Canadian operations was from provincial government sources, while the
remaining 10% was from a variety of third party payors.
- --------------------------------------------------------------------------------
29
<Page>
Management's discussion and analysis of financial condition and results of
operations
- --------------------------------------------------------------------------------
Our results of operations have been and can be expected to continue to be
subject to quarterly fluctuations. We experience lower testing volumes during
the holiday and vacation seasons and, to a lesser extent, in inclement weather.
As a result, because a significant portion of our expenses is relatively fixed
over the short term, our 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.
Our quarterly results can also fluctuate as a result of a number of other
factors including the timing and transition of new acquisitions or joint venture
partnerships and completion, non-renewal or commencement of significant hospital
contracts.
ACQUISITIONS AND JOINT VENTURE PARTNERSHIPS
Our growth strategy includes expanding our existing network of laboratory
operations by entering new regional markets through strategic acquisitions of
existing laboratory operations or forming joint venture partnerships with
prominent hospitals. In regions in which we currently operate, we complement our
internal "same store" growth by "fold-in" acquisitions. "Fold-in" acquisitions
are typically smaller laboratory acquisitions which can be consolidated into our
existing operations, maximizing synergies and increasing our market presence. In
2000, we made five fold-in acquisitions in the United States in which we
invested a total of $14.7 million. In addition, we entered one new regional
market through the acquisition of LabSouth in Alabama for a total investment of
$23.8 million. Finally, we invested $2.4 million in the Allegheny Partnership
with the Allegheny Hospital in Pittsburgh, Pennsylvania which commenced
operations in December 2000.
In 2001, we acquired the assets and operations of Medical Arts Laboratory, which
provided us with entry into the Oklahoma market. In addition, through two of our
joint venture partnerships we acquired the laboratory assets and operations of
two fold-in laboratories, one in Illinois and one in Texas, for a total purchase
price of $9.9 million.
The Memorial Hermann Partnership, which commenced operations in 1995 and
reflected our joint venture partnership model and strategy, successfully grew
from a hospital based laboratory in 1995 to a laboratory with a significant
community outreach business. In 2000, this joint venture partnership underwent a
transition which included the following elements:
- - as a result of the merger of the Hermann Hospital with the Memorial System,
the Memorial Hermann Partnership's laboratory services agreement with
Hermann Hospital was not renewed upon its expiration in September 2000. The
contract accounted for approximately $9.0 million of our revenues on an
annualized basis.
- - the joint venture partnership relocated its laboratory operations from the
Hermann Hospital to a new 66,800 square foot facility in Houston, Texas.
- - the geographic market of the joint venture partnership was expanded and
accordingly on October 1, 2000, we sold several wholly owned smaller
laboratory operations in Texas to the joint venture partnership for the
value of our original investment in these operations.
On October 31, 2001 we acquired Memorial Hermann's interest in the joint venture
partnership. The consideration for the acquisition was a cash payment of
$2.0 million on closing, with payments of $0.5 million to be made on each of the
first and second anniversaries of the closing.
For more information about these acquisitions, joint venture partnerships and
the Memorial Hermann Partnership see "Business--Acquisitions and Joint Venture
Partnerships."
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Management's discussion and analysis of financial condition and results of
operations
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OUR REVENUES
We recognize revenues on the accrual basis at the time we provide services,
which approximates the time test results are reported. Our revenues are stated
net of all contractual allowances and discounts. In the United States, payments
for laboratory services performed for certain payors are subject to contractual
allowances, which are price discounts negotiated by us with the various payors.
In arriving at net revenues in Canada, we deduct certain allowances and
discounts relating to our reimbursement agreement with the Ontario government.
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 to 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 would be made and withheld by the Ontario
government from monthly payments to be made to us with any residual amounts
payable being settled subsequent to year end.
DIFFERENCES BETWEEN CANADIAN AND U.S. GENERALLY ACCEPTED ACCOUNTING PRINCIPLES
We report our consolidated financial statements using Canadian GAAP with a
reconciliation to U.S. GAAP included in the notes to our financial statements.
Significant U.S.-Canadian GAAP differences applicable to our consolidated
financial statements are noted below:
ACCOUNTING FOR JOINT VENTURE PARTNERSHIPS. Under Canadian GAAP we include in
our financial statements our pro rata share of the revenues and expenses, as
well as of the assets and liabilities, of our joint venture partnerships. Under
U.S. GAAP, we would be required to account for the joint venture partnerships by
the equity method, with the earnings or losses of our joint venture partnerships
included as earnings or losses from equity investments and the assets and
liabilities of the joint ventures 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 impacts our consolidated statements of financial
position, operations and cash flows, it does not impact our consolidated
shareholders' equity or net earnings.
ACCOUNTING FOR INCOME TAXES. Under Canadian GAAP, the impact of changes in
income tax rates are 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 tax rates has been legislated. For the year ended
December 31, 2000, we recorded a tax benefit of $6.1 million due to
substantively enacted tax rate reductions introduced by the Canadian federal and
provincial governments. We recorded a further tax benefit of $3.0 million for
the six months ended June 30, 2001. As of June 30, 2001, all of the changes in
the Canadian income tax rates, including those recorded for the year ended
December 31, 2000, have been legislated and accordingly as at June 30, 2001, no
differences exist between U.S. and Canadian GAAP related to the tax benefits
that have been reflected in our financial statements.
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
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beginning January 1, 2002. Under the new U.S. and Canadian accounting rules,
goodwill and intangible assets deemed to have an indefinite life will no longer
be amortized but will be subject to annual impairment tests. Other intangible
assets will continue to be amortized over their useful life.
It is estimated that our net earnings for the six months ended June 30, 2001
would have increased by approximately $2.0 million or a diluted earnings per
share of $0.11 if goodwill and intangible assets deemed to have an indefinite
life were not amortized during this period.
We will perform the required impairment tests of goodwill and intangible assets
with an indefinite life effective as of January 1, 2002, and have not yet
determined what the effect of these tests will be on our net earnings and
financial position. We may incur impairment charges for licenses and goodwill in
the future, which would adversely impact our profitability and financial
position.
In August 2001, the Financial Accounting Standards Board issued Standard
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 FASB 121--Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to be Disposed of. FASB 144 retains the
fundamental provisions 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. We have not yet determined what the
effect of FASB 144 will be on our net earnings and financial position.
RESULTS OF OPERATIONS
Six months ended June 30, 2001 compared to six months ended June 30, 2000.
Revenues
Revenues for the six months ended June 30, 2001 were $197.7 million, an increase
of $25.9 million, or 15.1%, from $171.8 million in the comparable 2000 period.
This increase in revenues for the six months ended June 30, 2001, resulted
primarily from the continuing growth in our U.S. operations, where revenues
increased by $24.3 million to $144.9 million.
The increase in revenues for the six months ended June 30, 2001 from our U.S.
operations was due to:
- - growth of 7.6% in community or non-hospital revenues in our existing
operations;
- - additional revenues generated by our 2001 acquisitions of Medical Arts
Laboratory and the two other laboratories as previously described, and our
2000 acquisitions which included, LabSouth, West Texas Pathology Laboratory,
CHRISTUS Santa Rosa HealthCare, Olympic Laboratory, Shoals Laboratory,
Accu-Path Laboratory and our joint venture partnership with the Allegheny
Hospital in Pittsburgh, Pennsylvania (Allegheny Partnership).
The increase in revenues was offset in part by the non-renewal of the Hermann
Hospital contract in October 2000 and a reduction in revenues recognized by us
related to several smaller laboratories in Texas whose assets were previously
owned by us (Laboratories for Genetic Services, Accufast Diagnostic Laboratory,
Central Diagnostic Management, West Texas Pathology Laboratory and CHRISTUS
Santa Rosa HealthCare) and sold to the Memorial Hermann Partnership on
October 1, 2000. Subsequent to the sale, we include only 50%, which represents
our proportionate share, of the revenues of these operations.
Canadian revenues increased by $1.6 million to $52.8 million in the six months
ended June 30, 2001, reflecting reimbursement increases from government agencies
coupled with increases in non-government revenues.
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General and operating expenses
General and operating expenses for the six months ended June 30, 2001 were
$171.0 million, an increase of $24.3 million, or 16.6%, from $146.7 million in
the comparable 2000 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 new operations acquired during 2001 and 2000 and the formation of the
Allegheny Partnership in 2000.
General and operating expenses as a percentage of revenues were 86.5% for the
six months ended June 30, 2001, compared to 85.4% in the comparable 2000 period,
resulting in margins of 13.5% and 14.6%, respectively. The decrease in margins
in 2001 occurred primarily as a result of the factors noted above, the
continuing growth of lower margin business in the United States and a reduction
in margins for the Memorial Hermann Partnership due to the non-renewal of the
Hermann Hospital contract and the cost of operating a new and significantly
expanded facility.
Depreciation and Amortization
Depreciation and amortization expense for the six months ended June 30, 2001 was
$8.6 million, an increase of $0.8 million, or 10.3% from $7.8 million in the
comparable 2000 period. The increase in depreciation and amortization arose from
the additional amortization of the goodwill added as a result of our
acquisitions and new joint venture partnership and additional depreciation due
to the capital expenditures made during 2000 and 2001.
Interest
Interest expense for the six months ended June 30, 2001 was $10.6 million, a
decrease of $0.5 million, or 4.5%, from $11.1 million in the comparable 2000
period. The decrease in interest expense is primarily due to lower levels of
bank indebtedness in 2001 relative to the same periods in 2000. Our average
effective interest rate was 10.1% for the six months ended June 30, 2001 and
2000.
Income taxes
An income tax recovery of $0.4 million was recorded for the six months ended
June 30, 2001 compared to an income tax expense of $1.7 million for the
comparable 2000 period. We recorded tax benefits of $3.0 million and
$2.0 million for the six months ended June 30, 2001 and 2000, respectively, as a
result of a series of income tax rate reductions in Canada.
Net earnings
Net earnings for the six months ended June 30, 2001 were $8.0 million, compared
to $4.5 million in the comparable 2000 period. Excluding the impact of the tax
benefits noted above, net earnings for the six months ended June 30, 2001 were
$5.0 million, compared to $2.5 million in the comparable 2000 period.
Years ended December 31, 2000 and 1999 compared
Revenues
Revenues for the year ended December 31, 2000 were $352.9 million, an increase
of $80.2 million, or 29.4%, from $272.7 million in 1999. This increase in
revenues resulted primarily from the continuing growth of our U.S. operations,
the revenues from which increased by $77.2 million to $250.7 million.
The increase in revenues from our U.S. operations was due to:
- - growth of 10.4% in community or non-hospital revenues in our existing
operations; and
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- - additional revenues generated by: (i) our 1999 acquisitions and the joint
venture partnership with University Health Systems in Knoxville, Tennessee
(Tennessee Partnership) which commenced operations on August 1, 1999; and
(ii) our 2000 acquisitions, which included LabSouth, West Texas Pathology
Laboratory, CHRISTUS Santa Rosa HealthCare, Olympic Laboratory, Shoals
Laboratory and Accu-Path Laboratory as previously described.
The increase in revenues was partially offset by the loss of the Hermann
Hospital contract in October 2000 and a reduction in revenues recorded by us
related to several smaller laboratories in Texas, which, as previously noted,
were wholly owned by us, and which were sold to the Memorial Hermann Partnership
on October 1, 2000. Subsequent to the sale, we include only 50%, which
represents our proportionate share, of the revenues of these operations.
Canadian revenues increased by $3.0 million to $102.2 million for the year ended
December 31, 2000, reflecting reimbursement increases from government agencies
coupled with increases in non-government revenues.
General and operating expenses
General and operating expenses for the year ended December 31, 2000 were
$306.1 million, an increase of $75.3 million, or 32.6%, from $230.8 million in
1999. This increase resulted from a $75.4 million increase in general operating
expenses in the United States due to:
- - costs associated with processing additional volumes generated by internal
growth;
- - the additional operating expenses and costs associated with the new
operations acquired during 1999 and 2000;
- - the transitional expenses related to the Memorial Hermann Partnership
including the costs of recruiting and training new employees, relocation
costs related to the move of the laboratory to a new facility in Houston,
Texas, the costs associated with operating a significantly expanded facility
and the costs associated with integrating the operations which the Memorial
Hermann Partnership acquired from us on October 1, 2000; and
- - increased corporate costs associated with expanding the infrastructure
required to support our U.S. growth.
In Canada, general and operating expenses increased by $0.1 million. Increases
in salary, benefits and materials expenses, primarily as a result of increased
testing volume in our joint venture partnerships in Ontario and Alberta, were
offset by a reduction of certain expenses in our Ontario operations as well as a
reduction in administrative costs.
General and operating expenses as a percentage of revenues were 86.7% for the
year ended December 31, 2000, compared to 84.6% in 1999, resulting in margins of
13.3% and 15.4%, respectively. The decrease in margins occurred as a result of
the factors noted above as well as continuing growth of lower margin business,
primarily in the United States.
Severance, Relocation and Other Charges
Upon the completion of our initial public offering in 2000, we incurred
severance, relocation and other charges of approximately $6.7 million in
connection with:
- - severance, lease termination and other costs related to the relocation of
our corporate offices from Toronto, Ontario to Dallas, Texas;
- - termination costs associated with an employment contract with a senior
executive;
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- - amounts paid to certain of our officers to enable them to repay in full
outstanding loans made by us to them and associated taxes which were due as
a result; and
- - other non-cash restructuring charges, including termination of a services
contract.
Depreciation and Amortization
Depreciation and amortization expense for the year ended December 31, 2000 was
$16.6 million, an increase of $3.5 million, or 26.7%, from $13.1 million in
1999. The increase in depreciation and amortization arises from the additional
amortization of deferred financing costs incurred on the issuance of the
$70.0 million, 10.75% Senior Notes in February 1999 and on the long-term debt
related to the West Texas acquisition, additional amortization of the goodwill
added as a result of our acquisitions and additional depreciation due to the
capital expenditures made during 1999 and 2000.
Interest
Interest expense for year ended December 31, 2000 was $22.5 million, an increase
of $3.0 million, or 15.4% from $19.5 million in 1999. The increase in interest
expense was primarily due to the additional debt incurred on the issuance of the
1999 Senior Notes and the increased bank indebtedness of which $23.8 million was
paid down in November, 2000 with a portion of the net proceeds we received from
our initial public offering. Our average effective interest rate was 10.3% for
the year ended December 31, 2000 compared to 10.4% for the prior year.
Income taxes
Effective January 1, 2000, we adopted the Canadian Institute of Chartered
Accountants Handbook Section, Accounting for Income Taxes--3465 ("CICA-3465").
Similar to the Statement of Financial Accounting Standards--No. 109, Accounting
for Income Taxes in the United States, CICA-3465 requires the liability method
of tax allocation for accounting for income taxes. Under the liability method of
tax allocation, deferred tax assets and liabilities are recognized based on the
temporary differences between the accounting and tax bases of assets and
liabilities. The calculation of deferred tax assets and liabilities is based on
the substantively enacted tax rates and laws that will be in effect when the
temporary differences are expected to reverse. We have adopted CICA-3465 on a
retroactive basis with the previous comparable years restated.
We recorded an income tax recovery of $5.1 million for the year ended
December 31, 2000 compared to an income tax expense of $3.7 million in 1999. The
income tax recovery is primarily due to the recognition of a $6.1 million tax
benefit as a result of Canadian federal and provincial tax rate reductions that
were substantively enacted and recorded by us during 2000 as noted below:
<Table>
<Caption>
Tax Benefit
Quarter Ended (millions)
- ------------- -----------
March 31.................................................... $0.9
June 30..................................................... 1.1
September 30................................................ --
December 31................................................. 4.1
----
$6.1
====
</Table>
The cumulative reduction in the Canadian federal statutory tax rate is 1.0%,
3.0%, 5.0% and 7.0% for 2001, 2002, 2003 and 2004 (and thereafter),
respectively. A 1.0% pro rata reduction in the Ontario provincial statutory tax
rate was effective May 2, 2000 and was followed by a further 0.5% tax rate
reduction effective January 1, 2001. The Ontario government announced a further
6%
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reduction in its statutory tax rate on May 9, 2001. This tax rate reduction will
be phased in ratably over the period from 2002 to 2005.
In addition, the 2000 income tax recovery reflects a $2.4 million reduction in
our valuation allowance thereby recognizing the benefit of certain deferred tax
assets. It is our expectation that under our current business strategy we will
generate sufficient taxable income to fully realize these tax benefits.
Net earnings
Net earnings for the year ended December 31, 2000 were $6.0 million, compared to
$5.6 million in 1999. Excluding the after tax impact of the severance,
relocation and other charges and the tax benefit resulting from future tax rate
reductions in Canada, net earnings were $4.0 million in 2000.
Years ended December 31, 1999 and 1998 compared
Revenues
Revenues for the year ended December 31, 1999 were $272.7 million, an increase
of $47.8 million, or 21.3%, from $224.9 million in 1998. This increase in
revenues resulted primarily from continuing growth of our operations in the
United States, where revenues increased by $40.0 million to $173.6 million.
The increase in revenues from our U.S. operations was due to:
- - internal growth of $13.3 million, primarily from our Laboratory of Pathology
in Seattle, Washington and Louisiana Reference Laboratory in Baton Rouge,
Louisiana operations and two of our joint venture partnerships: the Memorial
Hermann Partnership and the United Partnership in Milwaukee;
- - the inclusion of one year of revenues of $3.0 million from Baylor Health
System's integrated physician network, Health Texas Provider Network;
- - the inclusion of revenues of $3.2 million from our acquisition of Accufast
Diagnostic Laboratory, which commenced operations on February 1, 1999, and
our acquisitions of Central Diagnostic Management and Central Wyoming
Medical Laboratory, which commenced operations on April 1, 1999;
- - the inclusion of $13.4 million from our Clinical Pathology Laboratory,
Medical Pathology Laboratory and SouthCoast Pathology Services acquisitions,
which commenced operations on February 1, 1999, June 1, 1999 and July 1,
1999 respectively;
- - the inclusion of revenues of $2.6 million from the Tennessee Partnership,
which commenced operations on August 1, 1999; and
- - the inclusion of revenues of $4.5 million from our Bayou Laboratory and
Doctors Diagnostic Laboratory acquisitions, which commenced operations on
July 1, 1999.
Canadian revenues increased by $7.8 million to $99.1 million from 1998,
reflecting fee increases received from the governments in the provinces of
Ontario and Alberta, coupled with increases in non-government revenues.
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General and operating expenses
General and operating expenses for the year ended December 31, 1999 were
$230.8 million, an increase of $41.2 million, or 21.7%, from $189.6 million in
1998. This increase resulted from an increase in the United States of
$39.5 million due to:
- - costs associated with processing additional volumes generated by internal
growth;
- - the additional operating costs for Health Texas, Clinical Pathology
Laboratory, Accufast Diagnostic Laboratory, Central Diagnostic Management,
Central Wyoming Medical Laboratory, Medical Pathology Laboratory, Bayou
Laboratory, SouthCoast Pathology Services, Doctors Diagnostic Laboratory and
the Tennessee Partnership; and
- - increased corporate costs associated with expanding the infrastructure
required to support our growth in the United States.
In Canada, general and operating expenses increased by $1.7 million, as
increases in salary and benefit expenses and other cost increases were offset in
part by rent and salary savings realized as a result of the change to the
corporate funding cap in Ontario.
General and operating expenses as a percentage of revenues were 84.6% for the
year ended December 31, 1999 compared to 84.3% in 1998, resulting in margins of
15.4% and 15.7%, respectively.
Depreciation and Amortization
Depreciation and amortization expense for the year ended December 31, 1999 was
$13.1 million, an increase of $2.6 million or 24.8% from $10.5 million in 1998.
The increase in depreciation and amortization expense arose primarily from the
inclusion of eleven months of amortization of deferred financing costs incurred
on the issuance in 1999 of our senior notes, increased capital expenditures and
additional amortization of licenses and goodwill related to the acquisitions
completed during 1999.
Interest
Interest expense for the year ended December 31, 1999 was $19.5 million, an
increase of $4.0 million, or 25.8%, from $15.5 million in 1998. The increase in
interest expense was primarily due to the additional debt related to our
issuance of senior notes in 1999. Our average effective interest rate for the
year ended December 31, 1999 was 10.4% compared to 9.7% in 1998.
Income taxes
Income tax expense for the year ended December 31, 1999 was $3.7 million as
compared to $3.0 million in 1998. The income tax expense varies from the amount
that would be computed by applying the statutory rates in the various
jurisdictions to earnings before taxes, primarily because of minimum corporate
tax of $0.4 million ($0.3 million in 1998) and non-deductible expenses of
$0.2 million in 1999 ($0.1 million in 1998). The effect of these items was
partially offset by the taxation of U.S. income at rates lower than the Canadian
federal statutory rates.
Net earnings
Net earnings for the year ended December 31, 1999 were $5.6 million compared to
$6.2 million in 1998. The $0.6 million decrease in net earnings was primarily
due to the increased interest expense incurred as a result of our issuance of
senior notes in 1999.
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LIQUIDITY AND CAPITAL RESOURCES
Our principal sources of liquidity are cash provided by operating activities and
borrowings under debt agreements including our $35.0 million working capital
facility in the United States. Since approximately 90% of our Canadian revenues
are received from government agencies, our Canadian operations receive prompt
payment for their services on a monthly basis and have no significant bad debt
expense. In the United States, we receive monthly payments for the provision of
laboratory services under our present long term contracts with hospitals. These
long-term contracts represented approximately 20% of total U.S. revenues for the
six months ended June 30, 2001. The Canadian revenues from governments, together
with U.S. revenues from hospitals, provide a relatively reliable monthly cash
flow and minimize our working capital which is required to finance these aspects
of our business. However, collecting accounts receivable from the balance of our
business is a complex and time-consuming process which we must finance.
In November 2000, we completed an initial public offering of common shares for
net proceeds to us of approximately $46.4 million (net of after tax costs of
$3.6 million). Approximately $22.3 million of these proceeds were used to fund
acquisitions completed in December 2000, March 2001 and June 2001 and our
capital contribution upon the commencement of the Allegheny Partnership in
December 2000. During the fourth quarter of 2000, we used approximately
$23.8 million of the net proceeds to temporarily pay down our outstanding U.S.
and Canadian working capital facilities.
If additional capital is required for acquisitions, joint venture partnerships
or other expenditures or if our operating results and cash flow are
significantly below expectations, we may require additional debt or equity
financing.
Operating activities
Cash provided by operating activities for the six months ended June 30, 2001 and
2000 was $6.3 million and $13.4 million, respectively. The cash provided by
(used in) non-cash working capital items was ($9.2) million in 2001 and
$0.9 million in 2000. The $9.2 million of cash used in non-cash working capital
items in 2001 primarily reflects an increase in working capital requirements
resulting from the growth of our U.S. operations.
Cash provided by operating activities was $23.9 million, $4.8 million and
$8.6 million for the years ended December 31, 2000, 1999 and 1998, respectively.
The cash provided by (used in) non-cash working capital items was $5.2 million,
($16.1) million and ($10.5) million in the years ended December 31, 2000, 1999
and 1998, respectively.
The $5.2 million of cash provided by non-cash working capital items for the year
ended December 31, 2000 primarily reflects an improvement in our accounts
receivable days sales outstanding, commonly referred to as DSOs, to 65 days as
of December 31, 2000 from 75 days as of December 31, 1999. The use of non-cash
working capital items of $16.1 and $10.5 million for the years December 31, 1999
and 1998, respectively, reflects the increase in working capital requirements
resulting from the significant growth of our U.S. operations.
At June 30, 2001, we had revolving credit facilities of approximately
$50.0 million, with availability of approximately $40.0 million, of which
$3.9 million was drawn. At June 30, 2001 accounts receivable were $68.3 million
(June 30, 2000--$67.1 million) of which $9.9 million (June 30, 2000--
$8.7 million) was derived from Canadian government agencies, $4.3 million
(June 30, 2000--$4.0 million) from U.S. long-term hospital contracts,
$14.0 million (June 30, 2000--$10.0 million)
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from Medicare/Medicaid and $40.1 million (June 30, 2000--$44.4 million) from
other payors. Cash, unused revolving credit facilities and accounts receivable
outstanding as of June 30, 2001, are anticipated to be sufficient to meet
short-term liabilities.
Our available cash position, which originates from both our Canadian and U.S.
operations was $10.2 million as at June 30, 2001 (2000-$5.0 million).
At December 31, 2000 we had revolving credit facilities which totaled
$50.5 million (1999--$25.6 million, 1998--$19.6 million). At December 31, 2000
accounts receivables were $62.1 million (1999--$59.6 million,
1998--$39.3 million) of which $10.8 million (1999--$11.3 million, 1998--
$8.8 million) was derived from Canadian governmental agencies, $4.5 million
(1999--$4.9 million, 1998--$4.1 million) from U.S. long-term hospital contracts,
$11.3 million (1999--$9.8 million, 1998--$4.8 million) from Medicare/Medicaid,
and $35.5 million (1999 -$33.6 million, 1998--$21.6 million) from other payors.
Our available cash position was $18.1 million as at December 31, 2000
(1999--$16.3 million, 1998--$4.7 million).
At June 30, 2001 our DSOs were 61 days compared to 66 days at June 30, 2000. Our
DSOs for the years ended December 31, 2000, 1999 and 1998 were 65 days, 75 days
and 61 days, respectively. The decrease in DSOs during 2000 and 2001 represents
an improvement in our collection of accounts receivable in the U.S. The increase
in DSOs in 1999 reflects both the increased portion of U.S. revenues which
generate higher DSOs than in Canada and the extensive changes made to our
management information systems in the United States during 1999 which disrupted
our billing process, largely attributable to our efforts to integrate the
operations that we acquired in 1999 and to prepare for the Year 2000. See
"Business--Billing--United States." Our DSOs are calculated on any particular
date based on revenues for the prior three months, which is considered
representative given the continuing growth in revenues.
Investing activities
Cash used in investing activities for the six months ended June 30, 2001 and
2000 was $18.1 million and $35.9 million, respectively. The cash used in
investing activities was $61.7 million, $37.5 million and $4.7 million for the
years ended December 31, 2000, 1999 and 1998, respectively. The major components
of the investing activities are outlined below.
Acquisitions and joint venture partnerships
The amount expended on our acquisitions for the six months ended June 30, 2001
aggregated $10.4 million. We acquired the laboratory assets and operations of
Medical Arts Laboratory during the first quarter of 2001 for a purchase price of
$7.7 million. In the second quarter of 2001, we acquired through two of our
joint venture partnerships the laboratory assets and operations of two
laboratories in Texas and Illinois for a purchase price of $0.8 million and
$1.4 million, respectively.
In 2000 we made six acquisitions and entered into one joint venture partnership
for a total investment of $40.9 million, which consisted of cash payments of
$38.5 million, the assumption of short-term liabilities of $1.1 million and the
assumption of long-term liabilities of $1.3 million.
In 1999, we made nine acquisitions and entered into one joint venture
partnership for a total investment of $27.3 million, which consisted of cash
payments of $20.8 million, issuance of $6.2 million of promissory notes and the
assumption of short-term liabilities of $0.3 million.
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Capital expenditures
Our capital expenditures exclusive of acquisitions and joint venture
partnerships for the six months ended June 30, 2001 and 2000 aggregated
$4.2 million and $5.4 million, respectively. Our capital expenditures aggregated
$14.8 million, $11.0 million and $5.0 million, for the years ended December 31,
2000, 1999 and 1998, respectively.
Our anticipated capital expenditures for the six months ending December 31, 2001
are anticipated to remain at approximately the same levels as for the six months
ended June 30, 2001.
Other assets
Our investment in other assets for the six months ended June 30, 2001 was
$3.5 million, compared to $2.2 million in the comparable 2000 period. Our
investment in other assets amounted to $8.4 million, $5.5 million and
$0.6 million for the years ended December 31, 2000, 1999 and 1998, respectively.
The increase in other assets for the year ended December 31, 2000 is primarily
due to a $4.5 million increase in working capital advances to the Memorial
Hermann Partnership as a result of the relocation of the partnership's
operations to a new laboratory facility and the change in the scope of its
operations. The increase in other assets for the years ended December 31, 1999
arises primarily as a result of deferred financing costs incurred in relation to
the issuance of the 1999 senior notes.
Financing activities
The net cash provided by financing activities for the six months ended June 30,
2001 and 2000 was $3.9 million and $10.9 million, respectively. The cash
provided by financing activities during the six months ended June 30, 2001
reflects an increase in bank indebtedness of $3.9 million and proceeds of
$0.3 million from the exercise of employee stock options. In addition, we made
long-term debt repayments totaling $0.3 million.
The net cash provided by (used in) financing activities was $38.8 million,
$46.1 million and ($0.9) million for the years ended December 31, 2000, 1999 and
1998 respectively.
The cash provided by financing activities during the year ended December 31,
2000 reflects net proceeds of $46.4 million received by us from our initial
public offering, a decrease in bank indebtedness of $5.8 million and long-term
debt proceeds of $4.5 million which were used to finance the West Texas
Pathology Laboratory acquisition. In addition, we made long-term debt repayments
totaling $6.3 million which included a $4.5 million repayment pertaining to the
debt used to finance the West Texas Pathology Laboratory acquisition.
The cash provided by financing activities during the year ended December 31,
1999 reflects the net proceeds of $69.2 million that we received from the
issuance of our $70.0 million senior notes, of which $15.3 million was used to
repay an interim loan and $6.9 million was used to pay down working capital
facilities. In addition, we repaid other long-term debt of $2.8 million during
the period.
As part of our 1999 financing activities, we issued $5.0 million and
$0.3 million of long-term debt related to our Medical Pathology Laboratory and
Central Wyoming Medical Laboratory acquisitions, respectively. Upon the
formation of the Tennessee Partnership, we entered into a capital lease
obligation of $0.9 million.
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Management's discussion and analysis of financial condition and results of
operations
- --------------------------------------------------------------------------------
Cash used in financing activities for the year ended December 31, 1998 consisted
of an increase in bank working capital indebtedness of $1.5 million offset by
repayments of long-term debt of $2.4 million.
Interest expense on outstanding long-term debt for the six months ended
June 30, 2001 was $10.6 million. Based on the long-term debt outstanding as of
June 30, 2001, our interest expense is expected to continue at substantially
this amount.
As of June 30, 2001, the total scheduled repayments of long-term debt for the
remainder of 2001 and in each of 2002 to 2006 are as follows:
<Table>
2001........................................................ $ 4.2 million
2002........................................................ $ 2.1 million
2003........................................................ $ 2.1 million
2004........................................................ $ 0.6 million
2005........................................................ $ 0.4 million
2006 and thereafter......................................... $198.1 million
</Table>
Our scheduled debt repayments and estimated interest obligations due for the
remainder of 2001 and in each of 2002 to 2006 are anticipated to be funded by
cash flows from operations and/or utilization of our credit facilities.
SEASONALITY
We experience lower testing volumes during the holiday and vacation seasons and,
to a lesser extent, inclement weather. As a result, because a significant
portion of our expenses are relatively fixed over the short term, our operating
income as a percentage of revenue tends to decrease during the third quarter due
to the summer vacation period and the fourth quarter due to the various holidays
in that quarter. See "Risk factors--Our quarterly operating results have varied
and we expect them to continue to vary" and "--Overview" above for additional
information.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We do 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
We have cross currency swap agreements which effectively convert a portion of
our U.S. dollar denominated borrowings into Canadian dollar obligations, to
match our Canadian dollar-denominated assets and cash flows. These swap
agreements limit our exposure to both favorable and unfavorable currency
fluctuations. As of June 30, 2001 a sensitivity analysis to changes in the U.S.
dollar on our main currency swap agreement indicates that if the U.S. dollar
weakened by 10% against the Canadian dollar, the fair value of this instrument
would decrease by Cdn$14.6 million. Conversely, if the U.S. dollar strengthened
by 10% against the Canadian dollar, the fair value of this instrument would
increase by Cdn$16.1 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, we
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Management's discussion and analysis of financial condition and results of
operations
- --------------------------------------------------------------------------------
have pledged shares of certain of our subsidiaries and joint venture partnership
interests to the counterparties to those agreements.
Interest rate risk
We have 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 and variable rate liabilities. The
variable rate liabilities have maturity terms of less than one year.
Based on our agreements outstanding at June 30, 2001, a 100 basis point increase
in interest rates would result in a decrease in the net aggregate market value
of these instruments of Cdn$6.3 million. Conversely, a 100 basis point decrease
in interest rates would result in a Cdn$6.3 million net increase in the net
aggregate market value of these instruments.
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Business
We are the third largest independent provider of clinical laboratory testing
services in North America as measured by revenues. Through our integrated
network of regional laboratory operations, we provide clinical laboratory
testing services in 21 states in the United States and two provinces in Canada.
We believe we offer a comprehensive menu of tests, comprised of more than 1,000
different tests. We provide clinical laboratory testing, which is performed on
body fluids such as blood and urine and on tissues and other specimens,
including human cells. Through Dynagene, our center for esoteric testing, we
also provide a growing number of more complex esoteric tests, including
molecular diagnostic services. Our customers include physicians, hospitals and
other healthcare providers who utilize clinical laboratory testing in
diagnosing, evaluating, monitoring and treating diseases and other medical
conditions. We provide clinical laboratory testing services either directly
through our wholly owned laboratories or through joint venture partnerships we
form with major local hospitals and academic medical centers.
Since entering the clinical laboratory testing market in the United States in
1993, we have grown to become a significant provider of clinical laboratory
testing services in a number of selected regions. Our U.S. revenues grew at a
compound annual rate of approximately 40% for the five-year period ended
June 30, 2001, as a result of strong internal growth combined with growth
generated by 20 acquisitions and the commencement of four joint venture
partnerships with hospitals. In the United States, we currently operate 22
central laboratories, 63 rapid response laboratories and 173 patient service
centers, which we own directly or through our joint venture partnerships. We are
positioned as a multi-regional provider with a major presence in four integrated
regions in the United States: the Southeast, which is comprised of Alabama,
Mississippi and Northern Florida; the Southwest, which is comprised of
Louisiana, Arkansas, Texas, Oklahoma and Missouri; the Northwest, which is
comprised of Oregon, Utah, Alaska, Wyoming, Colorado, Idaho, Montana and the
state of Washington; and the Midwest, which is comprised of Wisconsin and
Illinois. Additionally, we have operations in New York, Pennsylvania and
Tennessee.
In Canada, we operate in the provinces of Ontario and Alberta through two joint
venture partnerships. Our operations in these provinces include four central
laboratories, 18 rapid response laboratories and 143 patient service centers.
Through our joint venture partnership in Ontario, we have an estimated 31% share
of the Ontario independent clinical laboratory testing market. Through our joint
venture partnership in Alberta, we have an estimated 60% share of the Northern
Alberta market.
We processed approximately 7 million requisitions during the six months ended
June 30, 2001. For the six months ended June 30, 2001, we had net revenues of
$197.7 million and net earnings of $8.0 million.
THE CLINICAL LABORATORY TESTING INDUSTRY
Overview
Clinical laboratory testing is critical to the delivery of quality healthcare to
patients. Clinical laboratory tests are used generally by physicians to assist
in the detection, diagnosis, evaluation, monitoring and treatment of diseases
and other medical conditions through the measurement and analysis of chemical
and cellular components in blood, other body fluids and tissues. Clinical
laboratory tests are frequently ordered as part of physician office visits and
hospital admissions. According to the 1999 Washington G-2 Reports, a clinical
laboratory industry periodical, approximately 94% percent of all clinical
laboratory tests ordered are considered routine and can be performed by most
clinical laboratories. More specialized tests, commonly known as esoteric tests,
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generally require more sophisticated instruments and/or highly skilled
personnel, and are typically outsourced to independent clinical laboratories
that specialize in such tests.
We expect the demand for clinical laboratory testing services in both the United
States and Canada to increase in the future as a result of several factors,
including:
- - the general aging of the North American population;
- - advances in specialized equipment and cost efficiencies, which have made
clinical laboratory testing available to a broader market;
- - an expanded base of scientific knowledge, which has led to the development
of more sophisticated tests;
- - greater awareness by physicians and patients of the value of clinical
laboratory testing as a cost-effective means of disease detection and
treatment monitoring;
- - increased testing for high risk diseases, such as HIV/AIDS and hepatitis;
and
- - advances in genomics facilitating the development of new and more
specialized testing.
The impact of these factors is expected to be partially offset by declines in
volume as a result of increased controls over the utilization of laboratory
services by Medicare and other third-party payors.
United States
Based on the Lab Industry Strategic Outlook 2000 published by Washington G-2
reports, we believe that the total U.S. laboratory market in 1999 was
approximately $31.8 billion, which includes an estimated $2.0 billion derived
from esoteric testing.
The industry can be categorized into three broad types of laboratory providers:
- - hospital-based laboratories;
- - independent clinical laboratories; and
- - physician office laboratories.
Based on Lab Industry Strategic Outlook 2000, we believe that in 1999
approximately 63% of the clinical testing revenues in the United States was
derived by hospital-based laboratories, approximately 26% was derived by
independent clinical laboratories and approximately 11% was derived by
physicians in their offices.
The clinical laboratory testing business in the United States is highly
fragmented. Consolidation in the industry has occurred, and we believe
consolidation will continue due to the following factors:
- - pressure on pricing and test utilization from payors;
- - over-capacity in certain markets;
- - cost of compliance with increasingly stringent regulatory requirements;
- - cost burdens on smaller laboratories as they strive to obtain operating
efficiencies;
- - legislative initiatives, such as restrictions on physician referrals to
physician-owned laboratories; and
- - the growth of managed healthcare, which requires efficient, low cost testing
services.
Canada
We estimate the Canadian clinical laboratory testing market was approximately
$1.6 billion in 2000, with hospital laboratories performing approximately
two-thirds of total clinical laboratory testing and
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the balance performed by independent clinical laboratories. We operate in the
provinces of Ontario and Alberta, which account for approximately 48% of
Canada's clinical laboratory testing revenues.
The Canadian clinical laboratory testing market consists of two primary
segments:
- - public hospital-based laboratories; and
- - independent clinical laboratories.
The Canadian clinical laboratory testing industry operates in an environment
characterized by significant government regulation and reimbursement control, as
a substantial majority of clinical laboratory testing procedures are covered by
government healthcare plans. Fees paid to independent clinical laboratory
testing service providers in Canada are administered by the respective
provincial governments and are effectively controlled through a variety of
mechanisms, including fee caps similar to the ones described in "Risk factors--A
substantial portion of our Canadian revenues...."
In Ontario, through the Ontario Partnership, we provide clinical laboratory
testing services to physicians in an environment where reimbursement is largely
fixed on an annual basis. In addition, competition in Ontario is limited as
clinical laboratories must be licensed by the Ontario Ministry of Health and
Long Term Care.
Through the Alberta Partnership, we provide clinical laboratory testing services
to physicians, clinics and hospitals in Alberta pursuant to contracts with
regional health authorities. Competition is also limited, as the Alberta
Partnership is the only independent provider of clinical laboratory testing
services in Northern Alberta.
OUR STRATEGY
Our objective is to be a leading provider of clinical laboratory testing
services in selected regional markets by focusing on the following key strategic
elements:
Enhance our Market Position in Existing Regions
We intend to further develop our position in the regional markets in which we
currently operate in three ways.
- - INCREASED SALES EFFORTS--We believe we have established a strong and
identifiable brand in each region, where we offer state-of-the-art
diagnostic services, supported by cutting-edge information technology. This
allows us to promptly report results with minimum reliance on air transport.
With our local presence in the markets we service, we are able to provide
prompt support and information to physicians. We employ experienced sales
and marketing personnel who emphasize these attributes in marketing our
services. Without giving effect to any revenue growth attributable to
acquisitions and new joint venture partnerships and excluding revenues from
long-term hospital contracts, our revenues in the United States have grown
7.6% for the six months ended June 30, 2001, primarily through the addition
of new customers and increased testing volumes.
- - PURSUE FOLD-IN ACQUISITIONS--We expect to continue to make selective
acquisitions of smaller laboratories and to improve laboratory efficiency
and profitability by combining the acquired operations with our existing
laboratory operations. This enables us to expand within existing regions and
to strengthen our position in the local markets that we serve. During the
five years ended June 30, 2001, we made 16 fold-in acquisitions.
- - REALIZE OPERATING EFFICIENCIES--As we grow and establish our regional
operations, we seek to continue to realize operating efficiencies by
consolidating certain of our regional operations and by other cost
management initiatives. For example, we are currently in the process of
consolidating
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laboratory operations in our Southwest Region and have undertaken materials
management initiatives on a company-wide basis with a view to decreasing our
materials cost per requisition.
Expand into New Attractive Regional Markets
We target expansion opportunities in new regions where we believe that market
size, demographics, payor mix, competition and other factors will allow us to
become a significant and profitable regional provider of laboratory services. We
enter into selected new regional markets through either strategic acquisitions
or joint venture partnerships. We prefer to enter markets adjacent to our
existing regions as this allows us to leverage our existing infrastructure. Due
to the fragmented nature of the clinical laboratory testing industry, we believe
opportunities exist to selectively acquire additional clinical laboratories and
enter into joint venture partnerships on terms favorable to us.
Pursue the Hospital Market
The hospital market constitutes approximately 63% of the $31.8 billion U.S.
clinical laboratory business. We intend to continue to pursue this segment of
the market by establishing relationships with leading hospitals as follows:
- - FORM JOINT VENTURE PARTNERSHIPS WITH HOSPITALS--We believe that our joint
venture partnership model is a cost-effective means of expanding into new
markets. We gain access to an existing, fully equipped and staffed clinical
laboratory within our partner hospital for a small initial investment. By
marketing our services in the local community, we expand the volume of
testing performed in the hospital laboratory and leverage its fixed costs,
thereby maximizing profit on incremental testing volume.
We are able to compete effectively for community based testing business by
marketing clinical laboratory testing services to physicians, clinics and
other healthcare providers in the community, capitalizing on the hospital's
reputation and relationships with its network of affiliated physicians. We
believe the desire of hospitals to control costs and participate in the
revenue and profitability of community-based business will lead other
hospitals to consider our joint venture partnership model.
- - OBTAIN LONG-TERM EXCLUSIVE LABORATORY SERVICES CONTRACTS WITH HOSPITALS--An
integral component of our growth strategy is to secure, through our joint
venture partnerships and wholly-owned operations, long-term exclusive
contracts to provide all of a hospital's clinical laboratory testing
requirements. These contracts provide us with a stable base of revenues and
cash flows upon which we build our regional operations. For the six months
ended June 30, 2001, long-term hospital contracts accounted for
approximately 20% of our total revenues in the United States.
Grow Esoteric Testing Capability
We believe that esoteric testing is the fastest growing segment of the clinical
laboratory market. In November 2000, we launched Dynagene, our center for
genetic and esoteric testing and counseling. We will continue to expand our
esoteric testing capabilities to enhance our services to our existing clients,
to attract new clients and to internalize and reduce testing currently
out-sourced to other esoteric laboratories.
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LABORATORY TESTING OPERATIONS AND SERVICES
We operate 26 central laboratories, 81 rapid response laboratories, and 316
patient service centers in the United States and Canada. Central laboratories
are our major laboratories, which have a full complement of testing capability.
Rapid response laboratories are smaller laboratories which have the ability to
perform a limited number of routine tests that must be processed and reported to
a physician immediately. A patient service center is a facility in a medical
building or other appropriate location where specimens from patients are
collected.
Specimens are collected from physicians' offices, hospitals, clinics and our
patient service centers by our own courier system (or, in some cases,
independent couriers) and delivered to our central laboratories or rapid
response laboratories, as appropriate. We processed approximately 7 million
requisitions during the six months ended June 30, 2001. Patient specimens are
accompanied by a requisition or test request form. These forms, which are
completed by the physician and patient, indicate the tests to be performed and
provide all of the information necessary for billing purposes.
When the specimens arrive at one of our laboratories, the information from the
requisition form is entered into our laboratory system, the testing is completed
and results of the tests are produced. All routine testing can be completed
generally within 24 hours. The test results are available for distribution to
the physician or customer within this timeframe. Most of our testing equipment
is interfaced with our information systems. Test results can be provided to our
customers in any method selected by the customer, including hard copy,
electronic transmission to the physician or customer's office, printing on a
remote printer or through the Internet.
We currently offer more than 1,000 different clinical laboratory tests or
procedures. In the clinical laboratory testing industry, tests are generally
categorized as routine or esoteric. A routine test is generally a higher volume
test that is usually capable of being performed and reported within 24 hours and
is typically performed by automated testing equipment. Routine tests generally
provide information to physicians to assist them in determining the existence or
absence of diseases or abnormalities.
Esoteric tests are generally more complex tests that are performed less
frequently than routine tests and require more sophisticated technology and/or
more highly skilled personnel. Esoteric tests are generally ordered when a
physician requires additional information to confirm a diagnosis, establish a
prognosis or develop a plan of therapy or treatment. Esoteric tests often become
routine as volumes increase and new technology and/or instruments make the
testing cost-effective and less complex. Through Dynagene we have the capability
to perform and do perform many esoteric tests. We continually review the volumes
of esoteric tests referred out and new testing technologies with a view to
performing the tests in-house if it becomes cost-effective. We will continue to
refer low volume or extremely specialized esoteric tests to outside esoteric
clinical testing laboratories, as it is not cost-effective for us to perform the
testing in-house.
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ACQUISITIONS AND JOINT VENTURE PARTNERSHIPS
We have developed our networks of regional laboratories primarily through
acquisitions and joint venture partnerships. We pursue opportunities in markets
where we believe we can establish a significant regional presence, with a
reputation for trusted, quality service, and compete effectively with both
national and local laboratory service providers. We generally acquire the
laboratory assets (usually excluding receivables) and operations, and lease the
facilities.
United States
We have completed the following acquisitions and joint venture partnerships
since entering the U.S. market in October 1993:
<Table>
<Caption>
Date of Acquisition or Joint
Location Transaction Entity Venture Partnerships
- --------------------- ---------------- ---------------------------------- --------------------
Alabama
Muscle Shoals December 2000 Shoals Laboratory Acquisition
Birmingham/ March 2000 LabSouth Acquisition
Montgomery
Arkansas
El Dorado December 2000 Accu-Path Laboratory Acquisition
Illinois
Chicago June 2001 IMMC Laboratories Acquisition
Louisiana
Monroe July 1999 Bayou Laboratory Acquisition
Baton Rouge December 1997 Louisiana Reference Laboratory Acquisition(1)
Mississippi
Gulfport July 1999 SouthCoast Pathology Services Acquisition
Meridian June 1999 Medical Pathology Laboratory Acquisition
Jackson February 1999 Clinical Pathology Laboratory Acquisition
New York
Schenectady August 1996 Ellis Hospital Joint Venture
Partnership(1)(2)
Oklahoma
Oklahoma City March 2001 Medical Arts Laboratory Acquisition
Pennsylvania
Pittsburgh December 2000 Allegheny Hospital Joint Venture
Partnership(1)(2)
Tennessee
Knoxville August 1999 University Health Systems Joint Venture
Partnership(1)(2)
</Table>
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<Table>
<Caption>
Date of Acquisition or Joint
Location Transaction Entity Venture Partnerships
- --------------------- ---------------- ---------------------------------- --------------------
Texas
Beaumont June 2001 MEDSTAT Laboratories Acquisition
San Antonio May 2000 CHRISTUS Santa Rosa HealthCare Acquisition
Midland April 2000 West Texas Pathology Laboratory Acquisition
Houston December 1999 Laboratories for Genetic Services Acquisition
Texarkana July 1999 Doctors Diagnostic Laboratory Acquisition
Brownsville April 1999 Central Diagnostic Management Acquisition
San Antonio February 1999 Accufast Diagnostic Laboratory Acquisition
Houston March 1996 Kelsey-Seybold Clinic Acquisition
Houston September 1995 Memorial Hermann Hospital Joint Venture
Partnership(2)(3)
Washington
Bremerton December 2000 Olympic Laboratory Acquisition(1)
Seattle November 1997 Pacific Hospital Preservation & Acquisition
Development Authority
Seattle February 1995 Laboratory of Pathology Acquisition(1)
Mt. Vernon March 1994 Skagit Valley Laboratories Acquisition(1)
Wisconsin
Milwaukee August 1997 Froedtert Health Systems Joint Venture
Partnership(1)(2)
Wyoming
Casper April 1999 Central Wyoming Medical Laboratory Acquisition
Cheyenne October 1993 Clinical Laboratories Cheyenne Acquisition(1)
</Table>
- ---------
(1) long-term contract with hospital
(2) 50/50 joint venture partnership
(3) The contract with Memorial Hermann, which expired on September 30, 2000, was
not renewed as described below.
Acquisitions
We pursue strategic acquisition opportunities in new markets that allow us to:
- - acquire operations with full service capabilities and the capacity to
accommodate additional test volumes;
- - enter laboratory markets which are large enough to support a fully
functioning laboratory and do not have entrenched competition or a high
degree of managed care;
- - enter into long-term contracts to provide laboratory services to hospitals;
and
- - focus on markets adjacent to our existing regions in order to leverage our
existing infrastructure.
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We also pursue smaller fold-in acquisition opportunities in existing markets
that allow us to:
- - improve laboratory efficiency and profitability by combining the acquired
operations with our existing operations; and
- - strengthen our market penetration in that region.
We proactively identify acquisition targets as well as respond to proposals to
sell laboratory operations to us. It has generally taken six to 12 months
between initial contact with an acquisition candidate and the consummation of a
transaction. After a potential acquisition has been identified, we undertake a
due diligence review of the candidate's operations and the region within which
it is located. Our personnel conduct a formalized review of all aspects of the
candidate's operations, including an assessment of the local market and the
candidate's competition, payor billing mix, compliance, litigation and capital
requirements. During the course of our due diligence review, we prepare an
operating plan, identify opportunities for increased operating efficiencies and
assess overall productivity and management information systems. Following
consummation of an acquisition, in appropriate circumstances, we endeavor to
retain key personnel from the acquired entity to ensure its continued effective
operation. We typically obtain non-competition covenants from the sellers.
Joint venture partnerships
We have entered into five joint venture partnerships. Our joint venture
partnership model is based on the establishment of a new 50/50 joint venture
partnership with a hospital. The joint venture partnership purchases the
hospital's laboratory assets and any existing community-based business, and
enters into a long-term contract to be the hospital's exclusive provider of all
clinical laboratory testing services for the hospital's inpatients and
registered outpatients. The joint venture partnership also contracts with the
hospital's pathology group to provide medical oversight to the joint venture
partnership. We receive a management fee for managing the joint venture
partnership. The joint venture partnership then seeks to increase its revenues
and profitability by marketing laboratory services to physicians, clinics and
other healthcare providers in the community. Through the joint venture
partnership we gain access to an existing, fully equipped and staffed clinical
laboratory and to an established physician and payor network associated with the
hospital partner.
Our joint venture partnership business model allows us to enter a new region
with a smaller capital investment than an acquisition might otherwise require.
We compete for community-based testing business and generate a management fee
for managing the joint venture partnership. Our hospital partner benefits from
this arrangement by reducing and controlling the costs of laboratory testing for
inpatients and registered outpatients through its long-term contract with the
joint venture partnership and by sharing in the profits generated by the joint
venture partnership.
The Memorial Hermann Partnership, which commenced operations in 1995 and
reflected our joint venture partnership model and strategy, successfully grew
from a hospital based laboratory in 1995 to a laboratory with a significant
community outreach business. In 2000, this joint venture partnership completed a
transition which included the following elements:
- - as a result of the merger of the Hermann Hospital with Memorial System, the
Memorial Hermann Partnership's laboratory services agreement with Hermann
Hospital was not renewed upon its expiration in September 2000. The contract
accounted for approximately $9.0 million of our revenues on an annualized
basis.
- - the joint venture partnership relocated its laboratory operations from the
Hermann Hospital to a new 66,800 square foot facility in Houston, Texas.
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- - the geographic market of the joint venture partnership was expanded and
accordingly on October 1, 2000, we sold several wholly-owned smaller
laboratory operations in Texas to the joint venture partnership for the
value of our original investment in these operations.
On October 31, 2001 we acquired Memorial Hermann's interest in the joint venture
partnership. The consideration for the acquisition was a cash payment of
$2.0 million on closing, with payments of $0.5 million to be made on each of the
first and second anniversaries of the closing.
Canada
Acquisitions
Between 1988 and 1992, our Canadian laboratory operations grew rapidly as a
result of our acquisition of 12 laboratories. These 12 laboratories were
consolidated into our three laboratory operations in Ontario and our laboratory
in Alberta.
Joint venture partnerships
In 1995, we formed a joint venture partnership with our two major competitors in
Northern Alberta, creating a single clinical laboratory testing business with
one central laboratory. This joint venture partnership, in which we hold an
approximate 43% interest, was formed in response to the Alberta government's
reduction of healthcare funding and changes in healthcare delivery. Through the
consolidation of operations into one central laboratory and the implementation
of other changes, the joint venture partnership has been able to mitigate the
impact of the funding reductions.
In 1997, we formed a joint venture partnership in Ontario with two other
independent clinical laboratory testing providers. Our interest in the joint
venture partnership is approximately 73%. Our objective in entering into the
joint venture partnership was to generate cost savings, primarily from the
consolidation of the operations of one of the other providers into our Toronto
laboratory operations and consolidating the respective specimen collection
networks.
SALES AND MARKETING
Our sales and marketing efforts in the United States are coordinated through our
70 regional marketing representatives and 55 customer service representatives.
We focus on attracting and retaining high quality sales and marketing staff
through attractive incentive programs.
The stability of the Ontario and Alberta markets allows us to focus our sales,
marketing and customer service efforts in Canada on servicing our existing
physician base and pursuing non-government work, including substance abuse
testing and clinical trials.
We seek to educate our customers through our sales, marketing and customer
service efforts. Comprehensive service manuals are supplied to our customers,
and local customer service representatives who monitor customer satisfaction and
service, answer questions and help resolve problems.
CUSTOMERS AND PAYORS
United States
In many instances in the United States, testing services are billed to a payor
other than the customer who ordered the test, depending upon a patient's medical
benefits and insurance coverage. Our
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principal payors include hospitals, the individual physicians and clinics,
Medicare and Medicaid, patients and third party insurance companies. Our
customers include the following:
Hospitals
We provide laboratory testing services to hospitals on an exclusive basis
through nine long-term contracts. Six of these contracts are capitated contracts
where our fees are typically based on the number of adjusted hospital
admissions. These contracts provide for certain adjustments to mitigate the
risks of changes in test utilization and complexity. The other three contracts
are on a fee-for-service basis. Of the long-term contracts, our contract with
Swedish Medical generates the highest revenues, accounting for approximately 6%
of our U.S. (4% of our overall) revenues for the six months ended June 30, 2001.
In addition to the long-term hospital contracts, we also provide reference
testing services to hospitals on a fee-for-service basis.
Physicians and clinics
Physicians requiring testing for patients who are not covered by a managed care
contract generate a significant portion of our clinical laboratory testing
business. We bill the appropriate party who may be (i) the physician who
requested the testing, (ii) the patient or (iii) a third party who pays on
behalf of the patient, such as an insurance company, Medicare or Medicaid. We
bill the majority of our customers on a fee-for-service basis. Our fees to
physicians are based on a negotiated customer fee schedule. Fees billed to
patients are based on a separate patient fee schedule, which may be subject to
limits imposed by the physicians themselves or by third-party payors. Medicare
and Medicaid billings are based on fee schedules authorized by the government.
Employers and other institutions
We provide testing services to government agencies and to large employers
including testing for substance abuse, occupational exposures and comprehensive
wellness programs. We also perform a variety of reference tests for other
clinical laboratories, including hospital laboratories that do not have a full
range of testing capabilities.
Third party insurance companies
Certain of these organizations may contract with a limited number of clinical
laboratories for their members and instruct participating physicians to use
these laboratories for their testing.
The following table provides an estimate, on a percentage basis, of our clinical
laboratory testing revenues for our U.S. laboratory operations for the six
months ended June 30, 2001 applicable to each payor group, and the estimated
volume of requisitions associated with each group.
<Table>
<Caption>
Requisition
volume as a Revenues as a %
Payor % of total volume of total revenues
- ----------------------------------------------------------------------------------
Physicians and clinics..................... 35% -- 40% 25% -- 30%
Medicare and Medicaid...................... 20% -- 25% 15% -- 20%
Patients................................... 5% -- 10% 10% -- 15%
Third party insurance companies............ 10% -- 15% 15% -- 20%
Hospitals.................................. 20% -- 25% 20% -- 25%
</Table>
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Canada
In the provinces of Ontario and Alberta, tests are ordered by physicians, while
approximately 90% of testing performed by us is paid for by government agencies.
The remaining approximate 10% of testing is performed on a fee-for-service basis
for a variety of private payors for the purposes of: (i) substance abuse
testing, (ii) clinical trials and (iii) various non-government funded tests.
BILLING
Due to the significantly different make-up of payors in the United States and
Canada, the nature of the billing processes is also very different.
United States
Billing of laboratory services in the United States is complicated by the
following factors:
- - many different payors (including patients, insurance companies, Medicare,
Medicaid and physicians);
- - many different fee schedules for the different payors;
- - the reliance on the physician to provide complete and correct information
necessary for billing purposes;
- - uncertainty at times as to the party responsible for payment; and
- - complex compliance requirements such as medical necessity documentation.
Approximately 80% of our U.S. revenues for the six months ended June 30, 2001
were billed to various non-hospital payors and, like other laboratories in the
industry, we are impacted by these factors. The balance of our revenues were
billed on a monthly basis to hospitals pursuant to long term contracts. The
hospitals in turn bill their various payors for the laboratory services. Since
our payment from the hospitals is not dependent on the hospitals' billing and
collection process, we receive regular monthly payments from the hospitals and
experience virtually no bad debts from our hospital customers.
Most of our bad debt expense with respect to the non-hospital revenues is the
result of issues that are not credit related, primarily as a result of missing
or incorrect billing information on requisitions. We perform the requested tests
and report test results regardless of missing or incorrect billing information.
Subsequent to performing the test we attempt to obtain the required information.
This missing or incorrect information slows the billing process, creates
backlogs of unbilled requisitions and increases the aging of our accounts
receivable.
During 1999, we installed three new billing systems and upgraded three existing
billing systems. As a result, our billing workflow was interrupted. This, in
turn, resulted in an increase in our days sales outstanding, or DSOs.
We continue to focus on the billing area, with an objective of reducing DSOs.
Steps taken in this regard include:
- - strengthening our billing management and staff by recruiting experienced
billing personnel;
- - continued training of our staff and customers to provide complete and
accurate billing information on the ordering of a test;
- - installing and increasing the number of electronic billing interfaces with
our payors; and
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- - creating an incentive program for both management and staff.
These steps have resulted in a reduction of our DSOs in the United States from
93 days at December 31, 1999 to 75 days at December 31, 2000 and to 70 days at
June 30, 2001.
Canada
We bill government agencies in Ontario and Alberta for approximately 90% of our
Canadian revenues. DSOs tend to be in the 38-43 day range, and bad debts are
immaterial.
INFORMATION TECHNOLOGY
We believe that our information systems play an integral role in managing our
operations and controlling our costs. Our information systems perform a variety
of functions such as order entry and delivery of test results, accounts
receivable, billing, finance, human resources and other administrative
functions.
United States
The significant growth we have experienced in the United States through our
acquisitions and joint venture partnerships has necessitated continued expansion
and upgrading of our information technology infrastructure. To manage this
growth, to achieve greater consistency across operations and to recognize
economies of scale, we have embarked on a number of strategic initiatives over
the past three years.
The first initiative was to centralize our information technology management,
development and support in Dallas, Texas, which is under the control of our
Chief Information Officer. We expanded the number of specialized information
technology professionals, which decreased our reliance on external resources to
enhance and support our key systems.
We standardized our billing and accounts receivable functions. Currently all of
our operations utilize the Antrim billing application system. The system is
implemented at multiple sites which provide for back-up and disaster recovery
and is fully supported by our own in-house resources. We believe this
standardization has several benefits including:
- - enhanced billing accuracy and consistency;
- - efficient use of our resources to increase functionality and flexibility;
- - efficient electronic submissions of claims;
- - improved customer service; and
- - enhanced management oversight of regulatory and compliance requirements.
We integrated a series of stand-alone laboratory information systems into a
network of systems which enables us to communicate test orders and results among
our various laboratories in the United States and between our laboratories and
several of our customers and payors. Additionally, our laboratories are capable
of transferring testing between our various facilities in order to maximize
efficiency.
We developed and installed in all of our regions a web-based, secure, diagnostic
reporting capability that allows authorized clients to view their patient
results "any time" and "anywhere" and also provides them with the ability to
exchange the information instantly and electronically with other physicians for
consultation.
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Currently we are:
- - developing Web-based ordering and enhancing result delivery capabilities;
- - deploying centralized and standardized electronic data interchange between
our operations and various customers and payors, to enable us to transfer
laboratory test data as well as financial data from their respective
information systems to our own;
- - rolling out centralized electronic claims processing with our clearing house
partner; and
- - implementing a highly specialized esoteric laboratory information system to
integrate Dynagene into our existing corporate network.
We expect to continue to implement advanced information technologies and extend
our local and wide area networks and integrate these systems into our existing
corporate network. This enables us to respond to our customers' needs more
rapidly and efficiently. Finally, we are developing systems solutions to rapidly
and effectively integrate new operations within our network.
Canada
Many of the laboratory information, accounting and other support system
requirements in the Canadian clinical laboratory testing industry are similar to
those in the United States. However, billing system requirements in Canada are
less complex than those in the United States because government agencies are
responsible for approximately 90% of our Canadian revenues.
Our management information systems in Ontario operate on a common platform and
continue to meet the laboratory information, test result reporting and billing
requirements in the Ontario laboratory industry environment.
In Alberta, we utilize a laboratory information system which is a subsystem of
an overall healthcare information system operated by the Capital Health
Authority and made available to us under a long-term laboratory service
agreement with them.
COMPLIANCE PROGRAM
In 1997, we adopted and implemented a comprehensive, company-wide corporate
compliance program in the United States. Its objective was to educate and train
our employees to ensure the observance of all applicable laws, regulations and
general corporate policies. Our program was structured following the guidance of
the Office of the Inspector General of the U.S. Department of Health and Human
Services and includes a full-time compliance officer, an ethics and business
code of conduct, employee education and training programs, and an internal
system for auditing and monitoring programs. We believe that we are in
compliance in all material respects with all statutes, regulations and other
requirements applicable to our clinical laboratory testing operations. The
clinical laboratory testing industry, however, is subject to extensive and
continuously evolving regulation, and many of these statutes and regulations
have not been interpreted by the courts. Consequently, we may not be in full
compliance with all of these requirements. Any failure by us to comply with
these requirements could have a material adverse effect on our business. See
"Regulation."
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QUALITY ASSURANCE
We consider the quality of our testing services to be of critical importance,
and have comprehensive quality assurance programs in all of our laboratories and
specimen collection centers.
United States
In addition to external inspections and proficiency programs mandated by the
Centers for Medicare and Medicaid Services (CMS), formerly Health Care Financing
Administration (HCFA), under the Clinical Laboratory Improvement Amendments,
each testing laboratory has additional systems and procedures in place to
measure and monitor quality assurance.
Our quality control program is designed to assure the day-to-day validity of our
laboratory results. Known control material is run with each group of patient
samples, and the control values must fall within our acceptable range for the
release of patient samples included in this testing group. Whenever possible, at
least two levels of controls are run with each test, covering both the normal
and abnormal ranges for the test. These controls also serve as internal markers
to monitor our day-to-day testing reproducibility.
Our major U.S. laboratories are accredited by the College of American
Pathologists for clinical and anatomic pathology services and two facilities are
certified by the Substance Abuse and Mental Health Services Administration for
performing forensic drug testing. Accreditation is achieved by passing internal
or external inspections that assess all aspects of laboratory testing.
Our U.S. laboratories also participate in one or more federal, state or
independent proficiency-testing programs, such as the program administered by
the College of American Pathologists. With these programs, we analyze "blind"
samples, report back to the agency and are graded against strict federal
standards during which our results are evaluated against the results of other
laboratories in these nationwide peer group comparisons. We continuously review
our proficiency test performance results.
Canada
All our major Canadian laboratories are inspected and accredited by the College
of American Pathologists for clinical and anatomical pathology services. In
addition, our laboratories in the Province of Ontario are licensed, inspected
and accredited in accordance with provincial legislation by a branch of the
Ministry of Health and Long Term Care. A requirement of this legislation is
participation in the Laboratory Proficiency Testing Program administered by the
Ontario Medical Association. In Alberta, the College of Physicians and Surgeons
administers both the laboratory licensing function and laboratory accreditation
functions. It also administers an inspection program which is similar to that of
the College of American Pathologists.
Our drug testing laboratories in Ontario and Alberta are also accredited by the
Substance Abuse and Mental Health Services Administration for performing
forensic drug testing. Only one other such accredited laboratory exists in
Canada.
COMPETITION
We believe that, in selecting a clinical laboratory, healthcare providers in the
United States and Canada often consider a number of factors, including the
following:
- - reputation in the medical community;
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- - service capability and quality;
- - accuracy, timeliness and consistency in reporting test results;
- - number and type of tests performed by the laboratory;
- - number, convenience and geographic coverage of patient service centers; and
- - pricing.
We believe we compete favorably in each of these areas. In addition, we believe
we are well positioned in each of our regional markets due to the presence of
our laboratory operations in each market, joint venture partnership model and
our exclusive, long-term hospital contracts which enhance our market penetration
and overall regional presence in these markets.
United States
The clinical laboratory testing business in the United States is highly
competitive and fragmented and has undergone significant consolidation. We
compete on a regional and local basis with several independent clinical
laboratories as well as with laboratories owned by physicians and hospitals.
According to the 2001 Washington G-2 Reports, there are approximately 4,900
independent clinical laboratories in the United States, which generally fall
into two categories. The first category is comprised of smaller, local
laboratories that generally offer fewer tests and have limited financial
resources. The second category, which includes our laboratories, is comprised of
larger regional or national laboratories that provide a broader range of tests
and services. There are currently two large national independent clinical
laboratories: Quest Diagnostics Incorporated, which during 1999 purchased
SmithKline Beecham's clinical laboratory testing business, and Laboratory
Corporation of America Holdings.
Some of our competitors have substantially greater financial and other resources
and larger, more established marketing, sales and laboratory organizations than
we do. We may not be able to continue to compete successfully with these larger
competitors in the regional markets we serve. Furthermore, we may not be able to
continue to compete effectively with these organizations for acquisitions. If we
are unable to continue to make acquisitions, our ability to continue to grow
would be significantly reduced. See "Risk factors--The U.S. clinical laboratory
testing market is intensely competitive . . . ."
Canada
The Canadian laboratory services industry operates in an environment where
competition is limited due to the nature of the governmental regulation and
reimbursement systems. In the markets we serve, the other major providers of
laboratory services are independent clinical laboratories, with MDS Inc. and
Canadian Medical Laboratories Limited being the most significant ones, and
hospital based laboratories. See "Management's discussion and analysis of
financial condition and results of operations--Our Revenues."
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INSURANCE
We maintain liability insurance (subject to maximum limits) for claims, which
may be substantial, that could result from providing or failing to provide
clinical laboratory testing services, including inaccurate testing results.
Although coverage may not be adequate to cover all future exposure, we believe
that the present levels of coverage are adequate to cover currently estimated
exposures. We believe that we will be able to obtain adequate insurance coverage
in the future, but we may not be able to obtain such coverage, do so at an
acceptable cost or avoid incurring significant liabilities in excess of policy
limits.
EMPLOYEES
As of June 30, 2001, our U.S. clinical laboratory testing operations employed
approximately 4,100 full-time equivalent personnel. Our Canadian laboratory
operations employed approximately 2,200 full-time equivalent personnel.
Approximately, 900 of our personnel are currently represented by collective
bargaining units. We consider our relations with our employees to be good.
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PROPERTIES
Our principal U.S. properties, which are comprised of our corporate offices and
central laboratory facilities, are the following:
<Table>
<Caption>
Approximate area Nature of
Location (in square feet) Occupancy Expiration of Lease
- --------------------------------------------------------------------------------------------------
Houston, Texas Joint Venture
(Memorial Hermann Partnership)......... 66,800 Partnership(1) September 30, 2010
Milwaukee, Wisconsin Joint Venture
(United Partnership)................... 59,219 Partnership(1) August 1, 2030
Montgomery, Alabama (LabSouth)........... 54,150 Owned
Knoxville, Tennessee (Tennessee
Partnership)........................... 48,628 Joint Venture July 31, 2009
Partnership(1)
Dallas, Texas (Dynacare Laboratories
Inc.).................................. 39,621 Leased(2) October 31, 2003
Oklahoma City, Oklahoma (Medical Arts
Laboratory)............................ 38,147 Leased May 14, 2007
Pittsburgh, Pennsylvania (Allegheny Joint Venture
Partnership)........................... 34,177 Partnership(1) December 31, 2010
Seattle, Washington (Laboratory of
Pathology)............................. 33,215 Leased January 1, 2004
Meridian, Mississippi (Medical Pathology
Laboratory)............................ 29,232 Leased May 31, 2002
Birmingham, Alabama (LabSouth)........... 29,140 Leased October 31, 2010
Baton Rouge, Louisiana (Louisiana
Reference Laboratory).................. 27,500 Leased November 30, 2002
Schenectady, New York (Ellis
Partnership)........................... 16,324 Joint Venture September 2, 2004
Partnership(1)
Cheyenne, Wyoming (Clinical Laboratories
Cheyenne).............................. 10,618 Leased September 15, 2006
Midland, Texas (West Texas Pathology
Laboratory)............................ 10,309 Leased October 31, 2005
Houston, Texas
(Laboratories for Genetic Services).... 10,009 Leased May 31, 2003
Mt. Vernon, Washington (Skagit Valley
Laboratory)............................ 9,430 Leased February 1, 2007
Jackson, Mississippi (Clinical Pathology
Laboratory)............................ 8,744 Leased January 31, 2004
Monroe, Louisiana (Bayou Laboratory)..... 7,608 Leased July 31, 2004
San Antonio, Texas (Accufast Diagnostic
Laboratory)............................ 5,084 Leased August 31, 2002
El Dorado, Arkansas (Accu-Path
Laboratory)............................ 4,000 Leased November 30, 2001
Texarkana, Texas (Doctors Diagnostic
Laboratory)............................ 3,850 Leased April 30, 2002
Bremerton, Washington (Olympic
Laboratory)............................ 1,659 Leased June 30, 2015
Port Orchard, Washington (Olympic
Laboratory)............................ 623 Leased September 30, 2003
</Table>
- ---------
(1) We are a partner in a 50/50 joint venture partnership which operates the
clinical laboratory and leases the property.
(2) Represents our principal corporate offices in Dallas, Texas.
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Our principal Canadian properties include:
<Table>
<Caption>
Approximate area
Location (in square feet) Nature of Occupancy Expiration of Lease
- ---------------------------------------------------------------------------------------------------
Toronto, Ontario.................... 69,000 Owned
Edmonton, Alberta................... 54,138 Leased March 31, 2007(1)
London, Ontario..................... 39,544(2) Owned
Toronto, Ontario.................... 14,780 Leased October 31, 2002
Ottawa, Ontario..................... 12,353 Leased February 2002
</Table>
- ---------
(1) Through the Alberta Partnership in which we have an approximate 43%
interest.
(2) This property totals 43,605 square feet, 39,544 of which are occupied by the
laboratory and the remainder of which is leased to other parties.
All of our central laboratory facilities have been built for the sole purpose of
providing clinical laboratory testing services. We believe that these facilities
have sufficient capacity for any foreseeable increase in volumes. We believe
that if we were to lose any of our leaseholds, we could find alternate space at
competitive market rates and relocate the affected operations without material
disruption to our operations.
REGULATION
United States
The U.S. clinical laboratory testing industry is subject to significant
governmental regulation at the federal, state and local levels. Virtually all
clinical laboratories, including those we operate, are required to be certified
or licensed under the Clinical Laboratory Improvement Amendments, the Medicare
and Medicaid programs, and various state and local laws, and may be subject to
periodic inspections by regulatory agencies. We are also subject to licensing
and regulation under federal, state and local laws relating to the handling and
disposal of medical specimens and infectious and hazardous materials as well as
the safety and health of laboratory employees. Potential sanctions for failure
to comply with these regulations include the denial of the right to conduct
business, significant fines and criminal penalties. As part of an effort to
contain the growth of federal costs for clinical laboratory testing services,
several federal agencies including the Federal Bureau of Investigation, the
Office of the Inspector General of Health and Human Services, the Center for
Medicare and Medicaid Services (CMS) and the Department of Justice have devoted
increased governmental resources to investigations aimed at the appropriateness
of testing as well as fraudulent and abusive conduct by service providers.
Criminal conviction or successful prosecution of a civil fraud or false claims
action can result in substantial fines and penalties as well as exclusion from
the Medicare and Medicaid programs.
Over the past several years, CMS has taken several measures to reduce
utilization of clinical laboratory testing and to ensure that, except for
certain limited exceptions, Medicare does not pay for tests that are ordered for
screening purposes only. Since 1995, many Medicare carriers have begun to
require clinical laboratories to submit documentation supporting the medical
necessity for many commonly ordered tests, as judged by ordering physicians.
Further federal legislation has reduced ceilings on Medicare reimbursement to
clinical laboratories to 74% of the 1984 national median effective January 1,
1998 (84% on January 1, 1994; 80% on
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January 1, 1995; and 76% on January 1, 1996) and consumer price index
adjustments have been eliminated until at least 2002.
CMS previously had permitted payment for all tests contained in a chemistry
panel when at least one of the tests in the panel was "medically necessary."
However, now Medicare payment will not exceed the amount that would be payable
if only the tests that are "medically necessary" had been ordered. Therefore,
patients may be billed for clinical laboratory tests that are not deemed
"medically necessary" (E.G., limited coverage tests for which an approved
diagnosis code is not provided by the ordering physician) if the patient signs
an advance beneficiary notice. However, since the majority of our requisitions
are filled out by physician customers, we cannot mandate the proper use of the
advance beneficiary notice.
Certifications or licenses are required by various state and local laws. An
important accreditation for any U.S. clinical laboratory is by the College of
American Pathologists, or CAP. All of our major laboratories in the United
States are accredited by CAP and have Clinical Laboratory Improvement Act
certification except our laboratory in New York State, which is licensed by the
state. While neither CAP nor Clinical Laboratory Improvement Act accreditation
is required in Canada, our Ontario (Toronto, Ottawa and London) and Alberta
(Edmonton) laboratories are both CAP and Clinical Laboratory Improvement Act
accredited.
Specific federal legislation has been enacted to address fraud and abuse in the
healthcare industry. Anti-kickback statutes prohibit any offer, payment,
solicitation or receipt of any form of remuneration to induce, or in return for,
the referral of certain federal or state health program patients or patient care
opportunities, or in return for the purchase, lease or order of items or
services that are covered by certain federal or state health programs.
Violations of the statute can result in the imposition of substantial civil and
criminal penalties. In addition, certain federal laws prohibit a physician from
referring a patient to an entity with which the physician, or an immediate
family member of the physician, has a financial relationship for the provision
of eleven designated health services, including clinical laboratory testing
services (the "Stark Law"). Although CMS issued regulations in 1995 regarding
certain aspects of the Stark Law, on January 4, 2001, CMS issued additional
final regulations on the Stark Law, which were subject to a comment period.
These regulations are the first phase of a two-phase process with remaining
regulations to be issued some time in the future.
Many states have enacted anti-kickback, anti-rebate, anti-fee splitting and
other laws, which also govern our relationships with customers. For example, our
laboratory in New York State is subject to certain provisions that are
significantly more stringent than federal law on the same matters.
Federal and state governments are considering additional healthcare legislation
and regulation that could result in decreased revenues to clinical laboratories.
Over the past few years, CMS has considered whether to seek approval for a
demonstration project to determine whether competitive bidding can be used to
provide quality laboratory and other medical services at prices below current
Medicare reimbursement rates.
We are subject to licensing and regulation under federal, state and local laws
and regulations relating to the protection of the environment and human health
and safety, including laws and regulations relating to the handling,
transportation and disposal of medical specimens, infectious and hazardous waste
and radioactive materials as well as to the safety and health of laboratory
employees. In addition, the Federal Occupational Safety and Health
Administration (OSHA) has established extensive requirements relating to
workplace safety for healthcare employers, including clinical laboratories,
whose workers may be exposed to blood-borne pathogens such as HIV and the
hepatitis B virus. These regulations, among other things, require work practice
controls, protective clothing and equipment, training, medical follow-up,
vaccinations and other measures designed to minimize
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exposure to, and transmission of, blood-borne pathogens. As a result of the
Needlestick Safety and Prevention Act, which was enacted in 2000, in
January 2001, OSHA promulgated final regulations that revise the blood-borne
pathogens standard. In addition, a number of states in which we conduct business
have also recently adopted similar statutes and regulations related to injuries
that employees may sustain from contaminated needles and other sharps. Although
we are not aware of any current material non-compliance with such federal, state
and local laws and regulations, failure to comply could subject us to denial of
the right to conduct business, fines, criminal penalties and/or other
enforcement actions.
The transportation of infectious substances such as clinical laboratory
specimens is subject to regulation by the Department of Transportation, the
Public Health Service, the U.S. Postal Service and the International Civil
Aviation Organization. All our laboratories are subject to applicable federal
and state laws and regulations relating to the biohazard disposal of laboratory
specimens, and we utilize outside vendors for the disposal of such specimens.
Drug testing for public sector employees is regulated by the Substance Abuse and
Mental Health Services Administration (SAMHSA), which has established detailed
performance and quality standards that laboratories must meet in order to be
approved to perform drug testing on employees of Federal government contractors
and certain other entities. To the extent that our laboratories perform this
testing, they must be certified as meeting SAMHSA standards. The Drug
Enforcement Administration regulates access to controlled substances in drug
abuse testing.
The Health Insurance Portability and Accountability Act of 1996, or HIPAA,
governs the portability, privacy and security of electronically transmitted
patient data. HIPAA also mandates, among other things the adoption of standards
for the exchange of electronic health information in an effort to encourage
overall administrative simplification and enhance the effectiveness and
efficiency of the healthcare industry. Among the standards that the Department
of Health and Human Services has adopted (or will adopt in the future) pursuant
to HIPAA are standards for the following: electronic transactions and code sets;
unique identifiers for providers, employers, health plans and individuals;
security and electronic signatures; privacy and enforcement.
The Department of Health and Human Services has released two rules to date
mandating the use of new standards with respect to certain healthcare
transactions and health information. The first rule requires the use of uniform
standards for common healthcare transactions, including healthcare claims
information, plan eligibility, referral certification and authorization, claims
status, plan enrollment and disenrollment, payment and remittance advice, plan
premium payments and coordination of benefits and it establishes standards for
the use of electronic signatures. Secondly, the Department of Health and Human
Services has released new standards relating to the privacy of individually
identifiable health information. These standards not only require our compliance
with rules governing the use and disclosure of protected health information, but
they also require us to impose those rules, by contract, on any business
associate to whom such information is disclosed. Rules governing the security of
health information have been proposed but have not been issued in final form.
The Department of Health and Human Services finalized the new transaction
standards on August 17, 2000, and we will be required to comply with them by
October 6, 2002. The privacy standards were issued on December 28, 2000, and
became effective in mid-April 2001, with a compliance date of April 14, 2003.
With respect to the security regulations, once they are issued in final form, we
expect affected parties will have approximately two years to be fully compliant.
Sanctions for failure to comply with the HIPAA health information practices
provisions include criminal penalties and civil sanctions.
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We expect to conduct our business in compliance with all applicable federal,
state and local laws and regulations governing our computer-based operations.
However, the impact of regulatory developments affecting the use of
electronically transmitted data is complex and difficult to predict, and our
business could be adversely affected by existing or new regulatory requirements
or interpretations.
Although we believe that our service offerings address healthcare privacy
concerns by providing personalized healthcare information in a secure, private
manner, we may not be able to achieve and maintain compliance with all
applicable rules and regulations. Failure to comply could have a material
adverse impact on our business.
Canada
The clinical laboratory testing industry is also subject to significant
governmental regulation primarily at the provincial level in Canada. In general,
laboratory licenses authorize clinical diagnostic laboratories to perform
specific tests. The licensing and regulatory requirements relate to, among other
matters, the conduct of testing and reporting of results, the handling and
disposal of medical specimens and infectious and hazardous waste and other
materials, the safety and health of laboratory employees and the proficiency of
staff. The clinical laboratory testing industry in Canada is subject to periodic
inspections by regulatory agencies. The sanction for failure to comply with
licensing requirements and other regulations, including environmental and
employee occupational health and safety regulations, may include the revocation
of licenses, the denial of the right to conduct business, significant fines and
quasi criminal penalties. The revocation or loss of any of our laboratory
licenses in Canada would have a material adverse effect on us.
Environmental matters including use, storage, handling, discharge,
transportation and disposal of hazardous materials (including biomedical and
pathological waste, infectious products, chemicals and radioactive materials)
are strictly regulated. The provinces have the key role in regulating and
issuing licenses and registrations for operations within the province (such as
air and water effluent discharges and waste management) and federal regulators
also have jurisdiction, particularly in regard to the transportation of
dangerous goods (chemicals or infectious materials, for example), certain
defined toxic substances and radioactive substances. Penalties for infractions
of environmental regulations have been steadily increasing in Canada in recent
years, and emission, discharge and licensing standards have become increasingly
stringent.
Ontario
In Ontario, clinical laboratories must be licensed by the Ontario Ministry of
Health and Long Term Care. There are presently two forms of licenses under which
we operate: laboratory licenses and specimen collection center licenses.
Laboratory licenses authorize clinical laboratories to perform specific tests,
which vary from license to license. The licenses are issued for one-year terms
and are routinely renewed. Certain laboratory tests can only be carried out in
hospital laboratories. Specimen collection licenses authorize the collection of
specimens, which are then sent to a clinical diagnostic laboratory for analysis.
Specimen collection centers are typically located in medical buildings, clinics
and other similar facilities. Physicians are entitled to collect specimens
without being specifically licensed, but will typically have the specimen tested
by a licensed laboratory.
Our Ontario laboratories are subject to provincial regulation in respect of
occupational, health and safety. Laboratory workers are subject to the Health
Care and Residential Facilities Regulation made under the Occupational Health
and Safety Act (Ontario), which provides for extensive requirements relating to
workplace safety for healthcare employers, including clinical laboratories,
whose workers may be exposed to blood-borne pathogens such as HIV and the
hepatitis B virus. This regulation, among other things, requires work practice
controls, protective clothing and equipment, training,
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voluntary medical surveillance and other measures designed to minimize exposure
to, and transmission of, blood-borne pathogens.
Our laboratory operations in Ontario are subject to an agreement with the
Ontario government pursuant to which each laboratory service provider has been
allocated a fixed share (referred to as a corporate funding cap) of an overall
industry funding cap for government reimbursed services. For the six months
ended June 30, 2001, approximately 73% of our Canadian revenues (20% of our
total revenues) were for services that are subject to the corporate funding cap.
Under the agreement, we do not receive government payments in excess of our
annual corporate funding cap, even when we are required to provide testing
services that would otherwise have a value in excess of the cap. Having to
provide testing services in excess of our annual corporate funding cap could
have a material adverse impact on our revenues, profitability and financial
condition. Should a laboratory service provider perform testing valued below its
corporate funding cap in an 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 service providers as an increase to their share
of the corporate funding cap. Although we have continued to provide testing
services in excess of our annual corporate funding cap, we cannot assure you
that we will continue to process adequate test volumes to maintain our existing
corporate funding cap in the future.
The Ontario government continues to examine the future of the funding method and
the laboratory delivery system in the province, with a longer term view to
improving the efficiency and cost effectiveness of laboratory services provided
by both the independent and hospital sectors. We, independently and also through
the Ontario Association of Medical Laboratories, are an active participant in
addressing these areas and providing input to the Ministry of Health and Long
Term Care.
The government also has initiated a process in consultation with the Ontario
Medical Association, Ontario Hospital Association and the Ontario Association of
Medical Laboratories with a view to improve the quality of and access to
affordable laboratory service through better coordination of laboratory services
provided in each region of Ontario. Currently the process has commenced in three
regions.
Alberta
In Alberta, clinical laboratory services form a part of the practice of medicine
and, as such, are regulated by the College of Physicians and Surgeons of
Alberta.
Effective July 1995, the Alberta government implemented a reduction in funding
for healthcare services and changed the method of delivery of healthcare
services by establishing regional health authorities to receive bloc provincial
grants and to be responsible for all healthcare requirements within their
regions. In response to these changes, we formed a partnership with our two
major competitors in Northern Alberta to create a single clinical laboratory
testing business with one central clinical laboratory. The Alberta Partnership
serves the private sector's traditional physician base and certain of the
hospitals, which have traditionally operated their own in-hospital clinical
laboratories.
We hold an approximate 43% interest in the Alberta Partnership, which has
entered into a long-term agreement with the Capital Health Authority in Alberta
(encompassing Edmonton) to provide services to the region. In addition, the
Alberta Partnership has entered into agreements with several other regional
health authorities in northern Alberta. In the aggregate, these agreements
provide the Alberta Partnership with an estimated market share of approximately
60% of the clinical laboratory testing market in northern Alberta. The Alberta
Partnership on an annual basis has negotiated reimbursement increases with each
of the regional health authorities to reflect cost increases, additional
services and increased volumes.
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64
<Page>
Business
- --------------------------------------------------------------------------------
The Alberta Partnership is subject to provincial legislation and regulation of
general application in respect of the environment, privacy of information,
healthcare and occupational health and safety. In addition, the Alberta
Partnership and its laboratory personnel are subject to requirements under the
Occupational Health and Safety Act (Alberta) relating to workplace safety.
DETAILS OF INCORPORATION
We were incorporated under the Business Corporations Act (Ontario) in
September 1981. In 1992, we acquired all of the shares of our major operating
subsidiary, The Dynacare Health Group Inc., and we changed our name to
Dynacare Inc. In May 1997, our shareholders approved a plan of arrangement
whereby we were taken private. In November 2000, we completed an initial public
offering of 5,003,000 common shares in the United States and began trading on
the Nasdaq National Market and the Toronto Stock Exchange.
LEGAL PROCEEDINGS
We are involved in various legal proceedings arising in the ordinary course of
business. Although it is not feasible to predict the outcome of such proceedings
or any claims made against us, we do not anticipate that the ultimate resolution
of such proceedings or claims will have a materially adverse effect on our
financial position or results of operations as they primarily relate to
professional liability for which we believe we have adequate insurance coverage.
We maintain professional liability insurance for our professional liability
exposures. See "--Insurance."
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65
<Page>
- --------------------------------------------------------------------------------
Management
EXECUTIVE OFFICERS AND DIRECTORS
Set forth below is the name, age, position and a brief account of the business
experience of each of our executive officers and directors.
<Table>
<Caption>
Name Age Position
- -------------------------------------------------------------------------------------------------
Harvey A. Shapiro(1)...................... 56 Chairman, President, Chief Executive
Officer and Director
Osama I. Sherif(1)........................ 53 Executive Vice President and Chief
Operating Officer
Zbig S. Biskup, C.A.(2)................... 49 Executive Vice President, Chief Financial
Officer and Secretary
Albert J. Latner(1)....................... 74 Chairman Emeritus and Director
Donald J. Edwards(3)...................... 35 Director
Bruce V. Rauner(4)........................ 45 Director
Dino Chiesa(1)............................ 53 Director
William T. Brock(1)....................... 64 Director
Thomas Edward Long(1)..................... 43 Director
Paul Bellamy(5)........................... 53 Director
Robert J. Lipsig(6)....................... 59 Director
</Table>
- ---------
(1) Resident of Toronto, Ontario
(2) Resident of Vaughan, Ontario
(3) Resident of Chicago, Illinois
(4) Resident of Winnetka, Illinois
(5) Resident of Old Greenwich, Connecticut
(6) Resident of Boca Raton, Florida
HARVEY A. SHAPIRO has been our Chairman since September 2000 and our President
and Chief Executive Officer since May 1997. Mr. Shapiro has been a director
since September 1987. From April 1992 to May 1997, Mr. Shapiro was our President
and Chief Operating Officer and from 1987 to April 1992 was our Executive Vice
President. Mr. Shapiro originally joined us as Executive Vice President in 1987.
Before that, Mr. Shapiro was a partner with the law firm of Goodman and Carr
LLP, Toronto.
OSAMA I. SHERIF has been Executive Vice President with responsibility for
developing new joint venture partnerships with hospitals and other business
opportunities since 1997. Since May 2000, Mr. Sherif also served as the Chief
Operating Officer of our U.S. operations. Mr. Sherif originally joined us as
Senior Vice-President in June 1990. Previously, Mr. Sherif, as a partner with
Ernst & Young, Management Consultants, provided management services to the
healthcare industry.
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66
<Page>
Management
- --------------------------------------------------------------------------------
ZBIG S. BISKUP, C.A. has been an Executive Vice President and Secretary since
November 2000 and the Chief Financial Officer since February 1993. Prior to
February 1993, Mr. Biskup was a partner with Ernst & Young, Chartered
Accountants.
ALBERT J. LATNER has been a director since September 1987. Mr. Latner is a
developer, owner and operator of real estate projects. Mr. Latner has been our
Chairman Emeritus since November 2000, was Chairman of the Board since our
formation in 1987 until September 2000 and was Chief Executive Officer from 1987
to May 1997.
DONALD J. EDWARDS has been a director since May 1997. Mr. Edwards is a Principal
at GTCR Golder Rauner, LLC, a private equity investment company in Chicago,
Illinois, formed in 1998 as a successor entity to Golder, Thoma, Cressey,
Rauner, Inc., the general partner of the general partner of Golder, Thoma,
Cressey, Rauner Fund V, LP, which he joined in 1994.
BRUCE V. RAUNER has been a director since May 1997. Mr. Rauner is a Principal at
GTCR Golder Rauner, LLC, a private equity investment company in Chicago,
Illinois, formed in 1998 as a successor entity to Golder, Thoma, Cressey,
Rauner, Inc., the general partner of the general partner of Golder, Thoma,
Cressey, Rauner Fund V, LP, which he joined in 1980.
DINO CHIESA has been a director since November 2000. Mr. Chiesa is the President
and Chief Executive Officer of Residential Equities Real Estate Investment
Trust, a Canadian Real Estate Investment Trust, a position he has held since
April 1999. Prior to his position at Residential Real Estate Investment Trust,
Mr. Chiesa was Assistant Deputy Minister at the Ontario Ministry of Municipal
Affairs and Housing and Chief Executive Officer of the Ontario Housing
Corporation and the Ontario Mortgage Corporation from December 1995 to
March 1999.
WILLIAM T. BROCK has been a director since November 2000. Mr. Brock began his
career with the Toronto-Dominion Bank, Canada in 1963 where he served in a
variety of positions including Executive Vice President, Credit Division, Vice
Chairman, Credit Division, Vice Chairman, Risk Management and finally Deputy
Chairman from 1997 until his retirement in January 2000.
THOMAS EDWARD LONG has been a director since November 2000. Mr. Long is partner
in the Toronto office of the Monitor Group, a global strategy consulting firm
based in Cambridge, Massachusetts. Prior to joining the Monitor Group, Mr. Long
was a partner with Egon Zehnder International Inc., a leading international
executive search firm. Mr. Long is also a lawyer having been called to the bar
in 1984.
PAUL BELLAMY has been a director since January 2001. Mr. Bellamy was Chief
Restructuring Officer of and consultant to the Board of Directors of Zefer
Corporation, an internet services company, from May 2001 to September 2001.
Mr Bellamy was Chief Executive Officer and a member of the Board of Directors of
Esquire Communications, a professional services company, from December 1999 to
March 2001. From March 1998 to March 1999, Mr. Bellamy was President, Chief
Operating Officer, Chief Financial Officer and a member of the Board of
Directors of Graham Field, Inc., a medical home healthcare and surgical products
manufacturer. From October 1995 to February 1998, Mr. Bellamy was Chief
Financial Officer of Davis Vision, Inc., an eye care HMO and optical retail
company.
ROBERT J. LIPSIG has been a director since January 2001. Mr. Lipsig is the
Chairman and Chief Executive Officer of RJL Private Investments, a firm founded
in 1995. RJL Private Investments consults with and invests in privately held
corporations. From 1985 until his retirement in 1994, Mr. Lipsig was Chairman
and Chief Executive Officer of ERO Industries, a Chicago, Illinois Nasdaq listed
firm involved in the children's consumer products industry.
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67
<Page>
Management
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BOARD COMPOSITION
Each director is elected to serve until his successor is elected at the next
annual meeting of shareholders or until his earlier death, resignation or
removal as provided in our bylaws.
BOARD COMMITTEES
Our Board of Directors does not have an Executive Committee. In connection with
our initial public offering in November 2000, the Board established the
committees described below and gave each committee the responsibility to provide
initial, in-depth consideration to various matters falling within the Board's
mandate. None of the committees has decision-making authority, but rather each
committee considers the issues within its mandate and makes recommendations to
the Board. Our board of directors has the following three committees:
Audit Committee
The Audit Committee consists of William T. Brock, Dino Chiesa, Thomas Edward
Long and Paul Bellamy and assists the Board of Directors in fulfilling its
responsibility to oversee management's conduct of our financial reporting
process, including the selection of our outside auditors and the review of the
financial reports and other financial information provided by us to any
governmental or regulatory body, the public or other users thereof, our systems
of internal accounting and financial controls and compliance programs, and the
annual independent audit of our financial statements.
Compensation Committee
The Compensation Committee of the Board of Directors is responsible for making
recommendations for approval by the Board of Directors with respect to
remuneration of our executives, including our President and Chief Executive
Officer, our senior officers and senior management of us and our principal
subsidiaries. The Compensation Committee is currently composed of Albert J.
Latner, Donald J. Edwards, Thomas Edward Long and Robert J. Lipsig. The
Compensation Committee reviews and determines all elements of the executive
officers' compensation on an annual basis and adjusts such compensation in
appropriate cases.
Corporate Governance Committee
The Corporate Governance Committee is composed of Donald J. Edwards, Albert J.
Latner, William T. Brock and Paul Bellamy. The Corporate Governance Committee is
responsible for, among other things, developing our approach to corporate
governance and making recommendations to the Board of Directors concerning the
following:
- - effectiveness of the systems of governance;
- - size and composition of the Board;
- - suitable candidates for nomination as directors; and
- - mandate of each committee of the Board.
The Corporate Governance Committee has the authority to approve any director
requests to engage an outside advisor at our expense. The Corporate Governance
Committee also serves as a nominating committee and considers nominees for the
Board recommended by shareholders, management or other directors.
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68
<Page>
Management
- --------------------------------------------------------------------------------
Compensation committee interlocks and insider participation
None of our executive officers has served as a director or member of the
compensation committee during 2000.
COMPENSATION OF DIRECTORS AND OFFICERS
Each of our directors who is not also an employee of ours is entitled to receive
a fee for serving as a director, a fee for serving as a member of each board
committee on which the director serves and a fee for attending each board or
committee meeting. For serving on our Board of Directors, each director receives
an annual fee of $20,000 and an additional fee of $1,000 for each meeting of the
Board of Directors at which the director is in attendance. Directors serving as
members of committees of the corporation receive an annual fee of $1,000 and a
fee of $250 for each meeting of any committee at which the director is in
attendance. In addition, a director serving as a chairman of any committee
receives an additional annual fee of $1,000 and an additional fee of $250 for
each meeting at which the chairman is in attendance. Our directors are also
eligible to participate in our stock option plans and are entitled to be
reimbursed for out-of-pocket expenses incurred in attending board and committee
meetings.
We paid aggregate base compensation of $0.9 million for the year ended
December 31, 2000 ($0.9 million in 1999) to our executive officers who were
executive officers as at December 31, 2000 (a total of three) for their
services. In addition, upon the completion of our initial public offering in
November 2000, we paid $2.1 million to certain of our executives to enable them
to repay in full outstanding loans made by us to them and the associated taxes
which became due as a result. We also paid $0.8 million to one of our executives
in November 2000 to terminate our employment contract with the executive. See
"Related party transactions" for additional details.
We granted stock options for 1,316,859 common shares to our officers and
directors under our Stock Option Incentive Plan described below under
"--Employee Stock Option Plans." Of this amount, 1,212,224 stock options were
granted on June 12, 1997, 34,635 were granted on May 10, 1999 and 70,000 were
granted on January 16, 2001.
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69
<Page>
Management
- --------------------------------------------------------------------------------
Summary compensation table
The following table sets forth certain compensation awarded, earned by or paid
to our Chairman and to the four most highly paid executive officers, other than
the Chairman, who served as executive officers as of December 31, 2000, for
services rendered in all capacities to us during 2000, and compensation paid to
these executives in 1999 and 1998 for services rendered in all capacities to us
during such years.
<Table>
<Caption>
Long-term
compensation
awards/
securities
underlying
Base Other annual options All other
Name and principal position Year Salary(1) Bonus(1)(2) compensation(1) granted compensation(1)
- ------------------------------------------------------------------------------------------------------------------------------
Harvey A. Shapiro .................... 2000 $418,436 $ -- $41,278(4) -- $790,472(5)
Chairman, President, Chief Executive 1999 370,205 186,425 41,318(4) -- 11,490
Officer and Director 1998 336,713 168,275 39,735(4) -- 11,507
Osama I. Sherif ...................... 2000 300,821 -- 37,789(4) -- 776,389(5)
Executive Vice-President and Chief 1999 267,759 63,176 39,613(4) -- 9,087
Operating Officer 1998 262,899 91,878 41,484(4) -- 9,100
Zbig S. Biskup ....................... 2000 226,917 -- --(3) -- 594,379(5)
Executive Vice President, Chief 1999 226,565 56,007 --(3) 34,635 9,881
Financial Officer and Secretary 1998 222,453 77,743 --(3) -- 9,515
Albert J. Latner ..................... 2000 255,255 -- --(3) -- 9,088
Chairman Emeritus and Director 1999 269,240 -- --(3) -- 9,087
1998 269,240 -- --(3) -- 9,100
Michael E. Latner(6) ................. 2000 241,009 -- --(3) -- 822,571
Former Executive Vice-President, 1999 275,399 -- --(3) -- 9,087
Chief Operating Officer of Canadian 1998 275,808 96,354 --(3) -- 9,100
Operations and Corporate Secretary
</Table>
- ------------
(1) Any amount paid to the named Executive Officers in Canadian dollars were
converted into U.S. dollars based on an average exchange rate of Cdn$1.00 =
U.S. $0.6723, Cdn$1.00 = U.S. $0.6731 and Cdn$1.00 = U.S. $0.6741 for the
years ended December 31, 2000, 1999 and 1998.
(2) Bonus represents amount earned during the year.
(3) Amount paid was less than the lesser of $50,000 and 10% of each executive
officer's salary and bonus for the fiscal year.
(4) Amount paid consists of imputed interest benefit on loans and car
allowances.
(5) Amount includes: (i) $781,384, $767,301 and $585,291 paid to Harvey A.
Shapiro, Osama I. Sherif and Zbig S. Biskup, respectively, which enabled
them to repay in full outstanding loans made to them by us and associated
taxes which became due as a result and (ii) a contribution made to the
Registered Retirement Savings Plan on behalf of each executive.
(6) Michael E. Latner retired from his position as an Executive Officer on
November 22, 2000. Upon his retirement, Michael E. Latner received a
termination payment in the amount of $813,483, which is included in "All
other compensation."
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70
<Page>
Management
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Options
The following table sets out the information with respect to the individual
exercises of stock options during the fiscal year ended December 31, 2000 by
each of the named executive officers.
Aggregated option exercises during the most recently completed fiscal year.
- --------------------------------------------------------------------------------
<Table>
<Caption>
Number of Securities Value of Unexercised
Underlying Unexercised In-The-Money
Options as at Options as at
Shares December 31, 2000 December 31, 2000
Acquired on Value --------------------------- ---------------------------
Name Exercise(#) Realized($) Exercisable Unexercisable Exercisable Unexercisable
- -----------------------------------------------------------------------------------------------------------------------
Harvey A. Shapiro .............. -- -- 467,572 -- $2,181,814 --
Chairman, President, Chief
Executive Officer and Director
Osama I. Sherif ................ -- -- 311,715 -- 1,454,544 --
Executive Vice-President and
Chief Operating Officer
Zbig S. Biskup ................. -- -- 259,762 -- 1,143,749 --
Executive Vice-President
Chief Financial Officer and
Secretary
Albert J. Latner ............... -- -- 207,810 -- 969,696 --
Director and Chairman Emeritus
Michael E. Latner .............. -- -- 207,810 -- 969,696 --
Former Executive
Vice-President, Chief
Operating Officer of Canadian
Operations and Corporate
Secretary
</Table>
EMPLOYMENT AGREEMENTS
We have employment agreements with Harvey A. Shapiro, Osama I. Sherif and Zbig
S. Biskup. Each employment agreement has a three-year term to November 15, 2003.
Upon termination of employment by us without cause, or termination by the
employee for good reason or non-renewal of the term, Mr. Shapiro will be
entitled to a termination fee of $2,000,000, continuing benefits for a period of
up to three years and all stock options will vest and any restrictions on
restricted stock will lapse. A termination for good reason for Mr. Shapiro will
include the expiration of a period of one year following a Change In Control (as
defined in his employment agreement) of Dynacare. Upon termination of employment
by us without cause or termination by the employee for good reason or
non-renewal of the term, Mr. Sherif and Mr. Biskup will be entitled to a payment
of 18 months' base salary and one and a half times his average annual bonus,
continuing benefits for a period of 18 months and all stock options will vest
and any restrictions on restricted stock will lapse.
Each employment agreement provides for a base salary ($600,000 in the case of
Mr. Shapiro, $420,000 in the case of Mr. Sherif and $350,000 in the case of
Mr. Biskup), subject to annual increases not less than 5% and an annual bonus
with a target incentive opportunity of 100% of base salary in the case of
Mr. Shapiro and 50% of base salary in the case of Mr. Sherif and Mr. Biskup. The
bonuses are payable 75% in cash and 25% by the issuance of our common shares.
The
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71
<Page>
Management
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agreements include confidentiality provisions and an agreement to not compete
with our business or solicit our customers or employees for a two-year period
following termination of employment.
We also have an employment agreement with Albert J. Latner employing him as
Chairman Emeritus and which provides for a payment of $100,000 per year for a
two-year term to November 2002. This agreement also provides for the
continuation of his health and medical benefits and the use of an office and
administrative assistant. Upon termination of this agreement for any reason
other than for cause, by the voluntary termination of Mr. Latner or as a result
of death or permanent disability, Mr. Latner will receive the compensation and
benefits described above for the remainder of the term of the agreement. This
agreement includes confidentiality provisions and an agreement to not compete
with our business or solicit our customers for a two-year period following
termination of employment.
LIMITATION OF LIABILITY AND INDEMNIFICATION OF OFFICERS AND DIRECTORS
We are governed by the Business Corporations Act (Ontario) (OBCA). Our bylaws
provide that we will indemnify each of our directors and officers, current or
otherwise, to the fullest extent permitted by the OBCA, against all costs,
charges and expenses, and including any amount paid to settle an action or
satisfy a judgment, reasonably incurred by him in connection with any civil,
criminal or administrative action or proceeding to which he is made party by
reason of being or having been a director or officer, if:
(a) he or she acted honestly and in good faith with a view to our best
interests; and
(b) in the case of a criminal or administrative action or proceeding that is
enforced by a monetary penalty, he or she had reasonable grounds for
believing that his or her conduct was lawful.
Our bylaws provide that none of our directors or officers will be liable for:
(i) the acts, receipts, neglects or defaults of any other director or officer or
employee; (ii) any loss, damage or expense happening to us through the
insufficiency or deficiency of any security in or upon which any of our monies
shall be invested; (iii) any loss or damage arising from the bankruptcy,
insolvency or tortious acts of any person with whom any of our monies,
securities or effects will be deposited; (iv) any loss occasioned by any error
of judgment or oversight on his part; or (v) any other loss, damage or
misfortune which might happen in the execution of his duties. This does not
relieve any director or officer from his duties under the OBCA or from liability
for any breach of the OBCA. The OBCA provides that every director and officer in
connection with his duties shall:
(a) act honestly and in good faith with a view to the best interests of the
corporation; and
(b) exercise the care, diligence and skill that a reasonably prudent person
would exercise in comparable circumstances.
In addition, the OBCA provides that every director and officer will comply with
the OBCA, its regulations and the articles and bylaws of the corporation.
Subject to limited exceptions, the OBCA also provides that no provision in a
contract, the articles, the bylaws of the corporation or a resolution, relieves
a director or officer from the duty to act in accordance with the OBCA and its
regulations or relieves him or her from liability under the OBCA. We have
obtained insurance which insures our directors and officers against specified
losses and which insures us against specific obligations to indemnify our
directors and officers.
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<Page>
Management
- --------------------------------------------------------------------------------
EMPLOYEE STOCK OPTION PLANS
On June 12, 1997, we established our Stock Option Incentive Plan that provides
for the grant of stock options to our employees, directors, officers,
contractors and service providers. At June 30, 2001, stock options to purchase
1,454,669 common shares were outstanding under the plan. Options were
exercisable at a stated exercise price of Cdn$9.31, except for 34,635 options
which are exercisable at a stated exercise price of Cdn$12.27.
On August 14, 1998, we created our Employee Stock Option Plan pursuant to which
options to purchase common shares may be granted from time to time to our
directors, officers, employees of our affiliated entities and other specified
individuals. At June 30, 2001, options to purchase 722,105 common shares were
outstanding under the plan. Options granted and outstanding at June 30, 2001 are
exercisable at a stated exercise price of between Cdn$9.31 to Cdn$17.32, except
for 481,400 options which are exercisable at a stated price of $9.125. The
options expire at various dates approximately seven years from the grant date.
The options vest as to 20% each year on the anniversary date of the grant. The
plan also provides for an acceleration of the vesting periods and the exercise
of the option if an optionee's employment is terminated upon our sale to a third
party or because of death, permanent disability or retirement.
The aggregate number of common shares which may be issued pursuant to our stock
option plans is limited to approximately 2.9 million.
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73
<Page>
- --------------------------------------------------------------------------------
Related party transactions
Our board of directors reviews transactions proposed to be entered into between
us and any of our insiders, affiliates or associates. No such transaction is to
be entered into unless it has been approved by the board of directors. From time
to time, we lend money to directors and officers on terms approved by the board
of directors. At December 31, 2000, the aggregate amount of indebtedness to us
by all of our directors and officers was $39,312.
Under previous employment agreements, we provided interest-free loans in the
amount of $406,320 to Mr. Shapiro, $398,996 to Mr. Sherif and $304,351 to
Mr. Biskup. Subsequent to the closing of our initial public offering in
November 2000, we made a payment to each of these officers to enable them to
repay in full these loans and associated taxes which became due as a result.
We entered into a termination agreement dated November 22, 2000, terminating the
employment of Mr. Michael Latner as Executive Vice President and Chief Operating
Officer of the Canadian Operations and Secretary. Under such agreement,
Mr. Michael Latner received a termination payment in the amount of $813,483 and
released us from all claims arising out of his employment. This agreement
includes confidentiality provisions and an agreement not to compete with our
business or solicit our customers for a two-year period following the date of
the agreement.
We entered into a contract services agreement with Golder, Thoma, Cressey,
Rauner, Inc., or GTCR Inc. under which GTCR Inc. agreed to provide, for a
five-year period commencing May 14, 1997, strategic investment, financial
planning, contract procurement and other advice to us in relation to our
operations, investments and financing opportunities in the United States. This
agreement was terminated upon the closing of our initial public offering. Prior
to the termination, GTCR Inc. was entitled to annual compensation of Cdn$400,000
for its services under this agreement. The contract services agreement contained
confidentiality provisions binding on GTCR Inc. In addition, we had agreed to
indemnify GTCR Inc. in certain circumstances, which indemnification continues
after termination of the agreement.
For the years ended December 31, 1998, 1999 and 2000 consulting fees charged to
us by our shareholders were $749,233, $749,233 and $600,683, respectively. These
arrangements, which included the contract services agreement with GTCR Inc.,
were terminated upon the completion of our initial public offering.
Our offices in Toronto, Ontario comprise approximately 14,780 square feet in a
high rise office building located at 20 Eglinton Avenue West. One of our
significant shareholders, the Latner Group, has an indirect minority interest in
the entity that owns this office building. Effective November 1, 1997, one of
our subsidiaries entered into a lease agreement for this property for a term
expiring October 31, 2002, at a net rental of Cdn$2.00 per square foot for the
first three years and Cdn$3.00 per square foot thereafter. The gross rental
costs for the premises for the year ended December 31, 2000 was approximately
Cdn$266,350. We believe that this approximated the market rate for similar
property at the time of execution of the lease.
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74
<Page>
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Principal and selling shareholders
The following table shows information we have with respect to the beneficial
ownership of our common shares as of June 30, 2001, and as adjusted to reflect
the sale of the common shares offered under this prospectus by:
- - each person or group of affiliated persons we know to own beneficially 5% or
more of our common shares;
- - each of our directors;
- - each executive officer listed in the "Summary compensation table" above; and
- - all of our directors and executive officers as a group.
Except as indicated in the footnotes to this table and subject to community
property laws where applicable, the persons named in the table have sole voting
and investment power with respect to all of our common shares shown as
beneficially owned by them. Beneficial ownership and percentage ownership are
determined in accordance with the rules of the Securities and Exchange
Commission. The table below includes the number of shares underlying options
that are exercisable within 60 days after June 30, 2001. It is therefore based
on 18,497,551 common shares outstanding as of June 30, 2001 and 21,197,551
common shares outstanding as of June 30, 2001, as adjusted to give effect to
this offering. The address for those individuals for whom an address is not
otherwise indicated is: 14900 Landmark Boulevard, Suite 200, Dallas Texas,
75254.
<Table>
<Caption>
Common Shares Number of Common Shares
Beneficially Owned Shares to Beneficially Owned
Before The Offering be Sold in after The Offering
Beneficial owner Shares Percent The Offering Shares Percent
- ------------------------------------------------------------------------------------------------------
Directors and named executive officers
Harvey A. Shapiro..................... 470,072 2.5% -- 470,072 2.2%
Osama I. Sherif....................... 312,965 1.7 -- 312,965 1.5
Zbig S. Biskup, C.A................... 261,012 1.4 -- 261,012 1.2
Albert J. Latner(5)................... 4,173,333 22.6 1,000,000 3,173,333 15.0
Michael E. Latner(6).................. 207,810 1.1 -- 207,810 1.0
Donald J. Edwards(2) ................. 5,898,210 31.9 1,300,000 4,598,210 21.7
6100 Sears Tower
Chicago, Illinois 60606-6402
Bruce V. Rauner(2) ................... 5,898,210 31.9 1,300,000 4,598,210 21.7
6100 Sears Tower
Chicago, Illinois 60606-6402
Paul Bellamy.......................... -- -- -- -- --
Thomas Edward Long.................... -- -- -- -- --
Dino Cheisa........................... -- -- -- -- --
William Brock......................... -- -- -- -- --
Robert Lipsig......................... -- -- -- -- --
All directors and named executive
officers as a group (12 persons)...... 11,323,402 61.2 2,300,000 9,023,402 42.6
Five percent or more shareholders
Latner Group (1)...................... 6,023,324 32.6 1,000,000 5,023,324 23.7
Golder, Thoma, Cressey, Rauner Fund V,
L.P(3) ............................. 5,887,923 31.8 1,297,733 4,590,190 21.7
6100 Sears Tower
Chicago, Illinois 60606-6402
GTCR Associates V(4) ................. 10,287 * 2,267 8,020 *
6100 Sears Tower
Chicago, Illinois 60606-6402
</Table>
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* Represents less than 1%.
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Principal and selling shareholders
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(1) Includes shares beneficially owned by Albert J. Latner and members of his
immediate family. Of the members of the Latner Group, AJLCO Realty Limited
and JILCO Holdings Ltd. will be selling 294,448 and 705,552 shares,
respectively, in this offering.
(2) Includes shares held by GTCR Fund V and shares held by GTCR Associates V.
Messrs. Rauner and Edwards are principals in GTCR Inc. which is the general
partner of GTCR V L.P., which, in turn, is the general partner of GTCR Fund
V. GTCR Inc. is also the general partner in GTCR Associates V.
Messrs. Rauner and Edwards disclaim the beneficial ownership of the shares
held by such entities except to the extent of his proportionate ownership
interests therein.
(3) Consists solely of shares held by GTCR Fund V for which each of
Messrs. Rauner and Edwards disclaims beneficial ownership except to the
extent of his proportionate ownership interest therein.
(4) Consists solely of shares held by GTCR Associates V for which each of
Messrs. Rauner and Edwards disclaims beneficial ownership except to the
extent of his proportionate ownership interest therein.
(5) Includes shares owned by entities controlled by Albert J. Latner.
(6) Michael E. Latner retired from his position as an executive officer on
November 22, 2000.
REGISTRATION RIGHTS AGREEMENT
Each of the Latner Group, GTCR Fund V and GTCR Associates V is entitled to
require that we carry out: (i) up to three registrations of all or any portion
of the shares held by each of them on Form F-1 under the Securities Act or any
similar long-form registration (each a "Long-Form Registration"), in respect of
which we shall pay all related registration expenses; (ii) up to four Long-Form
Registrations in respect of which the GTCR entities and the Latner Group shall
pay their respective share of related registration expenses; and (iii) up to
four registrations of all or any portion of the shares held by each of them on
Form F-2 or Form F-3 under the U.S. Securities Act of 1933, or any similar
short-form registration, in respect of which we shall pay all related
registration expenses. In addition, in the event that we propose to register any
of our securities under the Securities Act, subject to certain exceptions and
limitations, each of the Latner Group and the GTCR entities is entitled to have
included in such registration, at our expense, the shares held by it. Pursuant
to these rights, it is contemplated that the Latner Group and the GTCR entities
will sell an aggregate of 2,300,000 shares in this offering. Other than the
shares to be sold in this offering, each of the Latner Group and the GTCR
entities, pursuant to lock-up agreements, has agreed not to exercise their
registration rights prior to 90 days following the date of this prospectus
without the prior written consent of UBS Warburg LLC.
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Description of capital stock
We are currently subject to the provisions of the Business Corporations Act
(Ontario). The following includes information concerning our common shares,
based on Ontario law and a summary of certain provisions of our Articles of
Amalgamation and Articles of Incorporation as at the closing of this offering.
This information and summary do not purport to be complete and are qualified in
their entirety by reference to the full Articles.
GENERAL
Our authorized capital stock consists of an unlimited number of common shares.
Neither our Articles nor our By-laws, nor the laws of Ontario, as such laws
apply to Dynacare, restrict in any way the ownership or voting of common shares
by non-residents of Ontario. However, certain special requirements apply to the
acquisition by a non-Canadian of control of a Canadian business. As of the close
of business on June 30, 2001, there were 16,928,937 common shares outstanding,
none of which were owned by our wholly-owned subsidiaries. We have no shares of
capital stock reserved for issuance other than as required for the exercise of
options. As of June 30, 2001 there were options outstanding for 2,176,774 common
shares under our stock option plans.
Our articles contain a provision allowing directors to borrow money on the
credit of Dynacare, to issue, sell or pledge debt obligations of Dynacare and to
charge, pledge or mortgage the assets of Dynacare.
Annual meetings of shareholders shall be held not later than fifteen months
after the previous annual shareholders meeting at the time and place determined
by the board of directors, the president or the secretary.
CAPITAL STOCK
Each holder of common shares is entitled to one vote per share, which may be
given in person or by proxy, in the election of our directors and on all other
matters submitted to a vote of our shareholders. Under the OBCA, the vote of two
thirds of shareholders of any class entitled to vote is required to change the
rights of the holders of such class of shares. The holders of common shares are
entitled to share pro rata in any dividends declared by our board of directors
out of funds legally available for the payment of such dividends. In the event
of our liquidation, dissolution or winding up, whether voluntary or involuntary,
the holders of common shares are entitled to receive all of our assets remaining
after the payment of all of our liabilities. There are no preemptive or
conversion rights, and the common shares are not subject to redemption. All
common shares currently outstanding are, and all common shares to be issued in
this offering will be, fully paid and non-assessable.
Shareholders do not have cumulative voting rights for the election of directors.
Therefore, the holders of more than 50% of the shares voting for the election of
directors could, if they choose to do so, elect all of the directors and, in
such event, the holders of the remaining shares would not be able to elect any
director.
While the payment of dividends rests within the discretion of the board of
directors, we presently intend to retain all earnings, if any, in the
foreseeable future for use in the development of our business.
There is no provision in our Articles or By-laws that would have the effect of
delaying, deferring or preventing a change in control of us or that would
operate only with respect to an extraordinary corporate transaction involving
us, such as a merger, reorganization, tender offer, sale or transfer of
substantially all of our assets or liquidation.
TRANSFER AGENT AND REGISTRAR
Mellon Investor Services, L.L.C. and CIBC Mellon Trust Company are the principal
transfer agents and registrars for the common shares in the United States and
Canada, respectively.
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Material income tax considerations
In this section, we summarize the material Canadian and U.S. federal income tax
consequences of the acquisition, ownership and disposition of our common shares.
Readers are cautioned that this is not a complete technical analysis or listing
of all potential tax effects that may be relevant to holders of our common
shares. In particular, this discussion does not deal with the tax consequences
applicable to all categories of investors, some of which may be subject to
special rules, and does not address the tax consequences under Canadian
provincial or territorial tax laws, U.S. state or local tax laws, or tax laws of
jurisdictions outside of Canada and the United States. Accordingly, you should
consult your own advisor regarding the particular tax consequences to you of an
investment in our common shares.
The statements of Canadian and U.S. federal tax laws that we make below are
based upon laws, regulations and relevant interpretations of the laws and
regulations in effect as of the date of this prospectus, all of which are
subject to change, possibly retroactively.
MATERIAL U.S. FEDERAL INCOME TAX CONSIDERATIONS
The following summarizes the material U.S. federal income tax consequences of
the acquisition, ownership and disposition of our common shares and is based on
the advice of our U.S. counsel, Weil, Gotshal & Manges LLP. This summary is
based on current provisions of the Internal Revenue Code of 1986, known as the
Code, current and proposed Treasury regulations under the Code, and
administrative and judicial interpretations of the Code and Treasury
regulations, all as in effect on the date of this prospectus and all of which
are subject to change, possibly on a retroactive basis.
This summary considers only U.S. holders who will own common shares as capital
assets, that is generally as investments. For purposes of this discussion a U.S.
holder is:
- - a citizen or resident of the United States;
- - a corporation (or other entity treated as a corporation for U.S. federal
income tax purposes) organized under the laws of the United States, of any
state of the United States or the District of Columbia;
- - an estate, the income of which is subject to U.S. federal income tax
regardless of the source;
- - a trust, if a court within the United States is able to exercise primary
jurisdiction over the administration of the trust and one or more U.S.
persons have the authority to control all substantial decisions of the
trust; or
- - trusts in existence on August 20, 1997 which were treated as U.S. persons
under the law in effect immediately before that date and which make a valid
election to continue to be treated as a U.S. person under the Code.
We discuss the material aspects of U.S. federal income taxation relevant to
holders that are not U.S. holders, or non-U.S. holders, separately below.
This discussion does not address all aspects of U.S. federal income taxation
that may be relevant to any particular holder based on the holder's individual
circumstances. In particular, not addressed are the potential application of the
alternative minimum tax or the U.S. federal income tax consequences to holders
that are subject to special treatment, including:
- - broker-dealers in securities or currencies;
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Material income tax considerations
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- - insurance companies, regulated investment companies or real estate
investment trusts; banks, thrifts or other financial institutions or
"financial services entities;"
- - taxpayers who have elected mark-to-market accounting;
- - individual retirement accounts and other tax-deferred accounts;
- - tax-exempt entities;
- - taxpayers who hold common shares as a position in a "straddle," or as part
of a "synthetic security" or "hedge," "conversion transaction" or other
integrated investment;
- - persons that receive our shares as compensation for services;
- - holders owning directly, indirectly or by attribution at least 10% of our
voting power;
- - persons who are citizens and residents of a possession or territory of the
United States; and
- - except to the extent discussed below under "Tax consequences for non-U.S.
holders of common shares," taxpayers whose functional currency is not the
U.S. dollar.
In addition, this discussion does not address any aspect of U.S. federal gift or
estate tax, or state, local or non-U.S. tax laws and does not consider the tax
treatment of persons who hold common shares through a partnership or other
pass-through entity.
Prospective investors are advised to consult their own tax advisor with respect
to the specific tax consequences to them of purchasing, holding or disposing of
our common shares.
Taxation of dividends paid on common shares
We have not paid cash dividends since 1993, and we currently do not intend to
pay dividends in the future. In the event that we do pay a dividend, and subject
to the discussion of the passive foreign investment company, or PFIC, rules
below, a U.S. holder will be required to include in gross income as ordinary
income the amount of any distribution paid on our common shares, including any
Canadian taxes withheld from the amount paid, on the date the distribution is
received to the extent the distribution is paid out of our current or
accumulated earnings and profits as determined for U.S. federal income tax
purposes. Distributions in excess of these earnings and profits will be applied
against and will reduce the U.S. holder's basis in the common shares and, to the
extent that basis is exceeded, will be treated as capital gain.
Distributions of current or accumulated earnings and profits paid in a currency
other than the U.S. dollar will be included in the income of a U.S. holder at
the U.S. dollar amount calculated by reference to the exchange rate on the date
the distribution is received. The amount of any distribution of property other
than cash will be the fair market value of the property on the date of
distribution. A U.S. holder that receives a distribution in a currency other
than the U.S. dollar and converts the non-U.S. currency into U.S. dollars
subsequent to its receipt will have foreign exchange gain or loss based on any
appreciation or depreciation in the value of the non-U.S. currency against the
U.S. dollar, which will generally be U.S. source ordinary income or loss.
U.S. holders will have the option of claiming the amount of any Canadian income
taxes withheld at source or paid with respect to dividends either as a deduction
from gross income or as a dollar-for-dollar credit against their U.S. federal
income tax liability. Individuals who do not claim itemized deductions, but
instead utilize the standard deduction, may not claim a deduction for the amount
of the Canadian income taxes withheld, but those individuals may still claim a
credit against their U.S. federal income tax liability. This election is made on
an annual basis and applies to all
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Material income tax considerations
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foreign income taxes (or taxes in lieu of income tax) paid by (or withheld from)
the U.S. holder during the year.
The amount of foreign income taxes which may be claimed as a credit in any year
is subject to complex limitations and restrictions, which must be determined on
an individual basis by each shareholder. The total amount of allowable foreign
tax credits in any year cannot exceed the pre-credit U.S. federal income tax
liability for the year attributable to foreign source taxable income, which
would include any dividends paid by us but generally would not include any gain
realized upon a disposition of common shares. A U.S. holder will be denied a
foreign tax credit with respect to Canadian income tax withheld from dividends
received on our common shares to the extent the U.S. holder has not held the
common shares for at least 16 days of the 30-day period beginning on the date
which is 15 days before the ex-dividend date or to the extent the U.S. holder is
under an obligation to make related payments with respect to substantially
similar or related property. Any days during which a U.S. holder has
substantially diminished its risk of loss on the common shares are not counted
toward meeting the 16-day holding period required by the statute. In addition,
distributions of our current or accumulated earnings and profits will, for U.S.
foreign tax credit purposes, be foreign source passive income and will not
qualify for the dividends received deduction available to corporations.
Taxation of the disposition of common shares
Subject to the discussion of the PFIC rules below, upon the sale, exchange or
other disposition of our common shares, a U.S. holder will recognize capital
gain or loss in an amount equal to the difference between the U.S. holder's
basis in the common shares, which is usually the cost of the shares, and the
amount realized on the disposition. The U.S. holder's adjusted tax basis in our
common shares will generally be equal to the U.S. dollar cost of acquiring the
common shares reduced (but not below zero) by the U.S. dollar value of any
distribution that is treated as a tax free return of basis. If the shares are
publicly traded, as our common shares are, a disposition of shares will be
considered to occur on the trade date regardless of the holder's method of
accounting. Capital gain from the sale, exchange or other disposition of common
shares held more than one year is long-term capital gain and is eligible for a
maximum 20% rate of taxation for non-corporate holders. Gain or loss recognized
by a U.S. holder on a sale, exchange or other disposition of our common shares
generally will be treated as U.S. source income or loss for U.S. foreign tax
credit purposes. The deductibility of a capital loss recognized on the sale,
exchange or other disposition of common shares is subject to limitations.
With respect to foreign currency gain or loss on the sale of our common shares,
a U.S. holder that uses the cash method of accounting calculates the U.S. dollar
value of the proceeds received on the sale as of the date that the sale settles,
while a U.S. holder that uses the accrual method of accounting is required to
calculate the value of the proceeds of the sale as of the trade date and may
therefore realize foreign currency gain or loss, unless the U.S. holder has
elected to use the settlement date to determine its proceeds of sale for
purposes of calculating the foreign currency gain or loss. In addition, a U.S.
holder that receives non-U.S. currency upon disposition of our common shares and
converts the non-U.S. currency into U.S. dollars subsequent to its receipt will
have foreign exchange gain or loss based on any appreciation or depreciation in
the value of the non-U.S. currency against the U.S. dollar, which will generally
be U.S. source ordinary income or loss.
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Material income tax considerations
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Tax consequences if we are a passive foreign investment company
We will be a PFIC if:
- - 75% or more of our gross income in a taxable year, including the pro rata
share of the gross income of any company, U.S. or foreign, in which we are
considered to own 25% or more of the shares by value, is passive income; or
- - 50% or more of our assets in a taxable year, averaged over the year and
ordinarily determined based on fair market value and including the pro rata
share of the assets of any company in which we are considered to own 25% or
more of the shares by value, are held for the production of, or produce,
passive income.
Passive income generally includes:
- - rent, royalty and lease income;
- - interest;
- - dividends from shares of stock in a corporation in which the foreign
corporation directly or indirectly owns less than 25% of the value of stock
in the corporation; and
- - recognized gains from the sale of any property that gives rise to passive
income or the sale of partnership interests.
In addition, passive income would include amounts derived by reason of the
temporary investment of funds raised in this offering. We believe that we will
not be a PFIC for fiscal 2001. The tests for determining PFIC status, however,
are applied annually, and it is difficult to make accurate predictions of future
income and assets, which are relevant to this determination. Accordingly, we
cannot assure you that we will not become a PFIC in the future. Neither we nor
our advisors have the duty to or will undertake to inform U.S. holders of
changes in circumstances that would cause us to become a PFIC.
If we were a PFIC, and a U.S. holder did not make an election to treat us as a
qualified electing fund (QEF) as described below:
- - Excess distributions by us to a U.S. holder would be taxed in a special way.
Excess distributions are amounts received by a U.S. holder with respect to
our shares in any taxable year after the taxable year in which our common
shares are acquired that exceed 125% of the average distributions received
by such U.S. holder from us in the shorter of either the three previous
years or the U.S. holder's holding period for common shares before the
present taxable year. Excess distributions must be allocated ratably to each
day that a U.S. holder has held our shares. A U.S. holder must include
amounts allocated to the current taxable year in its gross income as
ordinary income for that year. A U.S. holder must pay tax on amounts
allocated to each prior taxable year at the highest rate in effect for that
year on ordinary income and the tax is subject to an interest charge at the
rate applicable to deficiencies for income tax.
- - The entire amount of gain that is realized by a U.S. holder upon the sale or
other disposition of our common shares in any taxable year after the taxable
year in which the common shares were acquired will be treated as if it were
an excess distribution and will be subject to tax as described above.
- - A U.S. holder's tax basis in our shares that were acquired from a decedent
would not receive a step-up to fair market value as of the date of the
decedent's death but would instead be equal to the decedent's basis, if
lower.
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- - A U.S. holder would be required to complete IRS Form 8621 with the U.S.
holder's federal income tax return each year.
The special PFIC rules described above would not apply to a U.S. holder if the
U.S. holder makes an election to treat us as a QEF in the first taxable year in
which the U.S. holder owns our common shares and if we comply with the specified
reporting requirements. Instead, a shareholder of a qualified electing fund is
required for each taxable year to include in income a pro rata share of the
ordinary earnings of the qualified electing fund as ordinary income and a pro
rata share of the net capital gain of the qualified electing fund as long-term
capital gain, subject to a separate election to defer payment of taxes, which
deferral is subject to an interest charge. We have agreed to supply U.S. holders
with the information needed to report income and gain pursuant to a QEF election
if requested by a U.S. holder. The QEF election is made on a
shareholder-by-shareholder basis and can be revoked only with the consent of the
U.S. Internal Revenue Service, or IRS. A shareholder makes a QEF election
attaching a completed IRS Form 8621, including the PFIC annual information
statement, to a timely filed U.S. federal income tax return and by filing that
form with the IRS Service Center in Philadelphia, Pennsylvania. Even if a QEF
election is not made, a shareholder in a PFIC who is a U.S. person must file a
completed IRS Form 8621 every year.
A U.S. holder of PFIC shares which are publicly traded could elect to mark the
shares to market annually, recognizing as ordinary income or loss each year an
amount equal to the difference as of the close of the taxable year between the
fair market value of the PFIC shares and the U.S. holder's adjusted tax basis in
the PFIC shares. Losses would be allowed only to the extent of net
mark-to-market gain previously included by the U.S. holder under the election
for prior taxable years. If the mark-to-market election were made, then the
rules described above would not apply for periods covered by the election.
U.S. holders who hold common shares during a period when we are a PFIC would be
subject to the rules described above, even if we cease to be a PFIC, subject to
some exceptions for U.S. holders who made a QEF election. We strongly urge U.S.
holders to consult their tax advisors about the PFIC rules, including the
consequences to them of making a mark-to-market or QEF election with respect to
our common shares, in the event that we qualify as a PFIC.
Tax consequences for non-U.S. holders of common shares
Except as described in "Information reporting and back-up withholding" below, a
non-U.S. holder of our common shares will not be subject to U.S. federal income
or withholding tax on the payment of dividends on, and the proceeds from the
disposition of, our common shares, unless:
- - the dividend or disposition proceeds are effectively connected with the
conduct by the non-U.S. holder of a trade or business in the United States
and, in the case of a resident of a country which has a treaty with the
United States, the dividend or disposition proceeds are attributable to a
permanent establishment or, in the case of an individual, a fixed place of
business, in the United States;
- - the non-U.S. holder is an individual who holds the common shares as a
capital asset and is present in the United States for 183 days or more in
the taxable year of the disposition and does not qualify for an exemption;
or
- - the non-U.S. holder is subject to tax pursuant to the provisions of U.S. tax
law applicable to U.S. expatriates.
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Information reporting and back-up withholding
U.S. holders, other than corporations, generally are subject to annual
information reporting requirements with respect to dividends paid in the United
States on our common shares. Treasury regulations that took effect January 1,
2001 impose back-up withholding on dividends paid in the United States on our
common shares unless the U.S. holder provides an IRS Form W-9 or otherwise
establishes an exemption. Prospective investors should consult their tax
advisors concerning the effect, if any, of these Treasury regulations on an
investment in our common shares. The amount of any back-up withholding would be
allowed as a credit against a U.S. holder's or non-U.S. holder's U.S. federal
income tax liability and may entitle such holder to a refund, provided that the
holder provides required information to the IRS. U.S. holders are subject to
information reporting and back-up withholding at a rate that is currently 30.5%
on proceeds paid from the disposition of our common shares unless the U.S.
holder provides an IRS Form W-9 or otherwise establishes an exemption.
Non-U.S. holders generally are not subject to information reporting or back-up
withholding with respect to dividends paid on, or upon the disposition of, our
common shares, so long as the non-U.S. holder provides a taxpayer identification
number, certifies to its foreign status on an appropriate IRS Form W-8 BEN, or
otherwise establishes an exemption.
MATERIAL CANADIAN FEDERAL INCOME TAX CONSIDERATIONS
The following is a summary of the material Canadian federal income tax
considerations generally applicable to a person who acquires common shares
offered by this prospectus and who, at all relevant times, is a "U.S. holder."
This summary is based on the advice of our Canadian counsel, Goodman and Carr
LLP. A U.S. holder is a person that:
- - is not a resident and is not deemed to be a resident of Canada, and is a
resident of the United States, for purposes of the Income Tax Act (Canada)
and the Canada-United States Income Tax Convention, 1980;
- - holds our common shares as capital property for purposes of the Income Tax
Act (Canada);
- - deals at arm's length with us and is not affiliated with us within the
meaning of the Income Tax Act (Canada);
- - does not use or hold, and is not deemed to use or hold, our common shares in
connection with carrying on a business in Canada for purposes of the Income
Tax Act (Canada);
- - does not have a permanent establishment or fixed base in Canada for purposes
of the Canada-United States Income Tax Convention, 1980; and
- - does not own and is not treated as owning, 10% or more of our outstanding
voting shares for purposes of the Canada-United States Income Tax
Convention, 1980.
Generally, our common shares will be considered to constitute capital property
to a holder provided that the holder does not hold the common shares in the
course of carrying on a business of trading or dealing in securities or
otherwise as part of a business of buying and selling securities and has not
acquired them in one or more transactions considered to be an adventure in the
nature of trade.
Special rules, which we do not address in this discussion, may apply to a U.S.
holder that is (a) an insurer that carries on an insurance business in Canada
and elsewhere, or (b) a financial institution subject to special provisions of
the Income Tax Act (Canada) applicable to gain or loss arising from
mark-to-market property.
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This discussion is based on the current provisions of the Canada-United States
Income Tax Convention, 1980, the Income Tax Act (Canada) and their regulations,
all specific proposals to amend the Income Tax Act (Canada) and regulations
announced by the Minister of Finance (Canada) before the date of this prospectus
and counsel's understanding of the current published administrative practices of
the Canada Customs and Revenue Agency. This discussion is not exhaustive of all
potential Canadian tax consequences to a U.S. holder and does not take into
account or anticipate any other changes in law, whether by judicial,
governmental or legislative decision or action, nor does it take into account
the tax legislation or considerations of any province, territory or foreign
jurisdiction.
Taxation of dividends
Dividends paid or credited or deemed to be paid or credited on common shares
owned by a U.S. holder will be subject to Canadian withholding tax under the
Income Tax Act (Canada) at a rate of 25% on the gross amount of the dividends.
The rate of withholding tax generally is reduced under the Canada-United States
Income Tax Convention, 1980 to 15% where the U.S. holder is the beneficial owner
of the dividends. Under the Canada-United States Income Tax Convention, 1980,
dividends paid to religious, scientific, charitable and certain other tax exempt
organizations and pension organizations that are resident and exempt from tax in
the United States, other than such dividends that constitute income from
carrying on a trade or business, will generally not be subject to this Canadian
withholding tax, provided such entities comply with the administrative
procedures specified in the Canada-United States Income Tax Convention, 1980.
Taxation of capital gains
A gain realized by a U.S. holder on a sale, disposition or deemed disposition of
our common shares generally will not be subject to tax under the Income Tax Act
(Canada) unless the common shares constitute taxable Canadian property within
the meaning of the Income Tax Act (Canada) at the time of the sale, disposition
or deemed disposition. Our common shares generally will not be taxable Canadian
property provided that: (a) they are listed on a prescribed share exchange, and
(b) at no time during the five-year period immediately preceding the sale,
disposition or deemed disposition, did the U.S. holder, persons with whom the
U.S. holder did not deal at arm's length, or the U.S. holder acting together
with those persons, own or have an interest in or a right to acquire 25% or more
of the issued shares of any class or series of our shares. A deemed disposition
of common shares will occur on the death of a U.S. holder.
If our common shares are taxable Canadian property to a U.S. holder, any capital
gain realized on a sale, disposition or deemed disposition of those shares will
generally be exempt from tax under the Income Tax Act (Canada) by reason of the
Canada-United States Income Tax Convention, 1980, so long as the value of our
common shares at the time of the sale, disposition or deemed disposition is not
derived principally from real property situated in Canada, as defined by the
Canada-United States Income Tax Convention, 1980. We have been advised that
currently our common shares do not derive their value principally from real
property situated in Canada; however, the determination as to whether Canadian
tax would be applicable on a sale, disposition or deemed disposition of common
shares must be made at the time of that sale, disposition or deemed disposition.
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Shares eligible for future sale
Future sales of substantial amounts of our common shares in the public market
following this offering, including shares issued upon exercise of outstanding
options or options that may be granted after this offering, could harm the
market price of our shares and could impair our ability to raise capital through
the sale of our equity securities. As described in "U.S. Resale Restrictions"
and "Ontario Resale Restrictions" below, less than 54% of our shares currently
outstanding will be available for sale immediately after this offering because
of restrictions on resale in the United States and Canada. Sales of a
substantial amount of our common shares in the public market after the
restrictions lapse could adversely affect the prevailing market price of our
common shares and our ability to raise equity capital in the future.
U.S. RESALE RESTRICTIONS
Upon the closing of this offering and assuming that none of our outstanding
stock options is exercised, we will have outstanding 19,628,937 common shares.
Of these outstanding shares, 10,418,023 common shares will be freely tradable
without restriction under the Securities Act, except for shares purchased by our
"affiliates," as that term is defined in Rule 144 under the Securities Act, and
shares subject to the restrictions on transfer contained in the lock-up
agreements described in "Underwriting." Any shares purchased by our affiliates
generally may be sold in compliance with Rule 144 as described below.
The remaining 9,210,914 shares outstanding are "restricted securities" within
the meaning of Rule 144. Restricted securities may be sold in the public market
only if registered or if they qualify for an exemption from registration under
Rules 144 or 701 promulgated under the Securities Act, which are summarized
below. Sales of the restricted securities in the public market, or the
availability of these shares for sale, could adversely affect the market price
of our common shares.
As of June 30, 2001, options to purchase a total of 2,176,774 common shares had
been granted and are outstanding under our stock option-plans. Approximately
1,568,614 of those options will be vested and exercisable upon the closing of
this offering. All of these vested shares are subject to the lock up agreements
described in "Underwriting."
In general, under Rule 144 as currently in effect, after the expiration of the
lockup agreements, a person who has beneficially owned restricted shares for at
least one year would be entitled to sell within any three-month period a number
of shares that does not exceed the greater of:
- - 1% of the number of our common shares then outstanding, which will equal
approximately 196,289 shares immediately after this offering; or
- - the average weekly trading volume of our common shares during the four
calendar weeks preceding the sale.
Sales under Rule 144 are also subject to manner of sale provisions, notice
requirements and the availability of current public information about us. Under
Rule 144(k), a person who is not deemed to have been an affiliate of ours at any
time during the three months preceding a sale, and who had beneficially owned
the shares proposed to be sold for at least two years, is entitled to sell such
shares without complying with the manner of sale, public information, volume
limitation or notice provisions of Rule 144.
We have previously filed a registration statement on Form S-8 to register common
shares subject to outstanding options or reserved for future issuance under our
stock option plans. As of June 30, 2001,
- --------------------------------------------------------------------------------
85
<Page>
Shares eligible for future sale
- --------------------------------------------------------------------------------
options to purchase approximately 687,542 common shares were reserved for future
issuance under our stock option plans. As of June 30, 2001, we had a total
number of 2,864,317 common shares available for issuance under our stock option
plans.
ONTARIO RESALE RESTRICTIONS
Excluding any common shares purchased in this offering, as of June 30, 2001,
Canadian residents who are listed under "Principal and selling
shareholders--Directors and executive officers" held 3,970,523 common shares and
options to purchase 1,454,669 common shares, all of which are subject to the
lock-up agreements described in "Underwriting." Under applicable provincial
securities laws in Canada, such common shares or common shares issuable upon
exercise of such options may not generally be sold or otherwise disposed of for
value in such provinces, except pursuant to a prospectus, a discretionary
exemption or a statutory exemption available only in specific limited
circumstances, until we have been a reporting issuer for at least 12 months
(18 months in the case of a control person). We became a reporting issuer in
Ontario on November 22, 2000.
- --------------------------------------------------------------------------------
86
<Page>
- --------------------------------------------------------------------------------
Description of indebtedness
THE 10.75% SENIOR NOTES
We have issued an aggregate principal amount of $195.0 million of 10.75% senior
notes due January 15, 2006. Interest, at a rate of 10.75% per year, is payable
on the senior notes on January 15 and July 15 of each year.
The senior notes are redeemable at our option in whole or in part, at any time
on or after January 15, 2001, initially at 105.375% of their principal amount,
plus accrued and unpaid interest, if any, to the date of redemption, declining
ratably to 100% of the principal amount thereof, plus accrued and unpaid
interest, if any, to the date of redemption, on or after January 15, 2004.
If our ownership changes through specified events (which will not result from
this offering), the holders of notes may require us to buy back their notes at a
purchase price of 101% of their principal amount, plus accrued and unpaid
interest, if any, to the date of purchase.
The notes are unsecured senior obligations and have the same priority in right
of payment as all of our other existing and future senior indebtedness, and will
be senior in right of payment to all of our existing and future subordinated
indebtedness. The notes are effectively subordinated to all of our existing and
future secured indebtedness to the extent of the value of the assets securing
that indebtedness. The holders of notes will only be paid after all of the
holders of indebtedness and other obligations, including trade payables, of our
subsidiaries have been paid.
The indenture governing these notes contains covenants that limit our ability,
and the ability of our subsidiaries, to:
- - incur additional indebtedness;
- - repurchase capital stock and indebtedness;
- - pay dividends;
- - make specified investments;
- - incur liens;
- - use the proceeds from specified asset sales;
- - issue capital stock of subsidiaries;
- - enter into transactions with entities which control us or which we control;
and
- - engage in mergers, consolidations, amalgamations and sales of substantially
all of our assets.
All of these limitations are subject to important exceptions and qualifications.
The indenture is an exhibit to the registration statement of which this
prospectus is a part and you should refer to it for additional details.
- --------------------------------------------------------------------------------
87
<Page>
Description of indebtedness
- --------------------------------------------------------------------------------
CANADIAN WORKING CAPITAL FACILITIES
We have a working capital facility for corporate purposes with a Canadian
chartered bank that allows for maximum borrowings of Cdn$5.0 million, is
unsecured and generally carries an interest rate equal to the prevailing
Canadian prime rate plus 2%. The Ontario Partnership has a working capital
facility with a Canadian chartered bank that provides for maximum borrowings of
the lesser of (i) Cdn$25.0 million or (ii) 90% of all accounts receivable
payable by any provincial government or authority pursuant to any provincial
health insurance plan plus 75% of all other accounts receivable which have not
been outstanding for more than 60 days less a reasonable allowance for doubtful
accounts, plus 60% of inventory. Interest for Ontario Partnership borrowings is
generally at the Canadian prime rate. Borrowings under this facility are secured
by a pledge of all of the Ontario Partnership's accounts receivable and
inventory. This facility contains a covenant restricting the incurrence of
liens.
U.S. WORKING CAPITAL FACILITY
We have a revolving working capital facility for our U.S. operations other than
our joint venture partnerships. This facility can be drawn to a maximum amount
equal to the lesser of (i) $35.0 million or (ii) 80% of all eligible receivables
plus 50% of eligible inventory. This facility is secured by accounts receivable
and the inventory of all of our subsidiaries in which we hold a greater than 50%
interest. This facility bears interest at a fluctuating rate per annum with
respect to (i) Prime Rate Loans, at the U.S. prime rate plus the applicable
prime rate margin in effect and (ii) Eurodollar Loans, at the adjusted
eurodollar rate plus the applicable eurodollar margin in effect and matures on
September 12, 2002. This facility contains certain financial and other
covenants.
OTHER INDEBTEDNESS
In addition to the indebtedness described above, we have various other loans
outstanding amounting to approximately $13.1 million as of June 30, 2001. These
loans consisted of vendor take-back notes ($3.8 million), mortgages
($6.4 million) and other miscellaneous loans ($2.9 million). The vendor
take-back notes were provided in connection with the acquisitions of certain
U.S. operations. These notes have a weighted average interest rate of 7.3% per
annum and are generally repayable in varying installments through March 31,
2003. The mortgages referred to above have a weighted average interest rate of
7.7% with maturity dates ranging through April 1, 2004.
- --------------------------------------------------------------------------------
88
<Page>
- --------------------------------------------------------------------------------
Underwriting
We, the selling shareholders and the underwriters for the offering named below
have entered into an underwriting agreement concerning the shares being offered.
Subject to certain conditions, each underwriter has severally agreed to purchase
the number of shares indicated in the following table. UBS Warburg LLC, Banc of
America Securities LLC, U.S. Bancorp Piper Jaffray Inc. and McDonald Investments
Inc., a KeyCorp Company, are the representatives of the underwriters.
<Table>
<Caption>
Number of
Underwriter shares
- -----------------------------------------------------------------------
UBS Warburg LLC.............................................
Banc of America Securities LLC..............................
U.S. Bancorp Piper Jaffray Inc..............................
McDonald Investments Inc., a KeyCorp Company................
---------
Total..................................................... 5,000,000
=========
</Table>
If the underwriters sell more shares than the total number set forth in the
table above, the underwriters have a 30-day option to buy from us up to 750,000
additional shares to cover these sales at the offering price less the
underwriting discounts and commissions. If any shares are purchased under this
option, the underwriters will severally purchase shares in approximately the
same proportion as set forth in the table above. The underwriting agreement
provides that the underwriters are obligated to purchase all of the common
shares in the offering if any are purchased other than those covered by the
option described above. The obligations of the underwriters under the
underwriting agreement may be terminated upon the occurrence of the certain
stated events.
The following table shows the per share and total underwriting discounts and
commissions we will pay to the underwriters. These amounts are shown assuming
both no exercise and full exercise of the underwriters' option to purchase from
us up to 750,000 additional shares.
<Table>
<Caption>
Paid by the Paid by us
selling -----------------------------
shareholders No exercise Full exercise
------------- ------------- -------------
Per share..................... $ $ $
Total....................... $ $ $
</Table>
We estimate that the total expenses of the offering payable by us, excluding
underwriting discounts and commissions, will be approximately $800,000.
Shares sold by the underwriters to the public will initially be offered at the
public offering price set forth on the cover of this prospectus. Any shares sold
by the underwriters to securities dealers may be sold at a discount of up to $
per share from the public offering price. Any of these securities dealers may
resell any shares purchased from the underwriters to other brokers or dealers at
a discount of up to $ per share from the public offering price. If all the
shares are not sold at the public offering price, the representatives may change
the offering price and the other selling terms.
We, our directors and officers and the selling shareholders (and their
affiliates) have agreed with the underwriters, pursuant to lock-up agreements or
the underwriting agreement, not to offer, sell, contract to sell, pledge or
otherwise dispose of, directly or indirectly, any common shares or securities
convertible into or exchangeable or exercisable for any common shares, during
the period from the
- --------------------------------------------------------------------------------
89
<Page>
Underwriting
- --------------------------------------------------------------------------------
date of this prospectus continuing through the date 90 days after the date of
this prospectus, without the prior written consent of UBS Warburg LLC.
In addition, in connection with this offering, certain of the underwriters (and
selling group members) may engage in passive market making transactions in the
common shares on the Nasdaq National Market, prior to the pricing and completion
of this offering. Passive market making consists of displaying bids on the
Nasdaq National Market no higher than the bid prices of independent market
makers and making purchases at prices no higher than these independent bids and
effected in response to order flow. Net purchases by a passive market maker on
each day are limited to a specified percentage of the passive market maker's
average daily trading volume in the common shares during a specified period and
must be discontinued when such limit is reached. Passive market making may cause
the price of the common shares to be higher than the price that otherwise would
exist in the open market in the absence of such transactions. If passive market
making is commenced, it may be discontinued at any time.
In connection with this offering, the underwriters may purchase and sell our
common shares in the open market. These transactions may include stabilizing
transactions, short sales and purchases to cover positions created by short
sales. Stabilizing transactions consist of bids or purchases made for the
purpose of preventing or retarding a decline in the market price of our common
shares while this offering is in progress. Short sales involve the sale by the
underwriters of a greater number of shares than they are required to purchase in
the offering. Short sales may be either "covered short sales" or "naked short
sales." Covered short sales are sales made in an amount not greater than the
underwriters' over-allotment option to purchase additional shares in the
offering. The underwriters may close out any covered short position by either
exercising their over-allotment option or purchasing shares in the open market.
In determining the source of shares to close out the covered short position, the
underwriters will consider, among other things, the price of shares available
for purchase in the open market as compared to the price at which they may
purchase shares through the over-allotment option. Naked short sales are sales
in excess of the over-allotment option. The underwriters must close out any
naked short position by purchasing shares in the open market. A naked short
position is more likely to be created if the underwriters are concerned that
there may be downward pressure on the price of the shares in the open market
after pricing that could adversely affect investors who purchase in the
offering.
The underwriters may also impose a penalty bid. This occurs when a particular
underwriter repays to the underwriters a portion of the underwriting discount
received by it because the representatives have repurchased shares sold by or
for the account of that underwriter in stabilizing or short covering
transactions.
These activities by the underwriters may stabilize, maintain or otherwise affect
the market price of our common shares. As a result, the price of our common
shares may be higher than the price that otherwise might exist in the open
market. If these activities are commenced, they may be discontinued by the
underwriters at any time. These transactions may be effected on the Nasdaq
National Market, The Toronto Stock Exchange, in the over-the-counter market or
otherwise.
We and the selling shareholders have agreed to indemnify the several
underwriters against some liabilities, including liabilities under the
Securities Act of 1933, and to contribute to payments that the underwriters may
be required to make in respect thereof.
In the ordinary course of their respective businesses, certain of the
underwriters and their affiliates have in the past and may in the future engage
in investment and commercial banking or other transactions with us, including
the provision of certain advisory services and making loans to us.
- --------------------------------------------------------------------------------
90
<Page>
- --------------------------------------------------------------------------------
Legal matters
The validity of the common shares offered by this prospectus and certain other
legal matters in connection with this offering with respect to Canadian law will
be passed upon by Goodman and Carr LLP, Toronto, Ontario, Canadian counsel to us
and certain of the selling shareholders. Certain other legal matters in
connection with this offering with respect to U.S. law will be passed upon by
Weil, Gotshal & Manges LLP, New York, New York, U.S. counsel to us. Dewey
Ballantine LLP, New York, New York, and McCarthy Tetrault, Toronto, Ontario, are
United States and Canadian counsel, respectively, for the underwriters in
connection with this offering.
Goodman and Carr LLP has, from time to time, represented and may continue to
represent the Latner Group and some of their affiliates in connection with legal
matters.
Experts
Ernst & Young LLP, independent auditors, have audited our consolidated financial
statements and schedule as of December 31, 1999 and 2000 and for each of the
three years in the period ended December 31, 2000 as set forth in their reports.
We have included our consolidated financial statements and schedule in the
prospectus or elsewhere in the registration statement in reliance on Ernst &
Young LLP's reports, given on their authority as experts in accounting and
auditing.
- --------------------------------------------------------------------------------
91
<Page>
- --------------------------------------------------------------------------------
Where you can find more information
We have filed with the Securities and Exchange Commission a registration
statement on Form S-1 under the Securities Act of 1933 relating to the common
shares offered hereby. This prospectus does not contain all of the information
set forth in the registration statement and the exhibits and schedules thereto.
For further information with respect to our company and the common shares we are
offering by this prospectus, you should refer to the registration statement,
including the exhibits and schedule thereto. The registration statement,
including the exhibits and schedules thereto, and any other document we file
with the Securities and Exchange Commission in accordance with the Securities
Exchange Act of 1934 or otherwise, can be inspected without charge at the public
reference facilities maintained by the Commission at Room 1024, Judiciary Plaza,
450 Fifth Street, N.W., Washington, D.C. 20549, or at the Regional Offices of
the Commission at Citicorp Center, 500 West Madison Street, Suite 1400, Chicago,
Illinois 60661 and 233 Broadway, New York, New York 10279. Copies of such
material may be obtained by mail from the Public Reference Section of the
Securities and Exchange Commission at 450 Fifth Street, N.W., Washington, D.C.
20549, at prescribed rates. The public may obtain information on the operation
of the Public Reference Room by calling the Securities and Exchange Commission
at 1-800-SEC-0330.
We are subject to the informational requirements of the Securities Exchange Act
of 1934, and, in accordance therewith, file reports with the Securities and
Exchange Commission and with the Ontario Securities Commission in accordance
with the requirements of the Securities Act (Ontario).
- --------------------------------------------------------------------------------
92
<Page>
- --------------------------------------------------------------------------------
Exchange rate information
We publish our consolidated financial statements in U.S. dollars. In this
prospectus, except where otherwise indicated, all dollar amounts are expressed
in U.S. dollars and references to "Cdn$" are to Canadian dollars.
The following table sets forth, for each period indicated, the high and low
exchange rates for one Canadian dollar expressed in U.S. dollars, based upon the
inverse of the noon buying rate in New York City for cable transfers in foreign
currencies, the average of these exchange rates on the last Saturday of each
month during that period, and the exchange rate at the end of that period, as
certified for customs purposes by the Federal Reserve Bank of New York (the
"Noon Buying Rate").
<Table>
<Caption>
Six months
Year ended December 31, ended June 30,
---------------------------------------------------- -------------------
1996 1997 1998 1999 2000 2000 2001
- ------------------------------------------------------------------------------------------------------------
High............................ 0.7513 0.7487 0.7105 0.6925 0.6973 0.6969 0.6697
Low............................. 0.7235 0.6945 0.6341 0.6535 0.6413 0.6629 0.6333
Average......................... 0.7332 0.7221 0.6740 0.6730 0.6735 0.6814 0.6618
Rate at period end.............. 0.7301 0.6999 0.6504 0.6925 0.6666 0.6758 0.6590
</Table>
ON OCTOBER 31, 2001, THE INVERSE OF THE NOON BUYING RATE WAS CDN$1 =
U.S.$0.6287.
- --------------------------------------------------------------------------------
93
<Page>
Dynacare Inc.
(Incorporated under the Laws of Ontario)
- --------------------------------------------------------------------------------
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Audited Consolidated Financial Statements
As of December 31, 2000 and 1999 and for the years ended
December 31, 2000, 1999 and 1998
<Table>
<Caption>
Page
- ----------------------------------------------------------------------
Auditors' Report............................................ F-2
Consolidated Statements of Financial Position............... F-3
Consolidated Statements of Operations....................... F-4
Consolidated Statements of Deficit.......................... F-5
Consolidated Statements of Cash Flows....................... F-6
Notes to Consolidated Financial Statements.................. F-7
</Table>
Unaudited Consolidated Financial Statements
As of June 30, 2001 and June 30, 2000 and for the six months ended
June 30, 2001 and June 30, 2000
<Table>
<Caption>
Page
- ----------------------------------------------------------------------
Consolidated Statements of Financial Position (Unaudited)... F-3
Consolidated Statements of Operations (Unaudited)........... F-4
Consolidated Statements of Deficit (Unaudited).............. F-5
Consolidated Statements of Cash Flows (Unaudited)........... F-6
Notes to Consolidated Financial Statements (Unaudited)...... F-7
</Table>
- --------------------------------------------------------------------------------
F-1
<Page>
AUDITORS' REPORT
To the Shareholders of
Dynacare Inc.
We have audited the consolidated statements of financial position of
Dynacare Inc. as at December 31, 2000 and 1999, and the consolidated statements
of operations, deficit and cash flows for each of the years in the three-year
period ended December 31, 2000. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards
in Canada and the United States. Those standards require that we plan and
perform an audit to obtain reasonable assurance whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation.
In our opinion, these consolidated financial statements present fairly, in all
material respects, the financial position of the Company as at December 31, 2000
and 1999, and the results of its operations and its cash flows for each of the
years in the three-year period ended December 31, 2000, in accordance with
accounting principles generally accepted in Canada.
As described in note 11, the Company adopted the liability method of tax
allocation for accounting for future income taxes effective January 1, 2000.
[LOGO]
Chartered Accountants
February 21, 2001,
except as to note 2 which is as of
March 1, 2001
Toronto, Canada
- --------------------------------------------------------------------------------
F-2
<Page>
Dynacare Inc.
(Incorporated under the Laws of Ontario)
- --------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF FINANCIAL POSITION
<Table>
<Caption>
December 31, June 30,
--------------------- ---------------------
1999 2000 2000 2001
(in thousands of U.S. dollars) (unaudited)
- ------------------------------------------------------------------------------------------------
Assets
Current assets:
Cash and cash equivalents...................... $ 16,327 $ 18,099 $ 5,040 $ 10,170
Accounts receivable (Note 18).................. 59,562 62,065 67,139 68,318
Prepaid expenses............................... 5,354 2,654 6,381 4,198
Inventory...................................... 7,059 7,692 6,451 8,996
Deferred income taxes (Note 11)................ 2,263 5,956 2,246 5,960
-------- -------- -------- --------
Total current assets............................. 90,565 96,466 87,257 97,642
-------- -------- -------- --------
Capital assets (Note 3).......................... 33,846 45,907 41,377 45,269
Licenses and goodwill (Note 4)................... 140,124 166,691 167,076 172,813
Other assets (Notes 5 and 12).................... 23,984 39,912 27,135 43,671
-------- -------- -------- --------
197,954 252,510 235,588 261,753
-------- -------- -------- --------
$288,519 $348,976 $322,845 $359,395
======== ======== ======== ========
Liabilities
Current liabilities:
Bank indebtedness (Note 6)..................... $ 1,957 $ -- $ 13,561 $ 3,917
Accounts payable and accrued liabilities....... 34,723 44,995 42,055 45,392
Current portion of deferred income taxes (Note
11).......................................... 7,291 10,961 7,345 10,705
Current portion of long term debt (Note 7)..... 3,893 5,913 9,127 5,452
-------- -------- -------- --------
Total current liabilities........................ 47,864 61,869 72,088 65,466
Long term debt (Notes 7 and 8)................... 198,788 202,287 204,050 202,091
Deferred income taxes (Note 11).................. 40,221 29,569 39,731 27,977
Non-controlling interest......................... -- -- 375 --
-------- -------- -------- --------
286,873 293,725 316,244 295,534
-------- -------- -------- --------
Shareholders' Equity
Capital stock (Note 9)........................... 51,158 98,357 51,158 98,617
Deficit.......................................... (49,343) (44,085) (44,839) (36,131)
-------- -------- -------- --------
1,815 54,272 6,319 62,486
Foreign currency translation adjustment.......... (169) 979 282 1,375
-------- -------- -------- --------
1,646 55,251 6,601 63,861
-------- -------- -------- --------
$288,519 $348,976 $322,845 $359,395
======== ======== ======== ========
</Table>
Commitments and contingencies (Notes 13 and 14)
See accompanying notes to consolidated financial statements
Approved on behalf of the Board
<Table>
(signed) Harvey A. Shapiro (signed) William T. Brock
Director Director
</Table>
- --------------------------------------------------------------------------------
F-3
<Page>
Dynacare Inc.
(Incorporated under the Laws of Ontario)
- --------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF OPERATIONS
<Table>
<Caption>
Six months
Years ended December 31, ended June 30,
(in thousands of U.S. dollars, ------------------------------------------ ---------------------------
except for share and per share 2000 2001
amounts) 1998 1999 2000 (unaudited)
- --------------------------------------------------------------------------------------------------------
Revenues (Note 18)............ $ 224,911 $ 272,677 $ 352,919 $ 171,833 $ 197,681
----------- ----------- ----------- ----------- -----------
General and operating
expenses.................... 189,643 230,795 306,105 146,734 170,954
Depreciation.................. 6,433 8,351 11,368 5,192 5,775
Amortization of licenses and
goodwill.................... 4,112 4,707 5,279 2,575 2,788
Severance, relocation and
other charges............... -- -- 6,750 -- --
----------- ----------- ----------- ----------- -----------
200,188 243,853 329,502 154,501 179,517
----------- ----------- ----------- ----------- -----------
Operating earnings............ 24,723 28,824 23,417 17,332 18,164
Interest expense.............. 15,486 19,457 22,477 11,087 10,645
----------- ----------- ----------- ----------- -----------
Earnings before income
taxes....................... 9,237 9,367 940 6,245 7,519
Income tax expense (benefit)
(Note 11):
Current..................... 1,839 1,544 1,748 1,459 571
Deferred.................... 1,209 2,182 (6,833) 282 (1,006)
----------- ----------- ----------- ----------- -----------
3,048 3,726 (5,085) 1,741 (435)
----------- ----------- ----------- ----------- -----------
Net earnings.................. $ 6,189 $ 5,641 $ 6,025 $ 4,504 $ 7,954
=========== =========== =========== =========== ===========
Earnings per share (Note 17):
Basic....................... $ 0.52 $ 0.47 $ 0.48 $ 0.38 $ 0.47
=========== =========== =========== =========== ===========
Diluted..................... $ 0.52 $ 0.45 $ 0.46 $ 0.36 $ 0.46
=========== =========== =========== =========== ===========
Weighted average number of
common shares outstanding--
basic....................... 11,880,914 11,880,914 12,482,368 11,880,914 16,891,418
=========== =========== =========== =========== ===========
Weighted average number of
common shares outstanding--
diluted..................... 11,880,914 12,464,105 13,143,971 12,443,119 17,146,611
=========== =========== =========== =========== ===========
</Table>
See accompanying notes to consolidated financial statements
- --------------------------------------------------------------------------------
F-4
<Page>
Dynacare Inc.
(Incorporated under the Laws of Ontario)
- --------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF DEFICIT
<Table>
<Caption>
Six months
Years ended December 31, ended June 30,
--------------------------------- ---------------------
1998 1999 2000 2000 2001
(in thousands of U.S. dollars) (unaudited)
- -------------------------------------------------------------------------------------------------------
Deficit, beginning of period................ $(61,173) $(54,984) $(49,343) $(49,343) $(44,085)
Net earnings................................ 6,189 5,641 6,025 4,504 7,954
Increase in stated capital (Note 9)......... -- -- (767) -- --
-------- -------- -------- -------- --------
Deficit, end of period...................... $(54,984) $(49,343) $(44,085) $(44,839) $(36,131)
======== ======== ======== ======== ========
</Table>
See accompanying notes to consolidated financial statements
- --------------------------------------------------------------------------------
F-5
<Page>
Dynacare Inc.
(Incorporated under the Laws of Ontario)
- --------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF CASH FLOWS
<Table>
<Caption>
Six months
Years ended December 31, ended June 30,
------------------------------ -------------------
1998 1999 2000 2000 2001
(in thousands of U.S. dollars) (unaudited)
<Caption>
- ----------------------------------------------------------------------------------------------
Cash Flow Provided by Operating
Activities:
Net earnings.......................... $ 6,189 $ 5,641 $ 6,025 $ 4,504 $ 7,954
Adjustments to reconcile net earnings
to net cash provided by operations:
Depreciation...................... 6,433 8,351 11,368 5,192 5,775
Amortization of licenses and
goodwill........................ 4,112 4,707 5,279 2,575 2,788
Deferred income taxes............. 1,209 2,182 (6,833) 282 (1,006)
Loss (gain) on sale of capital
assets.......................... 1,175 (11) (110) -- --
Severance, relocation and other
charges......................... -- -- 3,021 -- --
Change in non-cash working capital,
net of effects of acquisitions (Note
16)................................. (10,517) (16,106) 5,168 895 (9,242)
-------- -------- -------- -------- --------
8,601 4,764 23,918 13,448 6,269
-------- -------- -------- -------- --------
Cash Flow Used in Investing Activities:
Acquisition of businesses (Notes 2 and
16)................................. -- (21,086) (39,551) (28,348) (10,429)
Purchase of capital assets (Note
16)................................. (4,223) (10,990) (13,852) (5,413) (4,204)
Proceeds from sale of capital
assets.............................. 130 68 132 -- --
Increase in other assets.............. (624) (5,528) (8,436) (2,188) (3,471)
-------- -------- -------- -------- --------
(4,717) (37,536) (61,707) (35,949) (18,104)
-------- -------- -------- -------- --------
Cash Flow Provided by (Used in)
Financing Activities:
Increase (decrease) in bank
indebtedness...................... 1,543 (6,855) (5,812) 6,926 3,917
Proceeds from long term debt........ -- 71,078 4,525 4,525 --
Repayment of long term debt......... (2,444) (18,090) (6,354) (514) (396)
Issue of capital stock-net proceeds
(Note 9).......................... -- -- 46,433 -- 330
-------- -------- -------- -------- --------
(901) 46,133 38,792 10,937 3,851
-------- -------- -------- -------- --------
Foreign exchange translation
adjustments........................... 73 (1,735) 769 277 55
-------- -------- -------- -------- --------
Increase (decrease) in cash and cash
equivalents during the period......... 3,056 11,626 1,772 (11,287) (7,929)
Cash and cash equivalents, beginning of
period................................ 1,645 4,701 16,327 16,327 18,099
-------- -------- -------- -------- --------
Cash and cash equivalents, end of
period................................ $ 4,701 $ 16,327 $ 18,099 $ 5,040 $ 10,170
======== ======== ======== ======== ========
</Table>
See accompanying notes to consolidated financial statements
- --------------------------------------------------------------------------------
F-6
<Page>
Dynacare Inc.
(Incorporated under the Laws of Ontario)
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands of U.S. dollars, except for share and per share amounts, all
amounts at June 30, 2001 and June 30, 2000 and for the six months ended
June 30, 2001 and June 30, 2000 are unaudited)
1. Summary of significant policies
These financial statements have been prepared in accordance with accounting
principles generally accepted in Canada ("Canadian GAAP"), which are in all
material respects in accordance with accounting principles generally accepted in
the United States and practices prescribed by the United States Securities
Exchange Commission ("U.S. GAAP"), except as outlined in Note 20.
The preparation of the consolidated financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual amounts could differ from those estimates.
The significant accounting policies are as follows:
Nature of business
Dynacare Inc. and its subsidiary companies ("Dynacare") provide clinical
laboratory services in the United States and Canada.
Principles of consolidation
The consolidated financial statements include the accounts of Dynacare Inc. and
all of its subsidiaries. The consolidated financial statements also include
Dynacare's proportionate share of the assets, liabilities, revenues and expenses
in the following clinical laboratory joint ventures in which it is a
participant:
i) Memorial Hermann Partnership
ii) Ellis Partnership
iii) United Partnership
iv) Tennessee Partnership
v) Allegheny Partnership
vi) Ontario Partnership
vii) Alberta Partnership
The proportionate consolidation method of accounting is used when contractual
arrangements exist which allow for joint control over the strategic operating,
investing and financing activities of the entity.
- --------------------------------------------------------------------------------
F-7
<Page>
Dynacare Inc.
(Incorporated under the Laws of Ontario)
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(in thousands of U.S. dollars, except for share and per share amounts, all
amounts at June 30, 2001 and June 30, 2000 and for the six months ended
June 30, 2001 and June 30, 2000 are unaudited)
Cash equivalents
Cash equivalents consist of short term investments which have remaining
maturities of three months or less from the date of purchase, and are carried at
cost which approximates market.
Revenue recognition
Revenues are recognized on the accrual basis at the time services are provided,
which for clinical laboratories approximate the time test results are reported.
Revenues are stated net of all contractual allowances and discounts.
Depreciation
Capital assets are stated at cost. Depreciation is provided on the
declining-balance basis at the annual rates set out below:
<Table>
Buildings................................................... 5%
Medical equipment........................................... 20%
Furniture and fixtures...................................... 20%
Computer equipment.......................................... 30%
Motor vehicles.............................................. 30%
</Table>
Leasehold improvements are amortized on the straight-line basis over the term of
the lease, plus one renewal option.
Inventory
Inventory is stated at the lower of cost determined on a first-in, first-out
basis, and replacement cost.
Licenses and goodwill
Licenses and goodwill which arise on acquisitions, are recorded at cost, and are
amortized on the straight-line basis primarily over forty years. The
amortization policy has been adopted after consideration of various factors
including the essential nature and continuing demand for laboratory services,
barriers to entry, the perpetual nature of licenses, and a significant market
share created in a number of the markets in which Dynacare operates. Laboratory
licenses are required to operate clinical laboratories and to receive
reimbursement in Ontario. Although new licenses are rarely issued, existing
licenses of Dynacare and its competitors have been routinely renewed on an
annual basis, provided the laboratory adheres to certain regulations. Dynacare
complies with the applicable regulations, has never had a license renewal denied
and as such believes it is unlikely that these licenses will be revoked.
Dynacare reviews the valuation and amortization of licenses and goodwill on a
regular basis, taking into consideration any events or circumstances which might
have impaired the carrying value. The amount of impairment, if any, is measured
based on undiscounted projected cash flow compared to the carrying value.
- --------------------------------------------------------------------------------
F-8
<Page>
Dynacare Inc.
(Incorporated under the Laws of Ontario)
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(in thousands of U.S. dollars, except for share and per share amounts, all
amounts at June 30, 2001 and June 30, 2000 and for the six months ended
June 30, 2001 and June 30, 2000 are unaudited)
Foreign currency translation
A) REPORTING CURRENCY
Effective July 1, 2000, Dynacare adopted the U.S. dollar as its reporting
currency as more than 50% of Dynacare's revenues are generated in the United
States, coupled with Dynacare's continued growth in the United States. Prior to
July 1, 2000, Dynacare's consolidated financial statements were presented in
Canadian dollars. The consolidated financial statements and notes for all
periods prior to June 30, 2000, have been restated in U.S. dollars in accordance
with accounting principles generally accepted in Canada using the July 1, 2000,
exchange rate of Cdn$1.48 per U.S.$1.00. The functional currencies of each of
Dynacare's operations in the United States and Canada are unchanged.
The assets and liabilities of Dynacare's operations having a functional currency
other than the U.S. dollar are translated into U.S. dollars using the exchange
rate in effect at the period-end and revenues and expenses are translated at the
average rate during the period. Exchange gains or losses on translation of
Dynacare's net investment in these operations are included in the foreign
currency translation adjustment component of shareholders' equity.
The exchange gains or losses accumulated in the foreign currency translation
adjustment component of shareholders' equity are not included in operations
until realized through a reduction in Dynacare's net investment in such
operations.
B) FOREIGN EXCHANGE TRANSACTIONS
Foreign exchange translation adjustments arising from long term debt repayable
in a currency different than an operation's functional currency are deferred
over the remaining term of the debt or if the long term debt is designated as a
hedge of the net investment in self sustaining foreign operations, exchange
translation adjustments are included in the foreign currency translation
adjustment component of shareholders' equity.
Income taxes
Effective January 1, 2000, Dynacare has adopted the recently issued Canadian
Institute of Chartered Accountants Handbook Section, Accounting for Income
Taxes--3465 ("CICA-3465") on a retroactive basis with all previous comparable
periods restated. Under the liability method of tax allocation, deferred tax
assets and liabilities are recognized based on the temporary differences between
the accounting and tax bases of assets and liabilities. The calculation of
deferred tax assets and liabilities is based on substantially enacted tax rates
and laws that will be in effect when the temporary differences are expected to
reverse. (See Note 11).
Prior to the required adoption of CICA-3465, accounting for income taxes was
determined using the deferral method of tax allocation. The deferral method of
tax allocation was statement of operations oriented and was based on the timing
differences arising between revenue and expense items reported for accounting
and income tax purposes. The tax rate used to calculate the deferred tax asset
and liability was the rate in effect in the period the timing difference
originated.
- --------------------------------------------------------------------------------
F-9
<Page>
Dynacare Inc.
(Incorporated under the Laws of Ontario)
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(in thousands of U.S. dollars, except for share and per share amounts, all
amounts at June 30, 2001 and June 30, 2000 and for the six months ended
June 30, 2001 and June 30, 2000 are unaudited)
Financial instruments
Dynacare does not hold or issue financial instruments for trading purposes.
Amounts receivable or payable under currency swaps, utilized as hedges, are
included in the statement of financial position as either long-term assets or
long term liabilities. Foreign exchange gains or losses on the related hedged
assets or liabilities are included in the carrying amount of such assets and
liabilities and are matched against the related gains and losses on the currency
swaps.
Costs for purchased interest rate swap agreements are amortized to interest
expense over the term of the swaps. Unamortized costs are included in other
assets in the statement of financial position. Payments and receipts under
interest rate swap contracts are recognized as adjustments to interest expense.
Earnings per share
Effective December 31, 2000, Dynacare adopted the recently issued Canadian
Institute of Chartered Accountants Handbook Section, Earnings Per Share--3500
("CICA--3500") on a retroactive basis with all previous comparable years
restated. Under CICA--3500 basic earnings per share are calculated on net
earnings using the weighted average number of shares outstanding. Fully diluted
earnings per share are calculated on the weighted average number of shares
outstanding during the year assuming all the dilutive stock options had been
exercised into common shares of Dynacare at the beginning of the period, or date
of issuance, if later.
Under CICA--3500, the treasury stock method is used in recognizing the use of
proceeds that could be obtained upon exercise of stock options in computing
fully diluted earnings per share. The treasury stock method assumes that the
proceeds received by Dynacare upon the exercise of stock options would be used
to purchase common shares outstanding at the average market price during the
period. Prior to the adoption of CICA--3500 the earnings applicable to the
common shares outstanding were increased by the amount of interest net of
applicable taxes that would have been earned on funds received due to the
exercise of stock options.
Stock-based compensation plans
Dynacare has two stock-based compensation plans, which are described in Note 9.
No compensation expense is recognized for these plans when stock options are
issued to employees. Any consideration paid by employees on exercise of stock
options is credited to share capital.
Interim financial statements
In the opinion of management, the unaudited interim consolidated financial
statements contain all adjustments, consisting only of normal recurring accruals
necessary to present fairly, in all material respects, the financial position of
Dynacare as at June 30, 2001 and 2000, and the results of operations and cash
flows for each of the six-month periods then ended.
- --------------------------------------------------------------------------------
F-10
<Page>
Dynacare Inc.
(Incorporated under the Laws of Ontario)
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(in thousands of U.S. dollars, except for share and per share amounts, all
amounts at June 30, 2001 and June 30, 2000 and for the six months ended
June 30, 2001 and June 30, 2000 are unaudited)
2. Acquisitions
Dynacare has acquired clinical laboratories and has accounted for these
acquisitions using the purchase method.
The purchase price has been allocated as follows:
<Table>
<Caption>
December 31, June 30,
------------------- -------------------
1999 2000 2000 2001
(in thousands of U.S. dollars) (unaudited)
<Caption>
- ------------------------------------------------------------------------------------------------
Capital and other assets............................. $ 3,598 $ 4,705 $ 2,359 $ 300
Goodwill............................................. 23,682 36,172 27,315 10,129
------- ------- ------- -------
Net assets........................................... $27,280 $40,877 $29,674 $10,429
======= ======= ======= =======
Purchase consideration:
Cash............................................... $20,785 $38,497 $27,400 $ 9,203
Promissory notes payable........................... 6,194 1,326 1,326 995
Other short term liabilities....................... 301 1,054 948 231
------- ------- ------- -------
$27,280 $40,877 $29,674 $10,429
======= ======= ======= =======
</Table>
On March 1, 2001, Dynacare purchased the laboratory assets and operations of
Medical Arts Laboratory located in Oklahoma for a purchase price of
$7.7 million. The purchase price consideration included cash of $7.5 million and
short-term liabilities of $0.2 million. The goodwill arising on the acquisition
is being amortized over 40 years.
In June 2001, Dynacare through two of its joint ventures in the United States,
purchased the laboratory assets and operations of two laboratories located in
Texas and Illinois for a purchase price of $2.2 million. The purchase price
consideration included cash of $1.2 million and a promissory note payable of
$1.0 million. The goodwill arising on these acquisitions is being amortized over
30 years.
In March 2000, Dynacare acquired the outstanding common shares of a clinical
laboratory located in Alabama for a purchase price of $23.8 million. The
purchase price consideration included cash of $22.0 million, long term debt of
$1.2 million and short term liabilities of $0.6 million. The goodwill arising on
the acquisition of $20.9 million is being amortized over 40 years.
In addition, during 2000 Dynacare purchased the assets and operations of five
clinical laboratory operations located in the United States for a purchase price
of $14.7 million. The purchase price consideration included cash of
$14.1 million, promissory notes payable of $0.1 million and short term
liabilities of $0.5 million. The goodwill arising on these acquisitions is being
amortized over periods ranging from 15 to 40 years. Also during 2000, Dynacare
entered into a partnership with a hospital located in Pennsylvania. Dynacare's
capital contribution to the partnership was cash of $2.4 million. The goodwill
arising on the partnership formation is being amortized over 30 years.
- --------------------------------------------------------------------------------
F-11
<Page>
Dynacare Inc.
(Incorporated under the Laws of Ontario)
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(in thousands of U.S. dollars, except for share and per share amounts, all
amounts at June 30, 2001 and June 30, 2000 and for the six months ended
June 30, 2001 and June 30, 2000 are unaudited)
In 1999, Dynacare purchased the assets and operations of nine clinical
laboratory operations in the United States for a purchase price of
$25.1 million. The purchase price consideration included cash of $19.5 million,
promissory notes payable of $5.3 million and short term liabilities of
$0.3 million. The goodwill arising on these acquisitions is being amortized over
periods ranging from 15 to 40 years. Additionally, Dynacare entered into a
partnership with a hospital located in Tennessee. Dynacare's capital
contribution to the partnership was $2.2 million, which was comprised of cash of
$1.3 million and a promissory note payable of $0.9 million. The goodwill arising
on the partnership formation is being amortized over 40 years.
Results of operations of the above acquisitions have been included in the
statement of operations from the respective dates of acquisition.
Effective October 1, 2000, Dynacare sold its direct ownership interests of
certain of its operations located in Texas to the Memorial Hermann Partnership
for proceeds of $17.6 million which represents the value of Dynacare's
investment in these operations. The purchase price for these acquisitions has
been financed by Dynacare and in return Dynacare received preferred partnership
units on which it is entitled to earn a 20% return. The preferential partnership
units have proposed terms of repayment of three years or more subject to certain
provisions in the capital contribution agreement.
3. Capital assets
<Table>
<Caption>
December 31, June 30,
------------------- -------------------
1999 2000 2000 2001
(in thousands of U.S. dollars) (unaudited)
- ----------------------------------------------------------------------------------------------
Land............................................... $ 2,974 $ 3,665 $ 3,702 $ 3,629
Buildings.......................................... 7,305 9,123 9,206 9,098
Medical equipment.................................. 11,704 15,491 13,105 20,394
Leasehold improvements............................. 6,787 10,964 8,289 13,036
Furniture and fixtures............................. 2,804 4,046 3,586 5,457
Computer equipment................................. 20,934 30,102 26,220 35,259
Motor vehicles..................................... 481 692 504 666
-------- -------- -------- --------
52,989 74,083 64,612 87,539
Accumulated amortization........................... (19,143) (28,176) (23,235) (42,270)
-------- -------- -------- --------
$ 33,846 $ 45,907 $ 41,377 $ 45,269
======== ======== ======== ========
</Table>
- --------------------------------------------------------------------------------
F-12
<Page>
Dynacare Inc.
(Incorporated under the Laws of Ontario)
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(in thousands of U.S. dollars, except for share and per share amounts, all
amounts at June 30, 2001 and June 30, 2000 and for the six months ended
June 30, 2001 and June 30, 2000 are unaudited)
4. Licenses and goodwill
<Table>
<Caption>
December 31, June 30,
--------------------- ---------------------
1999 2000 2000 2001
(in thousands of U.S. dollars) (unaudited)
- ------------------------------------------------------------------------------------------------
Licenses......................................... $159,832 $157,820 $159,832 $156,413
Goodwill......................................... 101,610 133,794 131,279 142,726
-------- -------- -------- --------
261,442 291,614 291,111 299,139
Accumulated amortization and impairment(1)....... (121,318) (124,923) (124,035) (126,326)
-------- -------- -------- --------
$140,124 $166,691 $167,076 $172,813
======== ======== ======== ========
</Table>
- ---------
(1) During 1997, Dynacare completed a major review of its laboratory operations
and as a result of certain adverse changes in the clinical laboratory
industry and its businesses, a write down of $79.4 million was recorded.
5. Other assets
<Table>
<Caption>
December 31, June 30,
------------------- -------------------
1999 2000 2000 2001
(in thousands of U.S. dollars) (unaudited)
- ------------------------------------------------------------------------------------------------
Investments and property held for sale............... $ 7,081 $19,305 $ 7,400 $23,101
Currency swap receivable............................. 4,179 7,312 6,321 8,244
Amounts receivable................................... 3,125 4,422 4,287 4,559
Deferred financing costs(1).......................... 9,599 8,873 9,127 7,767
------- ------- ------- -------
$23,984 $39,912 $27,135 $43,671
======= ======= ======= =======
</Table>
- ------------
(1) Net of accumulated amortization of $6.0 million at December 31, 2000
(1999--$4.5 million) and $6.9 million at June 30, 2001 (2000--$5.2 million)
6. Bank indebtedness
Dynacare has a $35.0 million revolving credit facility for working capital
purposes in the United States which can be drawn to a maximum amount of the
lesser of i) $35.0 million or ii) 80% of all eligible receivables plus 50% of
eligible inventory. Dynacare has pledged the accounts receivable and inventory
of Dynacare's U.S. wholly owned subsidiaries as collateral for this facility.
This facility matures on September 12, 2002, and bears interest at a fluctuating
rate per annum as follows: i) prime rate loans, at U.S. prime plus the
applicable margin in effect and ii) Eurodollar loans, at adjusted Eurodollar
rate plus the applicable Eurodollar margin.
In Canada, Dynacare has revolving credit facilities for working capital purposes
totaling approximately Cdn$23.3 million ($15.3 million). Collateral for these
operating facilities consists of an assignment of
- --------------------------------------------------------------------------------
F-13
<Page>
Dynacare Inc.
(Incorporated under the Laws of Ontario)
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(in thousands of U.S. dollars, except for share and per share amounts, all
amounts at June 30, 2001 and June 30, 2000 and for the six months ended
June 30, 2001 and June 30, 2000 are unaudited)
certain accounts receivable and inventory. Interest on these credit facilities
varies between Canadian prime rate and prime plus 2%.
For the year ended December 31, 2000, interest on Dynacare's operating loans
amounted to $1.6 million (1999--$0.6 million, 1998--$1.0 million). For the six
months ended June 30, 2001, interest on Dynacare's operating loans amounted to
$0.1 million (2000--$0.6 million).
7. Long term debt
<Table>
<Caption>
December 31, June 30,
--------------------- ---------------------
1999 2000 2000 2001
(in thousands of U.S. dollars) (unaudited)
- -------------------------------------------------------------------------------------------------
$195 million (1999--$195 million) senior
unsecured notes payable, interest at 10.75%
maturing in 2006, and other long term debt with
interest ranging from 0% to 10.1% maturing
through 2006.................................... $202,681 $208,200 $213,177 $207,543
Less: current portion............................ (3,893) (5,913) (9,127) (5,452)
-------- -------- -------- --------
$198,788 $202,287 $204,050 $202,091
======== ======== ======== ========
</Table>
The senior unsecured notes are redeemable in whole or part at the option of
Dynacare on or after January 15, 2001, at a premium redemption price of 105.375%
decreasing to par on January 15, 2004 and thereafter. The indenture governing
the senior unsecured notes contains certain restrictions including restrictions
on the payment of dividends and the incurrence of additional indebtedness.
At December 31, 2000, long term debt includes Canadian denominated debt totaling
Cdn$6.8 million (U.S.$4.5 million) (1999--Cdn$7.1 million (U.S.$4.8 million)).
At June 30, 2001, long term debt includes Canadian denominated debt totaling
Cdn$6.4 million (U.S.$4.2 million) (2000--Cdn$7.0 million (U.S.$4.7 million)).
For the year ended December 31, 2000, interest on long term debt amounted to
$21.2 million (1999--$20.2 million, 1998--$14.5 million). For the six months
ended June 30, 2001, interest on long-term debt amounted to $10.6 million (2000
$10.5 million). For the year ended December 31, 2000, the average interest rate
on bank indebtedness and long term debt including the effect of the interest
rate swaps was 10.3% (1999--10.4%, 1998--9.7%). For the six months ended
June 30, 2001, the average interest rate on the bank indebtedness and long-term
debt, including the effect of the interest rate swaps was 10.1% (2000--10.1%).
- --------------------------------------------------------------------------------
F-14
<Page>
Dynacare Inc.
(Incorporated under the Laws of Ontario)
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(in thousands of U.S. dollars, except for share and per share amounts, all
amounts at June 30, 2001 and June 30, 2000 and for the six months ended
June 30, 2001 and June 30, 2000 are unaudited)
The long term debt at December 31, 2000, is repayable as follows:
<Table>
<Caption>
(in thousands of U.S. dollars)
- -----------------------------------------------------------------------
2001........................................................ $ 5,913
2002........................................................ 1,220
2003........................................................ 1,998
2004........................................................ 513
2005........................................................ 257
Thereafter.................................................. 198,299
--------
$208,200
========
</Table>
The long term debt at June 30, 2001, is repayable as follows for the fiscal
years ending December 31:
<Table>
<Caption>
(in thousands of U.S. dollars)
- -----------------------------------------------------------------------
2001........................................................ $ 4,237
2002........................................................ 2,129
2003........................................................ 2,056
2004........................................................ 642
2005........................................................ 354
Thereafter.................................................. 198,125
--------
$207,543
========
</Table>
8. Financial instruments
Dynacare 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.
Dynacare's currency swap agreement effectively converts a portion of its U.S.
dollar-denominated borrowings to Canadian dollars to match Dynacare's Canadian
dollar denominated assets and cash flows.
Under interest rate swaps, Dynacare agrees with its counterparty to exchange, at
specified intervals, the difference between fixed rate and floating rate
interest amounts calculated by reference to an agreed upon notional principal
amount. The amounts exchanged are based on the notional amounts; however, the
notional amounts do not represent Dynacare's exposure to credit or market loss.
The net effect of the swaps is to convert certain fixed rate liabilities which
mature in 2006 to fixed and variable rate liabilities. The variable rate
liabilities have maturity terms of less than one year.
The counterparty to the financial instruments is an international financial
institution. Dynacare has not obtained collateral or other security to support
the financial instruments. Although Dynacare is potentially exposed to credit
loss, it does not anticipate nonperformance by the counterparty given its high
credit rating.
- --------------------------------------------------------------------------------
F-15
<Page>
Dynacare Inc.
(Incorporated under the Laws of Ontario)
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(in thousands of U.S. dollars, except for share and per share amounts, all
amounts at June 30, 2001 and June 30, 2000 and for the six months ended
June 30, 2001 and June 30, 2000 are unaudited)
On January 24, 1996, Dynacare entered into a currency swap agreement, with a ten
year term to January 15, 2006, whereby $85.0 million of long term debt was
swapped into $116.5 million Canadian dollar-denominated debt.
On February 29, 2000, Dynacare Inc. entered into cross currency swap agreements
due January 15, 2006, whereby Dynacare Inc. has swapped $85.5 million Canadian
dollar-denominated receivables due from certain of its subsidiaries for
$58.9 million. These same subsidiaries have swapped in aggregate $85.5 million
Canadian dollar-denominated debt due to Dynacare Inc. into $58.9 million.
As at June 30, 2001, Dynacare has entered into a number of interest rate swaps.
The net effect is to convert fixed rate debt which mature in 2006 to fixed and
variable rate debt with terms ranging from three months to five years with a
weighted average interest rate of 10.32% (2000--10.83%). At maturity, both fixed
and variable rate debts are automatically renewable at the option of Dynacare.
The only financial instrument that potentially subjects Dynacare to
concentrations of credit risk is accounts receivable. A significant amount of
accounts receivable are from hospitals in the United States and government
agencies in Canada. Dynacare does not foresee a credit risk associated with
these receivables, and believes that the allowance for doubtful accounts is
adequate to provide for normal credit losses.
The carrying amount of cash and cash equivalents, accounts receivable, other
amounts receivable, bank indebtedness, and accounts payable and accrued
liabilities are considered to be representative of their respective fair values.
The fair value of the borrowed funds is determined by recent market quotations
and by discounting the future contractual cash flows under current financing
arrangements, at discount rates which represent borrowing rates presently
available to Dynacare for loans with similar terms and remaining maturity, less
costs of settlement.
The fair value of interest rate swaps is based on quoted market prices from
financial institutions for similar financial instruments. Dynacare accounts for
its interest rate swaps on a mark-to-market basis.
At December 31, 2000, the estimated fair value for the long term debt is
$197.1 million (1999--$200.0 million). The estimated fair value of favorable
currency and interest rate swaps at December 31, 2000, is $12.6 million
(1999--$1.9 million) and the estimated fair value of unfavorable currency and
interest rate swaps is $5.3 million (1999--$2.6 million).
At June 30, 2001, the estimated fair value for the long term debt is
$210.7 million (2000--$193.7 million). The estimated fair value of favorable
currency and interest rate swaps at June 30, 2001, is $16.4 million
(2000--$1.8 million) and the estimated fair value of unfavorable currency and
interest rate swaps is $6.8 million (2000--$3.4 million).
- --------------------------------------------------------------------------------
F-16
<Page>
Dynacare Inc.
(Incorporated under the Laws of Ontario)
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(in thousands of U.S. dollars, except for share and per share amounts, all
amounts at June 30, 2001 and June 30, 2000 and for the six months ended
June 30, 2001 and June 30, 2000 are unaudited)
9. Capital stock
Dynacare's share capital is comprised as follows:
<Table>
<Caption>
December 31, June 30,
------------------- -----------
1999 2000 2001
(in thousands of U.S. dollars) (unaudited)
- --------------------------------------------------------------------------------
Authorized
Unlimited number of common shares
Issued and outstanding common shares:
Common shares (2000--16,883,914; 2001--
16,928,937).............................. $ -- $98,357 $98,617
Nil Class B common shares
(1999--5,982,704)........................ 20,324 -- --
Nil Class C common shares
(1999--5,898,210)........................ 30,834 -- --
------- ------- -------
$51,158 $98,357 $98,617
======= ======= =======
</Table>
- --------------------------------------------------------------------------------
F-17
<Page>
Dynacare Inc.
(Incorporated under the Laws of Ontario)
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(in thousands of U.S. dollars, except for share and per share amounts, all
amounts at June 30, 2001 and June 30, 2000 and for the six months ended
June 30, 2001 and June 30, 2000 are unaudited)
On September 28, 2000, all of Dynacare's outstanding special shares were
converted into Class B common shares and Class C common shares at a rate of
1.5504 Class B or C common shares for each special share. Additionally, on
September 28, 2000, Dynacare by the way of a Board of Directors resolution
increased its stated capital by $0.8 million on 666,720 Class B common shares.
On November 22, 2000, Dynacare completed an initial public offering of its
common shares. Dynacare issued 5,003,000 common shares for total proceeds of
$50.0 million (before after tax costs of $3.6 million).
Upon the closing of Dynacare's initial public offering of its common shares,
Dynacare converted all of its outstanding classes of common shares (including
common shares issuable upon exercise of Dynacare's stock options) into a single
class of common shares on a one-for-one basis and completed a 0.6927-for-1
reverse stock split of all its outstanding common shares (including common
shares issuable upon exercise of Dynacare's stock options). As a result of the
conversion and reverse stock split, 8,636,790 Class B common shares and
8,514,811 Class C common shares were exchanged into 11,880,914 common shares of
Dynacare. All prior years capital stock and stock option information presented
has been adjusted for Dynacare's special and common share conversion and reverse
stock split.
Under executive and employee stock option plans, Dynacare may grant stock
options to its executives and employees for up to 2,909,340 common shares.
A summary of the status of Dynacare's stock option plans for common shares is
presented below:
(i) Stock options for common shares--Executive Stock Option Plan
<Table>
<Caption>
Years Ended December 31,
----------------------------------------------------------------------------
1998 1999 2000
---------------------- -------------------------- ----------------------
Weighted Weighted
average Weighted average
Stock exercise Stock average Stock exercise
options price options exercise price options price
- ---------------------------------------------------------------------------------------------------
Outstanding at
beginning of
year............... 1,420,034 Cdn $9.31 1,420,034 Cdn $ 9.31 1,454,669 Cdn $9.38
Granted............ -- -- 34,635 Cdn $12.27 -- --
Exercised.......... -- -- -- -- -- --
Cancelled.......... -- -- -- -- -- --
--------- --------- --------- ---------- --------- ---------
Outstanding at end of
year............... 1,420,034 Cdn $9.31 1,454,669 Cdn $ 9.38 1,454,669 Cdn $9.38
========= ========= ========= ========== ========= =========
Stock options
exercisable at
year-end........... 284,007 Cdn $9.31 581,868 Cdn $ 9.38 1,454,669 Cdn $9.38
========= ========= ========= ========== ========= =========
Weighted-average fair
value of stock
options granted
during the year.... $Nil Cdn $ 2.01 $Nil
========= ========== =========
</Table>
- --------------------------------------------------------------------------------
F-18
<Page>
Dynacare Inc.
(Incorporated under the Laws of Ontario)
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(in thousands of U.S. dollars, except for share and per share amounts, all
amounts at June 30, 2001 and June 30, 2000 and for the six months ended
June 30, 2001 and June 30, 2000 are unaudited)
The contractual remaining life of the stock options outstanding at December 31,
2000 is approximately six years.
<Table>
<Caption>
Six Months Ended June 30,
-----------------------------------------------
2000 2001
---------------------- ----------------------
Weighted Weighted
average average
Stock exercise Stock exercise
options price options price
(unaudited) (unaudited)
- -----------------------------------------------------------------------------------------------
Outstanding at beginning of period............ 1,454,669 Cdn $9.38 1,454,669 Cdn $9.38
Granted..................................... -- -- -- --
Exercised................................... -- -- -- --
Cancelled................................... -- -- -- --
--------- --------- --------- ---------
Outstanding at end of period.................. 1,454,669 Cdn $9.38 1,454,669 Cdn $9.38
========= ========= ========= =========
Stock options exercisable at period-end....... 872,802 Cdn $9.34 1,454,669 Cdn $9.38
========= ========= ========= =========
Weighted-average fair value of stock options
granted during the year..................... $Nil $Nil
========= =========
</Table>
The contractual remaining life of the stock options outstanding at June 30,
2001, is approximately six years.
(ii) Stock options for common shares--Employee Stock Option Plan
<Table>
<Caption>
Years Ended December 31,
------------------------------------------------------------------------------------------------
1998 1999 2000
------------------------------ ------------------------------ ------------------------------
Weighted Weighted Weighted
average average average
Stock options exercise price Stock options exercise price Stock options exercise price
- ------------------------------------------------------------------------------------------------------------------------
Outstanding at
beginning of year.. -- -- 304,788 Cdn $ 9.31 393,107 Cdn $10.91
Granted............ 305,481 Cdn $9.31 102,173 Cdn $15.49 -- --
Exercised.......... -- -- -- -- -- --
Cancelled.......... (693) Cdn $9.31 (13,854) Cdn $ 9.31 (86,600) Cdn $10.55
------- --------- ------- ---------- ------- ----------
Outstanding at end of
year............... 304,788 Cdn $9.31 393,107 Cdn $10.91 306,507 Cdn $11.02
======= ========= ======= ========== ======= ==========
Stock options
exercisable at
year-end........... Nil Cdn $9.31 81,739 Cdn $ 9.31 145,114 Cdn $10.18
======= ========= ======= ========== ======= ==========
Weighted-average fair
value of stock
options granted
during the year.... Cdn $1.23 Cdn $ 2.53 $Nil
========= ========== ==========
</Table>
The contractual remaining life of the stock options outstanding at December 31,
2000 is approximately five years for 226,503 stock options and approximately six
years for the balance of
- --------------------------------------------------------------------------------
F-19
<Page>
Dynacare Inc.
(Incorporated under the Laws of Ontario)
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(in thousands of U.S. dollars, except for share and per share amounts, all
amounts at June 30, 2001 and June 30, 2000 and for the six months ended
June 30, 2001 and June 30, 2000 are unaudited)
80,004 stock options. The stock options vest as to 20% each year on the
anniversary date of the stock option grant.
<Table>
<Caption>
Six Months Ended June 30,
------------------------------------------------------------------
2000 2001
------------------------------- --------------------------------
Weighted Weighted
average 2001 average
Stock options exercise price Stock options exercise price
(unaudited) (unaudited)
- -----------------------------------------------------------------------------------------------------------
Outstanding at beginning of period..... 393,107 Cdn $10.91 306,507 Cdn $11.06
Granted.............................. -- -- 506,400 U.S. $9.125
Exercised............................ -- -- (45,023) Cdn $15.38
Cancelled............................ (31,172) Cdn $ 9.31 (45,779) Cdn $10.47
------- ---------- ------- -----------
Outstanding at end of period........... 361,935 Cdn $11.38 722,105 Cdn $13.17
======= ========== ======= ===========
Stock options exercisable at
period-end........................... 55,416 Cdn $ 9.50 113,945 Cdn $13.05
======= ========== ======= ===========
Weighted-average fair value of stock
options granted during the year...... $Nil U.S. $9.125
========== ===========
</Table>
The contractual remaining life of the stock options outstanding at June 30,
2001, is approximately 4 years for 180,096 stock options, 5 years for 60,609
stock options, and 6 years for the balance of 481,400 stock options. The stock
options vest as to 20% each year on the anniversary date of the stock option
grant.
10. Severance, relocation and other charges
Upon the completion of Dynacare's initial public offering of its common shares
in November 2000, Dynacare recorded severance, relocation and other charges of
$6.7 million. These charges are as follows:
Severance, lease termination and other costs of $1.9 million related to
the relocation of Dynacare's corporate offices from Toronto, Canada to
Dallas, Texas. As at December 31, 2000, and June 30, 2001, $0.3 million
and $0.8 million, respectively, of these costs were paid;
Termination costs of $0.8 million to terminate an employment contract
with a senior executive officer. As at December 31, 2000, $0.8 million
of these costs were paid:
Amounts paid of approximately $2.1 million to certain of Dynacare's
senior executives to enable them to repay in full outstanding loans made
to them by Dynacare and associated taxes which became due as a result.
As at December 31, 2000, $2.1 million of these costs were paid; and
Other non-cash restructuring charges of $1.9 million, which primarily
includes termination of a services contract.
- --------------------------------------------------------------------------------
F-20
<Page>
Dynacare Inc.
(Incorporated under the Laws of Ontario)
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(in thousands of U.S. dollars, except for share and per share amounts, all
amounts at June 30, 2001 and June 30, 2000 and for the six months ended
June 30, 2001 and June 30, 2000 are unaudited)
11. Income taxes
a) As described in Note 1--Summary of Significant Accounting Policies--Income
Taxes, Dynacare adopted CICA-3465 on a retroactive basis. As a result of the
application of CICA-3465, the book value of Dynacare's licenses and deferred
income taxes at December 31, 2000 and 1999 each increased by $34.6 million and
$35.7 million, respectively. Based on CICA-3465, the book value of Dynacare's
licenses and deferred income taxes at June 30, 2001, and 2000, each increased by
$34.1 million and $35.1 million, respectively.
In addition, under CICA-3465, Dynacare reduced the provision for deferred income
taxes for the year ended December 31, 2000, by $6.1 million due to substantively
enacted tax rate reductions announced by the Canadian federal and provincial
governments. The cumulative reduction in the Canadian federal statutory tax rate
is 1.0%, 3.0%, 5.0% and 7.0% for 2001, 2002, 2003 and 2004 (and thereafter),
respectively. A pro rata 1.0% reduction in the Ontario provincial statutory tax
rate became effective May 2, 2000, and was followed by a further substantively
enacted 0.5% tax rate reduction effective January 1, 2001. The Ontario
government announced a further 6% reduction in its statutory tax rate on May 9,
2001. This tax rate reduction will be phased in ratably over the period from
2002 to 2005.
During the six months ended June 30, 2000, Dynacare reduced the provision for
deferred income taxes by $2.0 million, due to substantively enacted tax rate
reductions announced by the Canadian federal and provincial governments. During
the six months ended June 30, 2001, Dynacare reduced the provision for deferred
income taxes by $3.0 million due to enacted tax rate reductions announced by the
Ontario provincial government. As of June 30, 2001, all of the tax rate
reductions previously announced by the federal and provincial governments have
been legislated.
b) The provision for income taxes differs from the amount computed by applying
the Canadian corporate tax rates to income before income taxes. The reason for
this difference is as follows:
<Table>
<Caption>
Years ended December 31,
------------------------------
(in millions of U.S. dollars) 1998 1999 2000
- --------------------------------------------------------------------------------------------
Canadian corporate income tax rate.......................... 44.62% 44.62% 43.95%
Provision for income taxes based on corporate income tax
rate...................................................... $ 4.1 $ 4.2 $ 0.4
Increase (decrease) in taxes resulting from:
Non-deductible licenses and goodwill amortization......... -- -- 0.2
Non-deductible expenses................................... 0.1 0.2 0.5
Loss (income) from U.S. sources taxed at lower tax
rates..................................................... (1.4) (0.2) 0.7
Minimum corporate tax (not calculated on the basis of
income)................................................... 0.3 0.4 0.5
Reduction in valuation allowance.......................... (0.3) (0.9) (2.4)
Substantively enacted tax rate reductions................. -- -- (6.1)
U.S. state income taxes................................... -- -- 0.7
Other income tax items.................................... 0.2 -- 0.4
------ ------ ------
Provision for income tax expense (benefit) as recorded...... $ 3.0 $ 3.7 $ (5.1)
====== ====== ======
</Table>
- --------------------------------------------------------------------------------
F-21
<Page>
Dynacare Inc.
(Incorporated under the Laws of Ontario)
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(in thousands of U.S. dollars, except for share and per share amounts, all
amounts at June 30, 2001 and June 30, 2000 and for the six months ended
June 30, 2001 and June 30, 2000 are unaudited)
c) The principal items giving rise to the deferred portion of income tax expense
(benefit) are as follows:
<Table>
<Caption>
Years ended December 31,
------------------------------
(in thousands of U.S. dollars) 1998 1999 2000
- --------------------------------------------------------------------------------
Net operating loss carryforwards................ $(3,684) $(5,472) $(4,016)
Deferred deductions............................. (190) (2,179) (3,146)
Deferred financing and restricted interest
carryforwards................................. 458 741 2,725
Deferred earnings............................... 4,804 9,175 2,144
Licenses and goodwill........................... (66) 134 1,058
Capital and other assets........................ 188 698 2,955
Substantively enacted tax rate reductions....... -- -- (6,089)
------- ------- -------
1,510 3,097 (4,369)
Reduction in valuation allowance................ (301) (915) (2,464)
------- ------- -------
Income tax expense (benefit).................... $ 1,209 $ 2,182 $(6,833)
======= ======= =======
</Table>
d) The geographical components of earnings (loss) before income taxes are
summarized below:
<Table>
<Caption>
Years ended December 31,
------------------------------
(in thousands of U.S. dollars) 1998 1999 2000
- ---------------------------------------------------------------------------------
United States.................................... $2,222 $2,556 $(7,147)
Canada........................................... 7,015 6,811 8,087
------ ------ -------
$9,237 $9,367 $ 940
====== ====== =======
</Table>
e) The provision for income tax expense (benefit) is summarized as follows:
<Table>
<Caption>
Years ended December 31,
------------------------------
(in thousands of U.S. dollars) 1998 1999 2000
- ---------------------------------------------------------------------------------
Current:
United States.................................... $ 184 $ 335 $ 1,362
Canada........................................... 1,655 1,209 386
------ ------ -------
1,839 1,544 1,748
------ ------ -------
Deferred:
United States.................................... 524 (299) (4,890)
Canada........................................... 685 2,481 (1,943)
------ ------ -------
1,209 2,182 (6,833)
------ ------ -------
$3,048 $3,726 $(5,085)
====== ====== =======
</Table>
- --------------------------------------------------------------------------------
F-22
<Page>
Dynacare Inc.
(Incorporated under the Laws of Ontario)
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(in thousands of U.S. dollars, except for share and per share amounts, all
amounts at June 30, 2001 and June 30, 2000 and for the six months ended
June 30, 2001 and June 30, 2000 are unaudited)
f) Dynacare's deferred tax assets and liabilities are as follows:
<Table>
<Caption>
December 31,
------------------------------
(in thousands of U.S. dollars) 1998 1999 2000
- -------------------------------------------------------------------------------
Current deferred tax assets:
Net operating loss carryforward................ $ 9,465 $13,417 $11,427
Deferred deductions............................ 2,069 4,035 7,913
------- ------- -------
11,534 17,452 19,340
Non-current deferred tax assets:
Net operating loss carryforwards............... 332 1,852 7,678
Deferred financing and restricted interest
carryforwards................................ 2,730 1,989 1,555
------- ------- -------
Total deferred tax assets...................... 14,596 21,293 28,573
Valuation allowance for deferred tax assets.... (4,605) (3,642) (1,178)
------- ------- -------
Net deferred tax assets........................ $ 9,991 $17,651 $27,395
======= ======= =======
Current deferred tax liability:
Deferred earnings.............................. $13,056 $22,480 $24,345
------- ------- -------
Non-current deferred tax liabilities:
Licenses and goodwill.......................... 34,960 35,120 29,691
Capital and other assets....................... 4,825 5,300 7,933
------- ------- -------
39,785 40,420 37,624
------- ------- -------
Total deferred tax liabilities................. $52,841 $62,900 $61,969
======= ======= =======
Net current deferred tax liabilities........... $ 1,522 $ 5,028 $ 5,005
Net non-current deferred tax liabilities....... 41,328 40,221 29,569
------- ------- -------
Total net deferred tax liabilities............. $42,850 $45,249 $34,574
======= ======= =======
</Table>
g) At December 31, 2000, Dynacare had net operating losses available for carry
forward in the amount of $9.1 million and $35.6 million in the United States and
Canada, respectively (1999-$5.0 million and $29.7 million) to offset against
taxable income in future years. These losses expire periodically to 2007 and
2020 for Canada and the United States, respectively.
12. Related party transactions
At December 31, 2000, housing loans of $1.1 million (1999-$1.1 million), which
were advanced to officers of Dynacare, were repaid (Note 10). These loans were
non-interest bearing and were secured by mortgages on the related properties.
For the years ended December 31, 2000, 1999 and 1998 consulting fees charged to
Dynacare by shareholders were $0.6 million, $0.7 million and $0.7 million,
respectively. These arrangements were terminated upon completion of Dynacare's
initial public offering.
- --------------------------------------------------------------------------------
F-23
<Page>
Dynacare Inc.
(Incorporated under the Laws of Ontario)
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(in thousands of U.S. dollars, except for share and per share amounts, all
amounts at June 30, 2001 and June 30, 2000 and for the six months ended
June 30, 2001 and June 30, 2000 are unaudited)
13. Commitments
Dynacare is committed under existing operating leases at December 31, 2000, to
the following payments:
<Table>
<Caption>
(in thousands of U.S. dollars)
- ---------------------------------------------------------------------
2001........................................................ $14,490
2002........................................................ 11,746
2003........................................................ 9,119
2004........................................................ 7,202
2005........................................................ 6,154
Thereafter.................................................. 36,112
</Table>
At June 30, 2001, Dynacare is committed under existing operating leases to the
following payments for the fiscal years ending December 31:
<Table>
<Caption>
(in thousands of U.S. dollars)
- ----------------------------------------------------------------------
2001........................................................ $ 8,311
2002........................................................ 11,468
2003........................................................ 9,288
2004........................................................ 6,924
2005........................................................ 5,801
Thereafter.................................................. 35,614
</Table>
14. Contingencies
In 1995 Dynacare sold its retirement homes division. On the sale of one of the
retirement homes, the purchaser assumed two mortgages with a total balance of
$12.3 million at December 31, 2000, and $13.0 million at December 31, 1999. The
total balance of these two mortgages was $12.0 million at June 30, 2001 and
$12.7 million at June 30, 2000. Dynacare has not been formally discharged from
the mortgages, however, Dynacare 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.
During 2000, the litigation as previously described in Dynacare's audited
consolidated financial statements for the years ended December 31, 1999, 1998
and 1997 was either dismissed or settled out of court with no material impact on
the financial position and results of operations of Dynacare.
Dynacare 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 Dynacare 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
- --------------------------------------------------------------------------------
F-24
<Page>
Dynacare Inc.
(Incorporated under the Laws of Ontario)
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(in thousands of U.S. dollars, except for share and per share amounts, all
amounts at June 30, 2001 and June 30, 2000 and for the six months ended
June 30, 2001 and June 30, 2000 are unaudited)
that may arise from these contingencies would not have a material adverse affect
on the financial position and results of operations of Dynacare.
15. Segmented information
Management has determined that Dynacare operates in two geographic segments, the
provision of clinical laboratory services in the United States and Canada.
<Table>
<Caption>
As of and for the year ended
December 31, 1998,
---------------------------------
(in thousands of U.S. dollars) U.S. Canada Total
- ----------------------------------------------------------------------------------------------
Revenues................................................... $133,552 $ 91,359 $224,911
Net earnings............................................... 1,515 4,674 6,189
---------------------------------
Total assets............................................... $ 88,059 $143,071 $231,130
Capital assets and licenses and goodwill................... 50,110 100,725 150,835
Purchase of capital assets -- net.......................... 3,805 1,182 4,987
---------------------------------
Laboratory revenue by payor type:
Canadian government agencies............................... $ -- $ 82,415 $ 82,415
Long term hospital contracts............................... 47,279 2,292 49,571
Community (non-hospital) and other......................... 86,273 6,652 92,925
---------------------------------
</Table>
<Table>
<Caption>
As of and for the years ended December 31,
---------------------------------------------------------------------
1999 2000
--------------------------------- ---------------------------------
(in thousands of U.S. dollars) U.S. Canada Total U.S. Canada Total
- ---------------------------------------------------------------------------------------------------------
Revenues.......................... $173,566 $ 99,111 $272,677 $250,747 $102,172 $352,919
Net earnings (loss)............... 2,519 3,122 5,641 (3,619) 9,644 6,025
---------------------------------------------------------------------
Total assets...................... $133,287 $155,232 $288,519 $214,476 $134,500 $348,976
Capital assets and licenses and
goodwill........................ 75,448 98,522 173,970 117,541 95,057 212,598
Purchase of capital assets-net.... 8,667 2,323 10,990 12,302 2,463 14,765
---------------------------------------------------------------------
Laboratory revenue by payor type:
Canadian government agencies.... $ -- $ 87,645 $ 87,645 $ -- $ 90,405 $ 90,405
Long term hospital contracts.... 49,056 2,129 51,185 52,232 1,863 54,095
Community (non-hospital) and
other......................... 124,510 9,337 133,847 198,515 9,904 208,419
---------------------------------------------------------------------
</Table>
- --------------------------------------------------------------------------------
F-25
<Page>
Dynacare Inc.
(Incorporated under the Laws of Ontario)
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(in thousands of U.S. dollars, except for share and per share amounts, all
amounts at June 30, 2001 and June 30, 2000 and for the six months ended
June 30, 2001 and June 30, 2000 are unaudited)
<Table>
<Caption>
As of and for the six months ended June 30,
---------------------------------------------------------------------
2000 2001
--------------------------------- ---------------------------------
U.S. Canada Total U.S. Canada Total
(in thousands of U.S. dollars) (unaudited) (unaudited)
<Caption>
- ---------------------------------------------------------------------------------------------------------
Revenues.......................... $120,631 $ 51,202 $171,833 $144,914 $ 52,767 $197,681
Net earnings (loss)............... 1,365 3,139 4,504 (326) 8,280 7,954
---------------------------------------------------------------------
Total assets...................... $182,388 $140,457 $322,845 $227,647 $131,748 $359,395
Capital assets and licenses and
goodwill........................ 111,362 97,091 208,453 125,264 92,818 218,082
Purchase of capital assets-net.... 4,522 891 5,413 3,307 897 4,204
---------------------------------------------------------------------
Laboratory revenue by payor type:
Canadian government agencies.... $ -- $ 45,125 $ 45,125 $ -- $ 47,637 $ 47,637
Long term hospital contracts.... 26,727 1,114 27,841 28,410 -- 28,410
Community (non-hospital) and
other......................... 93,907 4,960 98,867 116,504 5,130 121,634
---------------------------------------------------------------------
</Table>
16. Consolidated statements of cash flows
Supplementary disclosure required for Dynacare's consolidated statements of cash
flows is as follows:
i) Income taxes paid
For the year ended December 31, 2000, income taxes paid by Dynacare were
$2.9 million (1999--$2.0 million, 1998--$0.3 million). Income taxes paid by
Dynacare during the six months ended June 30, 2001, were $0.9 million
(2000--$1.3 million).
ii) Interest payments
For the year ended December 31, 2000, interest paid by Dynacare was
$18.8 million (1999--$18.5 million, 1998--$15.1 million). Interest paid by
Dynacare during the six months ended June 30, 2001, was $11.0 million
(2000--$9.1 million).
iii) Business combinations
Dynacare's total purchase price consideration for acquisitions made in 2000,
1999, and 1998 was $40.9 million, $27.3 million and $Nil, respectively. Dynacare
did not acquire cash in any of its acquisitions. The total purchase price
consideration was comprised of cash paid of $38.5 million (1999--$20.8 million,
1998--$Nil), promissory notes payable of $1.3 million (1999--$6.2 million,
1998--$Nil) and other short term liabilities of $1.1 million
(1999--$0.3 million, 1998--$Nil).
Dynacare's total purchase price consideration for acquisitions made in the six
months ended June 30, 2001 and 2000 was $10.4 million and $29.7 million,
respectively. Dynacare did not acquire cash in
- --------------------------------------------------------------------------------
F-26
<Page>
Dynacare Inc.
(Incorporated under the Laws of Ontario)
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(in thousands of U.S. dollars, except for share and per share amounts, all
amounts at June 30, 2001 and June 30, 2000 and for the six months ended
June 30, 2001 and June 30, 2000 are unaudited)
any of its other acquisitions. The total purchase price consideration was
comprised of cash paid of $9.2 million (2000--$27.4 million), promissory notes
payable of $1.0 million (2000--$1.3 million) and other short term liabilities of
$0.2 million (2000--$1.0 million).
iv) Capital assets
For the year ended December 31, 2000, capital assets were acquired at an
aggregate cost of $14.8 million (1999--$11.0 million, 1998--$5.0 million) of
which $0.9 million (1999--$Nil, 1998--$0.8 million) were financed by means of
capital leases. During the six months ended June 30, 2001, capital assets were
acquired at an aggregate cost of $4.2 million (2000--$5.4 million).
v) Cash and cash equivalents
<Table>
<Caption>
December 31,
------------------------------
(in thousands of U.S. dollars) 1998 1999 2000
- --------------------------------------------------------------------------------
Cash............................................ $4,701 $ 2,057 $ 7,850
Short term investments with initial maturities
of three months or less at acquisition........ -- 14,270 10,249
------ ------- -------
$4,701 $16,327 $18,099
====== ======= =======
</Table>
<Table>
<Caption>
June 30,
-------------------
2000 2001
(in thousands of U.S. dollars) (unaudited)
<Caption>
- -------------------------------------------------------------------------------
Cash...................................................... $5,040 $10,170
Short term investments with remaining maturities of three
months or less at acquisition........................... -- --
------ -------
$5,040 $10,170
====== =======
</Table>
- --------------------------------------------------------------------------------
F-27
<Page>
Dynacare Inc.
(Incorporated under the Laws of Ontario)
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(in thousands of U.S. dollars, except for share and per share amounts, all
amounts at June 30, 2001 and June 30, 2000 and for the six months ended
June 30, 2001 and June 30, 2000 are unaudited)
vi) Change in non-cash working capital
<Table>
<Caption>
Years ended December 31,
------------------------------
(in thousands of U.S. dollars) 1998 1999 2000
- ------------------------------------------------------------------------------
Accounts receivable........................... $(10,490) $(21,876) $(1,395)
Prepaid expenses.............................. (309) (21) 2,897
Inventory..................................... (182) (2,042) 273
Accounts payable and accrued liabilities...... 464 7,833 3,393
-------- -------- -------
$(10,517) $(16,106) $ 5,168
======== ======== =======
</Table>
<Table>
<Caption>
Six months ended
June 30,
-------------------
2000 2001
(in thousands of U.S. dollars) (unaudited)
<Caption>
- ------------------------------------------------------------------------------
Accounts receivable...................................... $(1,772) $(6,396)
Prepaid expenses......................................... (706) (1,552)
Inventory................................................ 839 (1,212)
Accounts payable and accrued liabilities................. 2,534 (82)
------- -------
$ 895 $(9,242)
======= =======
</Table>
- --------------------------------------------------------------------------------
F-28
<Page>
Dynacare Inc.
(Incorporated under the Laws of Ontario)
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(in thousands of U.S. dollars, except for share and per share amounts, all
amounts at June 30, 2001 and June 30, 2000 and for the six months ended
June 30, 2001 and June 30, 2000 are unaudited)
17. Earnings per share
Earning per share data was computed as follows:
<Table>
<Caption>
Years ended December 31,
(in thousand of U.S. dollars, ---------------------------------------
except for share and per share amounts) 1998 1999 2000
- -----------------------------------------------------------------------------------------------
BASIC EARNINGS PER SHARE
Net earnings.......................................... $ 6,189 $ 5,641 $ 6,025
---------- ---------- ----------
Weighted average number of common shares outstanding
during the year..................................... 11,880,914 11,880,914 12,482,368
---------- ---------- ----------
Basic earnings per share.............................. $ 0.52 $ 0.47 $ 0.48
========== ========== ==========
DILUTED EARNINGS PER SHARE
Net earnings.......................................... $ 6,189 $ 5,641 $ 6,025
---------- ---------- ----------
Weighted average number of common shares outstanding
during the year..................................... 11,880,914 11,880,914 12,482,368
Stock options....................................... -- 583,191 661,603
---------- ---------- ----------
11,880,914 12,464,105 13,143,971
========== ========== ==========
Diluted earnings per share............................ $ 0.52 $ 0.45 $ 0.46
========== ========== ==========
</Table>
<Table>
<Caption>
Six months
ended June 30,
-------------------------
(in thousand of U.S. dollars, 2000 2001
except for share and per share amounts) (unaudited)
<Caption>
- ---------------------------------------------------------------------------------------
BASIC EARNINGS PER SHARE
Net earnings................................................ $ 4,504 $ 7,954
---------- ----------
Weighted average number of common shares outstanding
during the period......................................... 11,880,914 16,891,418
---------- ----------
Basic earnings per share.................................... $ 0.38 $ 0.47
========== ==========
DILUTED EARNINGS PER SHARE
Net earnings................................................ $ 4,504 $ 7,954
---------- ----------
Weighted average number of common shares outstanding
during the period......................................... 11,880,914 16,891,418
Stock options............................................. 562,205 255,193
---------- ----------
12,443,119 17,146,611
========== ==========
Diluted earnings per share.................................. $ 0.36 $ 0.46
========== ==========
</Table>
- --------------------------------------------------------------------------------
F-29
<Page>
Dynacare Inc.
(Incorporated under the Laws of Ontario)
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(in thousands of U.S. dollars, except for share and per share amounts, all
amounts at June 30, 2001 and June 30, 2000 and for the six months ended
June 30, 2001 and June 30, 2000 are unaudited)
18. Major customers
Dynacare's laboratories in Canada are subject to certain regulatory controls
issued by the Ontario Ministry of Health and Long Term Care and the Ministry of
Health and Wellness, Province of Alberta. Revenues received from government
agencies approximates 26% of total revenues for the year ended December 31, 2000
(32% in 1999; 37% in 1998). Revenues received from Canadian government agencies
approximate 24% and 26% of total revenues for the six months ended June 30, 2001
and 2000, respectively. As at December 31, 2000, 1999 and 1998 approximately
17%, 18% and 18% respectively, of accounts receivable were due from these
government agencies. As at June 30, 2001 and 2000, approximately 15% and 13%,
respectively, of accounts receivable were due from these government agencies.
In the United States, Dynacare earns a portion of its revenues from U.S.
government agencies (Medicare/Medicaid). These revenues constituted
approximately 13% of total revenues for the year ended December 31, 2000 (9% in
1999, 8% in 1998). Revenues received from the Medicare/Medicaid programs
approximate 14% and 13% of total revenues for the six months ended June 30, 2001
and 2000. As at December 31, 2000, 1999 and 1998 approximately 18%, 16% and 12%,
respectively, of accounts receivable were due from the Medicare/Medicaid
programs. As at June 30, 2001 and 2000, approximately 20% and 15%, respectively,
of accounts receivable were due from the Medicare/ Medicaid programs.
In arriving at net revenues, certain allowances and discounts are deducted
relating to Dynacare's reimbursement agreement with the Ontario government in
Canada and contractual allowances for certain payors in the United States. The
laboratory industry in Ontario is subject to an agreement with the provincial
government wherein each laboratory is allocated a fixed share of the overall
industry reimbursement each year. Factors can arise to cause an individual
laboratory to receive more than its pro rata share of reimbursement, obligating
it to repay the Ontario government for such excess. An estimate of the excess is
withheld by the Ontario government from monthly payments made to Dynacare with
any residual amounts payable being settled subsequent to year end. In the United
States, payment arrangements for laboratory services performed for certain
payors include prospectively determined rates for service, discounted charges,
capitation and other arrangements.
The calculation of these allowances and discounts and the resultant provision on
the balance sheet requires estimates and assumptions based on a number of
different factors including Dynacare's past experiences. Despite the use of
Dynacare's best estimates, it is reasonably possible that these amounts could
change based on experience and other factors. Allowances and discounts of
$138.1 million, $71.9 million and $58.3 million for the years ended
December 31, 2000, 1999 and 1998, and $87.6 million and $62.6 million for the
six months ended June 30, 2001 and 2000, respectively, have been deducted in
arriving at net revenues. Included in accounts receivable as at December 31,
2000, 1999 and 1998 and as at June 30, 2001 and 2000, are allowances and
discounts of $50.2 million, $26.6 million, $19.3 million, $56.4 million and
$51.8 million, respectively.
- --------------------------------------------------------------------------------
F-30
<Page>
Dynacare Inc.
(Incorporated under the Laws of Ontario)
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(in thousands of U.S. dollars, except for share and per share amounts, all
amounts at June 30, 2001 and June 30, 2000 and for the six months ended
June 30, 2001 and June 30, 2000 are unaudited)
19. Joint venture partnerships
Dynacare conducts certain of its businesses through incorporated and
unincorporated joint ventures in which Dynacare has a 73% or less interest.
Condensed combined statements of financial position, statements of operations
and statements of cash flows based on Dynacare's proportionate interests in
these joint ventures are presented below. Certain costs recorded at the
corporate level, have not been allocated to the operating results of the joint
ventures.
<Table>
<Caption>
December 31, June 30,
--------------------------------- ---------------------
1998 1999 2000 2000 2001
(in thousands of U.S. dollars) (unaudited)
<Caption>
- -------------------------------------------------------------------------------------------------
Current assets........................ $ 24,244 $ 28,293 $ 27,088 $ 25,660 $ 27,981
Other assets.......................... 108,590 106,916 116,229 109,528 115,319
-------- -------- -------- -------- --------
$132,834 $135,209 $143,317 $135,188 $143,300
======== ======== ======== ======== ========
Current liabilities................... $ 16,296 $ 12,855 $ 13,712 $ 16,516 $ 15,035
Long term debt........................ 2,936 2,939 2,883 2,796 2,692
-------- -------- -------- -------- --------
$ 19,232 $ 15,794 $ 16,595 $ 19,312 $ 17,727
======== ======== ======== ======== ========
Net investment in joint ventures...... $113,602 $119,415 $126,722 $115,876 $125,573
======== ======== ======== ======== ========
</Table>
<Table>
<Caption>
Six months ended
Years ended December 31, June 30,
--------------------------------- -------------------
1998 1999 2000 2000 2001
(in thousands of U.S. dollars) (unaudited)
<Caption>
- -----------------------------------------------------------------------------------------------
Revenues.............................. $125,105 $137,633 $149,412 $ 73,590 $ 82,657
General and operating expenses........ 93,686 100,833 113,660 54,849 63,720
Depreciation.......................... 2,586 3,108 3,262 1,556 1,914
Amortization of licenses and
goodwill............................ 1,722 2,265 2,210 756 1,433
-------- -------- -------- -------- --------
Earnings before income taxes.......... $ 27,111 $ 31,427 $ 30,280 $ 16,429 $ 15,590
======== ======== ======== ======== ========
Cash provided by operating
activities.......................... $ 24,977 $ 33,678 $ 35,689 $ 21,210 $ 18,360
-------- -------- -------- -------- --------
Cash used in investing activities..... $ (342) $ (2,858) $(14,788) $ (4,926) $ (2,436)
-------- -------- -------- -------- --------
Cash used in financing activities..... $(22,688) $(31,136) $(23,944) $(15,770) $(16,576)
-------- -------- -------- -------- --------
</Table>
- --------------------------------------------------------------------------------
F-31
<Page>
Dynacare Inc.
(Incorporated under the Laws of Ontario)
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(in thousands of U.S. dollars, except for share and per share amounts, all
amounts at June 30, 2001 and June 30, 2000 and for the six months ended
June 30, 2001 and June 30, 2000 are unaudited)
20. Differences between U.S. and Canadian Generally Accepted Accounting
Principles
The effects on Dynacare's consolidated financial statements resulting from the
differences between Canadian and U.S. generally accepted accounting principles
("GAAP") as described in 20(a) to 20(j) are presented in the consolidated
financial information that follows:
Consolidated Balance Sheets (a) -- U.S. GAAP
<Table>
<Caption>
December 31, June 30,
--------------------- ---------------------
1999 2000 2000 2001
(in thousands of U.S. dollars) (unaudited)
- ------------------------------------------------------------------------------------------------
Assets
Current assets:
Cash and cash equivalents...................... $ 13,627 $ 17,856 $ 1,484 $ 6,259
Accounts receivable............................ 39,252 39,225 48,954 44,448
Prepaid expenses............................... 4,531 1,844 5,105 3,002
Inventory...................................... 4,150 4,797 3,760 5,453
Deferred income taxes.......................... 2,322 5,956 2,246 5,960
-------- -------- -------- --------
Total current assets............................. 63,882 69,678 61,549 65,122
-------- -------- -------- --------
Capital assets................................... 24,697 30,899 31,259 30,433
Goodwill......................................... 55,435 76,989 82,711 83,308
Other assets..................................... 20,935 36,956 22,931 40,151
Equity investments............................... 120,907 125,141 111,266 125,573
-------- -------- -------- --------
221,974 269,985 248,167 279,465
-------- -------- -------- --------
$285,856 $339,663 $309,716 $344,587
======== ======== ======== ========
Liabilities
Current liabilities:
Bank indebtedness.............................. $ 1,901 $ -- $ 9,162 $ --
Accounts payable and accrued liabilities....... 23,139 32,669 30,611 31,420
Current portion of deferred income taxes....... 7,480 10,961 7,455 10,705
Current portion of long term debt................ 2,010 5,524 8,505 4,509
-------- -------- -------- --------
Total current liabilities........................ 34,530 49,154 55,733 46,634
Long term debt................................... 202,296 199,404 201,253 198,959
Deferred income taxes............................ 40,275 34,534 40,629 26,845
-------- -------- -------- --------
277,101 283,092 297,615 272,438
-------- -------- -------- --------
Shareholders' equity
Capital stock.................................... 54,420 101,514 54,420 101,984
Deficit.......................................... (46,991) (47,785) (44,571) (34,122)
-------- -------- -------- --------
7,429 53,729 9,849 67,862
Accumulated other comprehensive earnings......... 1,326 2,842 2,252 4,287
-------- -------- -------- --------
8,755 56,571 12,101 72,149
-------- -------- -------- --------
$285,856 $339,663 $309,716 $344,587
======== ======== ======== ========
</Table>
- --------------------------------------------------------------------------------
F-32
<Page>
Dynacare Inc.
(Incorporated under the Laws of Ontario)
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(in thousands of U.S. dollars, except for share and per share amounts, all
amounts at June 30, 2001 and June 30, 2000 and for the six months ended
June 30, 2001 and June 30, 2000 are unaudited)
Consolidated Statements of Operations and Comprehensive Earnings (a)--U.S. GAAP
<Table>
<Caption>
Six Months
Years Ended December 31, Ended June 30,
-------------------------------- --------------------
1998 1999 2000 2000 2001
(in thousands of U.S. dollars) (unaudited)
- -------------------------------------------------------------------------------------------------
Revenues................................ $99,612 $134,581 $203,922 $99,266 $115,024
Earnings from equity investments........ 25,698 30,364 29,565 15,616 15,584
------- -------- -------- ------- --------
125,310 164,945 233,487 114,882 130,608
------- -------- -------- ------- --------
General and operating expenses.......... 96,247 129,955 194,107 93,015 107,896
Depreciation............................ 3,840 5,225 8,095 3,668 3,862
Amortization of goodwill................ 1,275 1,728 2,337 1,001 1,243
Severance, relocation and other
charges............................... -- -- 6,750 -- --
------- -------- -------- ------- --------
101,362 136,908 211,289 97,684 113,001
------- -------- -------- ------- --------
Operating earnings...................... 23,948 28,037 22,198 17,198 17,607
Interest expense........................ 14,967 18,949 22,124 11,009 10,355
Non-controlling interest................ 12 -- -- 32 --
------- -------- -------- ------- --------
Earnings before income taxes............ 8,969 9,088 74 6,157 7,252
Income taxes expense (benefit):
Current............................... 1,836 1,539 1,734 1,473 429
Deferred.............................. 1,190 2,159 (866) 2,264 (6,841)
------- -------- -------- ------- --------
3,026 3,698 868 3,737 (6,412)
------- -------- -------- ------- --------
Net earnings (loss)..................... 5,943 5,390 (794) 2,420 13,664
Other comprehensive earnings (loss), net
of tax................................ (241) 327 1,516 926 1,445
------- -------- -------- ------- --------
Comprehensive earnings.................. $ 5,702 $ 5,717 $ 722 $ 3,346 $ 15,109
======= ======== ======== ======= ========
</Table>
<Table>
<Caption>
Six Months
Years Ended December 31, Ended June 30,
--------------------------------------- -------------------------
1998 1999 2000 2000 2001
(in thousands of U.S. dollars) (unaudited)
- ---------------------------------------------------------------------------------------------------
Basic earnings (loss) per
share....................... $ 0.50 $ 0.45 $ (.06) $ 0.20 $ 0.81
========== ========== ========== ========== ==========
Diluted earnings (loss) per
share....................... $ 0.50 $ 0.43 $ (.06) $ 0.19 $ 0.80
========== ========== ========== ========== ==========
Weighted average number of
common shares outstanding-
Basic....................... 11,880,914 11,880,914 12,482,368 11,880,914 16,891,418
========== ========== ========== ========== ==========
Weighted average number of
common shares outstanding-
Diluted..................... 11,880,914 12,464,105 13,143,971 12,443,119 17,146,611
========== ========== ========== ========== ==========
</Table>
- --------------------------------------------------------------------------------
F-33
<Page>
Dynacare Inc.
(Incorporated under the Laws of Ontario)
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(in thousands of U.S. dollars, except for share and per share amounts, all
amounts at June 30, 2001 and June 30, 2000 and for the six months ended
June 30, 2001 and June 30, 2000 are unaudited)
Consolidated Statements of Cash Flows(a)--U.S. GAAP
<Table>
<Caption>
Six Months
Years Ended December 31, Ended June 30,
------------------------------- -------------------
1998 1999 2000 2000 2001
(in thousands of U.S. dollars) (unaudited)
- --------------------------------------------------------------------------------------------------
Cash flow from operating activities
Net earnings (loss)........................ $5,943 $ 5,390 $ (794) $ 2,420 $13,664
Adjustments to reconcile net earnings
(loss) to net cash provided by (used in)
operating activities:
Depreciation............................. 3,840 5,225 8,095 3,668 3,862
Amortization of goodwill................. 1,275 1,728 2,337 1,001 1,243
Deferred income taxes.................... 1,190 2,159 (866) 2,264 (6,412)
Severance, relocation and other
charges................................ -- -- 3,021 -- --
Non-controlling interest................. -- -- -- 32 --
Equity earnings (net of distributions to
joint venture partners)................ (3,267) (6,150) 4,418 2,346 1,174
Gain on sale of capital assets........... (61) (11) (110) -- --
Stock compensation....................... -- -- 660 -- 140
Change in assets and liabilities, net of
effects of acquisitions:
Accounts receivable...................... (3,623) (18,129) (3,037) (5,092) (5,368)
Prepaid expenses......................... (445) (216) 2,700 (366) (1,166)
Inventory................................ (154) (1,198) 225 495 (564)
Accounts payable and accrued
liabilities............................ (1,267) 4,756 3,324 1,410 (1,021)
------ ------- ------- ------- -------
Net cash provided by (used in) operating
activities............................... 3,431 (6,446) 19,973 8,178 5,552
------ ------- ------- ------- -------
Cash flow from investing activities
Decrease (increase) in equity
investments.............................. 1,338 135 (3,901) 4,560 (2,140)
Acquisition of businesses.................. -- (20,005) (37,681) (28,918) (7,729)
Purchase of capital assets................. (2,193) (8,234) (7,745) (3,764) (2,195)
Proceeds from sale of capital assets....... 125 38 132 -- --
Decrease (increase) in other assets........ 789 (6,420) (7,670) (1,228) (4,293)
------ ------- ------- ------- -------
Net cash provided by (used in) investing
activities............................... 59 (34,486) (56,865) (29,350) (16,357)
------ ------- ------- ------- -------
</Table>
- --------------------------------------------------------------------------------
F-34
<Page>
Dynacare Inc.
(Incorporated under the Laws of Ontario)
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(in thousands of U.S. dollars, except for share and per share amounts, all
amounts at June 30, 2001 and June 30, 2000 and for the six months ended
June 30, 2001 and June 30, 2000 are unaudited)
<Table>
<Caption>
Six Months
Years Ended December 31, Ended June 30,
------------------------------ -------------------
1998 1999 2000 2000 2001
(in thousands of U.S. dollars) (unaudited)
- ------------------------------------------------------------------------------------------------
Cash flow from financing activities
Increase (decrease) in bank
indebtedness............................ $ (418) $ (1,768) $(6,679) $ 2,483 $ --
Proceeds from long term debt.............. -- 69,156 4,738 4,490 --
Repayment of long term debt............... (1,969) (16,841) (5,806) (377) (1,199)
Issue of capital stock -- net proceeds.... -- -- 46,433 -- 330
------- -------- ------- -------- --------
Net cash provided by (used in) financing
activities.............................. (2,387) 50,547 38,686 6,596 (869)
------- -------- ------- -------- --------
Foreign exchange translation
adjustments............................. (47) 2,716 2,435 2,433 77
------- -------- ------- -------- --------
Net increase (decrease) in cash and cash
equivalents during the period........... 1,056 12,331 4,229 (12,143) (11,597)
Cash and cash equivalents, beginning of
period.................................. 240 1,296 13,627 13,627 17,856
------- -------- ------- -------- --------
Cash and cash equivalents, end of
period.................................. $ 1,296 $ 13,627 $17,856 $ 1,484 $ 6,259
======= ======== ======= ======== ========
</Table>
Supplemental disclosure required under U.S. GAAP:
<Table>
<Caption>
Six Months
Ending
Years Ended December 31, June 30,
------------------------------ -------------------
1998 1999 2000 2000 2001
(in thousands of U.S. dollars) (unaudited)
- ------------------------------------------------------------------------------------------------
Rental expense............................ $ 2,634 $ 3,172 $ 5,044 $ 1,991 $ 2,660
======= ======== ======= ======== ========
</Table>
- --------------------------------------------------------------------------------
F-35
<Page>
Dynacare Inc.
(Incorporated under the Laws of Ontario)
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(in thousands of U.S. dollars, except for share and per share amounts, all
amounts at June 30, 2001 and June 30, 2000 and for the six months ended
June 30, 2001 and June 30, 2000 are unaudited)
The effects on Dynacare's consolidated earnings (loss) from operations resulting
from the differences between Canadian and U.S. GAAP are as follows:
<Table>
<Caption>
Six Months
Years Ended December 31, Ended June 30,
------------------------------- -------------------
1998 1999 2000 2000 2001
(in thousands of U.S. dollars) (unaudited)
<Caption>
- ----------------------------------------------------------------------------------------------------
Net earnings based on Canadian GAAP.......... $6,189 $5,641 $ 6,025 $4,504 $ 7,954
Earnings from equity investments (c)....... (250) (250) (250) (127) (120)
Stock compensation(f)...................... -- -- (660) -- (140)
Change in reporting currency (g)........... (12) (17) 60 28 --
Income taxes (i)........................... 16 16 (5,969) (1,985) 5,970
------ ------ ------- ------ -------
Net earnings (loss) based on U.S. GAAP....... 5,943 5,390 (794) 2,420 13,664
Adjustment to reconcile to comprehensive
earnings:
Foreign currency translation adjustment...... (241) 327 1,516 926 1,445
------ ------ ------- ------ -------
Comprehensive earnings based on U.S. GAAP.... $5,702 $5,717 $ 722 $3,346 $15,109
====== ====== ======= ====== =======
</Table>
The cumulative effect of these adjustments on the consolidated shareholders'
equity of Dynacare is as follows:
<Table>
<Caption>
Six Months
Years Ended December 31, Ended June 30,
------------------------------- -------------------
1998 1999 2000 2000 2001
(in thousands of U.S. dollars) (unaudited)
<Caption>
- --------------------------------------------------------------------------------------------------
Shareholders' equity based on Canadian
GAAP..................................... $(3,968) $1,646 $55,251 $ 6,601 $63,861
Amortization of licenses and goodwill
(b)...................................... (6,980) (6,980) (6,980) (6,980) (6,980)
Earnings from equity investments (c)....... (2,092) (2,342) (2,592) (2,593) (2,713)
Write-down in equity investments (d)....... (4,357) (4,357) (4,357) (4,357) (4,357)
Start-up costs and capitalized interest
(h)...................................... (1,661) (1,661) (1,661) (1,661) (1,661)
Foreign currency translation............... (70) 267 697 887 1,815
Income taxes (i)........................... 22,166 22,182 16,213 20,204 22,184
------- ------ ------- ------- -------
Shareholders' equity based on U.S. GAAP.... $ 3,038 $8,755 $56,571 $12,101 $72,149
======= ====== ======= ======= =======
</Table>
The significant differences between Canadian GAAP and the principles prescribed
by U.S. GAAP and U.S. securities regulations and the impact on the consolidated
financial statements are described as follows:
(A) EQUITY METHOD OF ACCOUNTING FOR JOINT VENTURES AND PARTNERSHIPS
APB Opinion 18 and Statement of Position 78-9 generally require that investments
in corporate and unincorporated joint ventures and partnerships are to be
accounted for by the equity method.
- --------------------------------------------------------------------------------
F-36
<Page>
Dynacare Inc.
(Incorporated under the Laws of Ontario)
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(in thousands of U.S. dollars, except for share and per share amounts, all
amounts at June 30, 2001 and June 30, 2000 and for the six months ended
June 30, 2001 and June 30, 2000 are unaudited)
Under Canadian GAAP, investments in joint ventures and partnerships are
accounted for by the proportionate consolidation method, as the use of the
equity method is not permitted.
The use of proportionate consolidation method as compared to the equity method
of accounting from a financial presentation perspective impact almost all areas
of Dynacare's consolidated balance sheets, statements of operations and
comprehensive earnings, and cash flow statements and as a result this financial
information has been presented in its entirety. The proportionate consolidation
and equity method of accounting do not impact Dynacare's consolidated
shareholders' equity or net earnings (loss) for the periods presented.
(B) AMORTIZATION OF LICENSES AND GOODWILL
Prior to December 31, 1990, Dynacare did not amortize certain components of
licenses and goodwill on the basis that they were considered to have an
indefinite life. Commencing January 1, 1991, Dynacare began amortizing the cost
of licenses and goodwill on a straight-line basis primarily over forty years to
comply with the pronouncement of the Canadian Institute of Chartered Accountants
requiring the amortization of intangible assets. Licenses in Ontario are
required to perform specific tests and receive reimbursement for these tests.
U.S. GAAP requires the cost of intangible assets to be amortized from the date
of acquisition over a period not exceeding forty years.
(C) EARNINGS FROM EQUITY INVESTMENTS
Under the equity method of accounting, Dynacare's ownership interest in certain
licenses and goodwill has been reclassified and appropriately accounted for in
the equity investments account. The additional amortization of these licenses
and goodwill has been reflected in the earnings from equity investments. The
differences in the book value and amortization of licenses and goodwill arose
from the 1997 licenses and goodwill impairment charge which under Canadian and
U.S. GAAP totaled $79.4 million and $69.1 million, respectively. In addition,
under U.S. GAAP, licenses and goodwill accounted for through the equity
investments have been amortized since the date of acquisition, whereas under
Canadian GAAP there was no amortization prior to 1991.
(D) WRITE-DOWN EQUITY INVESTMENTS
The write-down in equity investments for U.S. GAAP purposes arises as the
impairment of certain of Dynacare's licenses and goodwill are accounted for
through the equity investments account, whereas for Canadian GAAP purposes they
have been proportionately consolidated.
U.S. to Canadian GAAP differences in the write-down of equity investments of
$4.4 million arose due to the following: (i) under U.S. GAAP, licenses and
goodwill accounted for through the equity investments account have been
amortized since the date of acquisition, whereas under Canadian GAAP there was
no amortization prior to 1990; and (ii) different methods were used in the
calculation of the cash flows to determine the fair value of the licenses and
goodwill held through equity investments. The calculation of the licenses and
goodwill impairment under U.S. GAAP does not include an allocation of interest
expense but is based upon a discounted cash flow. Under Canadian GAAP, the cash
flow is undiscounted and includes an allocation of interest.
- --------------------------------------------------------------------------------
F-37
<Page>
Dynacare Inc.
(Incorporated under the Laws of Ontario)
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(in thousands of U.S. dollars, except for share and per share amounts, all
amounts at June 30, 2001 and June 30, 2000 and for the six months ended
June 30, 2001 and June 30, 2000 are unaudited)
(E) BUSINESS ACQUISITIONS
For U.S. GAAP purposes, "APB Opinion 16--Business Combinations" requires
supplemental pro forma information on business acquisitions made during the
years ended December 31, 2000 and 1999 and for the six months ended June 30,
2001 and 2000 to be disclosed as part of the notes to the acquiror's
consolidated financial statements. The pro forma information shown below
includes revenues and net earnings prepared both on a U.S. and Canadian GAAP
basis.
The unaudited pro forma results of operations of Dynacare for the years ended
December 31, 2000 and 1999 assuming that Dynacare's acquisitions made during
2000 had been consummated as of January 1, 1999 and assuming Dynacare's
acquisitions made during the six months ended June 30, 2001 had been consummated
as of January 1, 2000, is as follows:
CANADIAN GAAP
<Table>
<Caption>
Years Ended December 31, Six Months Ended June 30,
------------------------- -------------------------
1999 2000 2000 2001
(in thousands of U.S. dollars) (unaudited) (unaudited)
<Caption>
- ------------------------------------------------------------------------------------------------
Revenues................................. $327,264 $371,624 $182,155 $202,051
-------- -------- -------- --------
Net earnings............................. $ 6,950 $ 7,371 $ 5,265 $ 8,531
-------- -------- -------- --------
</Table>
U.S. GAAP
<Table>
<Caption>
Years Ended December 31, Six Months Ended June 30,
------------------------- -------------------------
1999 2000 2000 2001
(in thousands of U.S. dollars) (unaudited) (unaudited)
<Caption>
- ------------------------------------------------------------------------------------------------
Revenues................................. $217,350 $251,335 $124,412 $134,108
-------- -------- -------- --------
Net earnings............................. $ 7,026 $ 551 $ 3,180 $ 14,241
-------- -------- -------- --------
</Table>
Results of operations of Dynacare's acquisitions for 2000 and for the six months
ended June 30, 2001 have been included in the statement of operations and
comprehensive earnings from the respective dates of acquisition.
(F) STOCK COMPENSATION
At June 30, 2001 and December 31, 2000, Dynacare had two stock option plans
which are described below and in Note 9. For U.S. GAAP requirements, Dynacare
applies APB Opinion 25 and related Interpretations in accounting for its plans
and follows the disclosure requirements as set out by FASB 123. In 1997,
Dynacare repurchased all of its outstanding options for Class B subordinate
voting shares. For the year ended December 31, 2000, under APB Opinion 25, the
compensation charged was $0.7 million (1999--$Nil, 1998--Nil). For the six
months ended June 30, 2001 and 2000 the compensation charged was $0.1 million
(2000--$Nil).
- --------------------------------------------------------------------------------
F-38
<Page>
Dynacare Inc.
(Incorporated under the Laws of Ontario)
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(in thousands of U.S. dollars, except for share and per share amounts, all
amounts at June 30, 2001 and June 30, 2000 and for the six months ended
June 30, 2001 and June 30, 2000 are unaudited)
If the compensation cost for Dynacare 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 method of FASB Statement 123, the pro forma net
earnings (loss) under U.S. GAAP would have been as follows:
<Table>
<Caption>
Six Months
Years Ended December 31, Ended June 30,
1998 1999 2000 2000 2001
(in thousands of U.S. dollars) (unaudited)
<Caption>
- ------------------------------------------------------------------------------------------------------
Pro forma net earnings (loss)................... $5,539 $5,054 $ (461) $2,290 $13,482
====== ====== ====== ====== =======
Pro forma earnings (loss) per share............. $ 0.47 $ 0.43 $(0.04) $ 0.13 $ 0.80
====== ====== ====== ====== =======
</Table>
Beginning on November 22, 2000, which is the date Dynacare completed an initial
public offering of its common shares, 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 period November 17, 2000
(initial market trade date) to December 31, 2000; dividend yield of Nil%,
risk-free interest rate range of 4.73% to 5.93% and expected life of 5 years.
Using the same stock option pricing model, the following assumptions were used
by Dynacare for the six months ended June 30, 2001: dividend yield of Nil%,
risk-free interest rate range of 4.52% to 5.28%, expected life of 5 years and
volatility factor of 0.96. Prior to Dynacare's initial public offering of its
common shares the fair value of each option grant of common shares for all
options was estimated on the date of the option grant using an option-pricing
model for non-public companies with the following assumptions: dividend yield of
Nil%, risk-free interest rate range of 4.76% to 5.07% and expected life of
5 years.
(G) FOREIGN CURRENCY TRANSLATION
Effective July 1, 2000, Dynacare adopted the U.S. dollar as its reporting
currency. Prior to this change the Canadian dollar had been used as Dynacare's
reporting currency. Under Canadian GAAP, Dynacare's financial statements for all
periods presented through June 30, 2000, have been translated from Canadian
dollars to U.S. dollars using the exchange rate in effect at July 1, 2000. Under
U.S GAAP, the financial statements for periods prior to the change in reporting
currency must be translated to U.S. dollars using the current rate method, which
method uses period end or annual average exchange rates as appropriate.
(H) START-UP COSTS AND CAPITALIZED INTEREST
Dynacare's policy has been to capitalize certain carrying costs, including
interest, on real estate properties under development until the property became
operational, which was deemed to be the earlier of when break-even cash flow was
achieved and a reasonable time period after substantial completion, not to
exceed thirty months. U.S. GAAP requires that interest costs incurred on real
estate properties be capitalized, but only during the period in which the asset
is being readied for its intended use. The Company's real estate retirement
properties were disposed in 1995.
(I) INCOME TAXES
Effective January 1, 2000, Dynacare has adopted CICA--3465 which is
substantially similar with the Statement of Financial Accounting Standards--No
109, Accounting for Income Taxes in the United States. CICA--3465 and FASB 109
require the liability method of tax allocation for accounting for
- --------------------------------------------------------------------------------
F-39
<Page>
Dynacare Inc.
(Incorporated under the Laws of Ontario)
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(in thousands of U.S. dollars, except for share and per share amounts, all
amounts at June 30, 2001 and June 30, 2000 and for the six months ended
June 30, 2001 and June 30, 2000 are unaudited)
income taxes. Under the liability method of tax allocation, deferred tax assets
and liabilities are recognized based on the temporary differences between the
accounting and tax bases of assets and liabilities. Changes in income tax rates
under CICA--3465 are recorded when the tax rates have been substantially
enacted. As discussed in Note 11, changes in income tax rates resulted in the
recognition by Dynacare of an income tax benefit in the amount of $6.1 million
for the year ended December 31, 2000 and $3.0 million and $2.0 million for the
six months ended June 30, 2001, and 2000. Under U.S. GAAP, changes in income tax
rates are recorded when the change in income tax rates have been legislated. As
of June 30, 2001, all of the tax rate reductions previously announced by the
Canadian federal and provincial governments have been legislated.
(J) ACCOUNTING PRONOUNCEMENTS
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 is effective for
Dynacare 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.
Dynacare's foreign currency derivatives are designated as a fair value hedge.
Under U.S. GAAP, for derivative instruments that are designated and qualify as a
fair value hedge (i.e., hedging the exposure to changes in the fair value of an
asset or a liability or an identified portion thereof that is attributable to a
particular risk), the gain or loss on the derivative instrument as well as the
offsetting loss or gain on the hedged item attributable to the hedged risk are
recognized in current earnings during the period of the change in fair values.
For derivative instruments that are designated and qualify as a cash flow hedge
(i.e., hedging the exposure to variability in expected future cash flows that is
attributable to a particular risk), the effective portion of the gain or loss on
the derivative instrument is reported as a component of other comprehensive
income and reclassified into earnings in the same period or periods during which
the hedged transaction affects earnings. The remaining gain or loss on the
derivative instrument in excess of the cumulative change in the present value of
future cash flows of the hedged item, if any, is recognized in current earnings
during the period of change. For derivative instruments that are designated and
qualify as a hedge of a net investment in a foreign currency, the gain or loss
is reported in other comprehensive income as part of the cumulative translation
adjustment to the extent it is effective. For derivative instruments not
designated as hedging instruments, the gain or loss is recognized in current
earnings during the period of change. Canadian GAAP does not provide for other
comprehensive income.
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. Under the new rules, goodwill and
intangible assets deemed to have an indefinite life will no longer be amortized
but will be subject to annual impairment tests in accordance with FASB 141 and
FASB 142. Other intangible assets will continue to be amortized over their
useful life.
- --------------------------------------------------------------------------------
F-40
<Page>
Dynacare Inc.
(Incorporated under the Laws of Ontario)
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(in thousands of U.S. dollars, except for share and per share amounts, all
amounts at June 30, 2001 and June 30, 2000 and for the six months ended
June 30, 2001 and June 30, 2000 are unaudited)
Dynacare will perform the required impairment tests of goodwill and intangible
assets with an indefinite life effective as of January 1, 2002, and has not yet
determined what the effect of these tests will be on its net earnings and
financial position.
In August 2001, the Financial Accounting Standards Board issued Standard
No. 144--Accounting for the Impairment or Disposal of Long-Lived Assets
("FASB 144") effective for fiscal years beginning after December 15, 2001.
FASB 144 addresses financial accounting and reporting for the impairment of
long-lived assets and for long-lived assets to be disposed of. This statement
supersedes FASB 121--Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to be Disposed of. FASB 144 retains the fundamental provisions
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. Dynacare has not yet determined what the effect of
FASB 144 will be on its net earnings and financial position.
21. Comparative Figures
Certain comparative figures have been reclassified to conform with the current
year's presentation.
- --------------------------------------------------------------------------------
F-41
<Page>
DESCRIPTION OF PICTURES ON INSIDE BACK COVER OF PROSPECTUS:
4 pictures
Upper left--lab technician loading lab specimens on a testing instrument.
Upper right--lab technician sorting and placing lab specimen on a testing rack.
Lower left--lab technician examining specimen through a microscope
Lower right-pathologist conversing with Dynacare General Manager.
<Page>
[LOGO]
<Page>
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION
The following table sets forth all expenses, other than the underwriting
discounts and commissions, payable by the registrant in connection with the sale
of the securities being registered. All amounts shown are estimates except the
SEC registration fee and the NASD filing fee.
<Table>
SEC registration fee........................................ $ 19,766
NASD filing fee............................................. 8,406
Printing and engraving expenses............................. 175,000
Accountant's fees and expenses.............................. 125,000
Legal fees and expenses..................................... 325,000
Registrar and Transfer Agent fees........................... 50,000
Miscellaneous............................................... 96,828
--------
Total....................................................... $800,000
========
</Table>
ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS
The Company is governed by the Business Corporations Act (Ontario) (OBCA).
As authorized by Section 136 of the OBCA, the By-laws of the Company (copies of
which are or will be filed as Exhibit 3.2(a) and Exhibit 3.2(b) to this
registration statement), being the general By-law of the Company, provides that
subject to the OBCA the Company shall indemnify each director and officer of the
Company, each former director and officer of the Company, and each person who
acts or acted at the Company's request as a director or officer of any body
corporate of which the Company is or was a shareholder or creditor (or a person
who undertakes or has undertaken any liability on behalf of the Company or any
such body corporate) and his heirs and representatives against all costs,
charges and expenses, and including an amount paid to settle an action or
satisfy a judgment, reasonably incurred by him in respect of any civil, criminal
or administrative action or proceeding to which he is made a party by reason of
being or having been a director or officer of the Company or such body
corporate, if:
(a) he acted honestly and in good faith with a view to the best interests of
the Company; and
(b) in the case of a criminal or administrative action or proceeding that is
enforced by a monetary penalty, he had reasonable grounds for believing
that his conduct was lawful.
The By-laws provide that no director or officer of the Company shall be
liable for the acts, receipts, neglects or defaults of any other director or
officer or employee, or for joining in any receipt or other act for conformity,
or for any loss, damage or expense happening to the Company through the
insufficiency or deficiency of title to any property acquired for or on behalf
of the Company, or for the insufficiency or deficiency of any security in or
upon which any of the monies of the Company shall be invested, or for any loss
or damage arising from the bankruptcy, insolvency or tortious acts of any person
with whom any of the monies, securities or effects of the Company shall be
deposited, or for any loss occasioned by any error of judgment or oversight on
his part, or for any other loss, damage or misfortune whatever which shall
happen in the execution of the duties of his office or in relation thereto; but
provide that nothing in that section relieves any director or officer from his
duty to act in accordance with the OBCA and the Regulations thereunder or from
liability for any breach thereof.
II-1
<Page>
Section 134 of the OBCA provides that every director and officer of a
corporation in exercising his or her powers and discharging his or her duties
shall:
(a) act honestly and in good faith with a view to the best interests of the
corporation; and
(b) exercise the care, diligence and skill that a reasonably prudent person
would exercise in comparable circumstances.
Section 134 also provides that every director and officer of a corporation
shall comply with the OBCA, the regulations thereto, and the articles and
by-laws of the corporation. Subject to limited exceptions, Section 134 of the
OBCA also provides that no provision in a contract, the articles, the by-laws of
the corporation, or a resolution, relieves a director or officer from the duty
to act in accordance with the OBCA and the regulations thereto or relieves him
or her from liability for a breach thereof.
The Underwriting Agreement (Exhibit 1.1 hereto) provides for indemnification
by the underwriters of the registrant and its executive officers and directors,
and by the registrant of the underwriters for certain liabilities, including
liabilities arising under the Securities Act, in connection with matters
specifically provided in writing by the underwriters for inclusion in the
Registration Statement.
ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES
Between 1997 and June 30, 2001, the registrant granted options to acquire
2,368,724 common shares to its officers and employees, at prices ranging from
Cdn$9.31 to Cdn$17.32. Of the options granted, 146,926 and 45,023 were cancelled
and exercised, respectively, as of June 30, 2001. These options were granted
pursuant to an exemption from the registration requirements of the Securities
Act of 1933 provided by Regulation S thereunder.
ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) Exhibits.
<Table>
<Caption>
Exhibit No. Description of Document
- ----------- ------------------------------------------------------------
1.1* Form of Underwriting Agreement.
3.1(a) Articles of Incorporation of the Company as amended, filed
as Exhibit 3.1(a) to the Registrant's Registration Statement
on Form F-1 (Registration No. 333-12650), and incorporated
herein by reference.
3.1(b)* Articles of Amalgamation.
3.2(a) By-laws No. 1 and 2 of the Company dated January 30, 1998,
filed as Exhibit 3.2(a) to the Registrant's Registration
Statement on Form F-1 (Registration No. 333-12650), and
incorporated herein by reference.
3.2(b) By-law No. 3 of the Company dated November 22, 2000, filed
as Exhibit 3.2(b) to the Registrant's Annual Report on
Form 10-K (File No. 33-80127), and incorporated herein by
reference.
4.1 Indenture, dated as of January 24, 1996, between the Company
and The Chase Manhattan Bank, as Trustee, filed as
Exhibit 4.1 to the Registrant's Registration Statement on
Form F-1 (Registration No. 333-12650), and incorporated
herein by reference.
4.2 First Supplemental Indenture, dated as of February 3, 1999,
between the Company and The Chase Manhattan Bank, as
Trustee, filed as Exhibit 4.2 to the Registrant's
Registration Statement on Form F-1 (Registration
No. 333-12650), and incorporated herein by reference.
4.3 Form of Common Share Certificate, filed as Exhibit 4.3 to
the Registrant's Registration Statement on Form F-1
(Registration No. 333-12650), and incorporated herein by
reference.
</Table>
II-2
<Page>
<Table>
<Caption>
Exhibit No. Description of Document
- ----------- ------------------------------------------------------------
4.4 Registration Rights Agreement dated March 4, 1997, by and
among Dynacare Inc., Golder, Thoma, Cressey, Rauner Fund V
LP, Albert J. Latner, MELCO Holdings Corp., SDLCO Holdings
Ltd., EPLCO Holdings Ltd., EPLCO Realty Group Ltd., JILCO
Holdings Ltd. and AJLCO Realty Limited, filed as
Exhibit 4.4 to the Registrant's Registration Statement on
Form F-1 (Registration No. 333-12650), and incorporated
herein by reference.
4.5 Amendment No. 1 to the Registration Rights Agreement
referred to in Exhibit 4.4 above, filed as Exhibit 4.5 to
the Registrant's Annual Report on Form 10-K (File
No. 33-80127), and incorporated herein by reference.
4.6* Registration Rights Amending Agreement dated December 23,
2000 by and among Golder, Thoma, Cressey, Rauner V, L.P. and
GTCR Associates V (collectively, "GTCR"), Albert J. Latner,
AJLCO Realty Limited, Ditlent Holdings SPRL, SDLCO Holdings
Ltd., Arfall Holdings SPRL, SPLCO Holdings Ltd., Asteroid
Holdings SPRL, EPLCO Realty Group Ltd., MELCO Holdings
Corp., Mooster Holdings SPRL, JILCO Holdings Ltd., Kakao
Holdings SPRL and Joshua Latner (collectively, the "Latner
Group;" and together with GTCR, the "Stockholders").
5.1* Opinion of Goodman and Carr LLP, Canadian counsel to the
Company.
10.1 Amended and Restated Employee Stock Option Plan, filed as
Exhibit 4.5 to the Registrant's Registration Statement on
Form S-8 (Registration No. 333-61834), and incorporated
herein by reference.
10.2 Amended and Restated Stock Option Incentive Plan, filed as
Exhibit 4.4 to the Registrant's Registration Statement on
Form S-8 (Registration No. 333-61834), and incorporated
herein by reference.
10.3* Amended and Restated Agreement between Dynacare Inc. and
Albert J. Latner.
10.4 Amended and Restated Employment Agreement of Harvey A.
Shapiro, filed as Exhibit 10.4 to the Registrant's Annual
Report on Form 10-K (File No. 33-80127), and incorporated
herein by reference.
10.5 Amended and Restated Employment Agreement of Osama I.
Sherif, filed as Exhibit 10.5 to the Registrant's Annual
Report on Form 10-K (File No. 33-80127), and incorporated
herein by reference.
10.6 Amended and Restated Employment Agreement of Zbig S. Biskup,
filed as Exhibit 10.6 to the Registrant's Annual Report on
Form 10-K (File No. 33-80127), and incorporated herein by
reference.
10.7 Termination Agreement of Michael Latner filed as
Exhibit 10.7 to the Registrant's Annual Report on Form 10-K
(File No. 33-80127), and incorporated herein by reference.
10.8 Lease Agreement between AEW/Midway Industrial, L.P. and
J.J./DL, L.P., a Texas limited partnership dated March 14,
2000, filed as Exhibit 10.8 to the Registrant's Registration
Statement on Form F-1 (Registration No. 333-12650), and
incorporated herein by reference.
10.9 Lease Agreement between FH Healthcare Development, Inc. and
United/Dynacare LLC dated July 22, 1999, filed as Exhibit
10.9 to the Registrant's Registration Statement on Form F-1
(Registration No. 333-12650), and incorporated herein by
reference.
10.10 Lease Agreement between Wright Runstad Properties L.P., and
Dynacare Inc. dated January 11, 1995, filed as
Exhibit 10.10 to the Registrant's Registration Statement on
Form F-1 (Registration No. 333-12650), and incorporated
herein by reference.
10.11* ISDA Master Agreement between Citibank Canada, Dynacare Inc.
and Dynacare Northwest Inc. dated February 29, 2000.
10.12* Canadian Revolving Working Capital Facility, Letter
Agreement between The Toronto-Dominion Bank and The Dynacare
Health Group Inc. dated September 26, 2001 and Letter
Agreement between The Toronto-Dominion Bank and Dynacare
Gamma Laboratory Partnership dated September 26, 2001.
10.13 Credit Agreement dated as of September 12, 2000 among
Dynacare Laboratories Inc., the lending institutions thereto
and Keybank National Association, filed as Exhibit 10.13 to
the Registrant's Registration Statement on Form F-1
(Registration No. 333-12650), and incorporated herein by
reference.
</Table>
II-3
<Page>
<Table>
<Caption>
Exhibit No. Description of Document
- ----------- ------------------------------------------------------------
10.14 Amalgamation Agreement among Sdlcodyn Inc., Eplcodyn
Holdings Inc., Eplcodyn Realty Inc., Melcodyn Inc. and
Jilcodyn Holdings Inc. and Dynacare Inc., filed as Exhibit
10.14 to the Registrant's Annual Report on Form 10-K (File
No. 33-80127), and incorporated herein by reference.
10.15 Indemnity Agreement among Albert J. Latner, certain parties
related to him, Dynacare Inc., Golder, Thoma, Cressey,
Rauner Fund V L.P. and Golder, Thoma, Cressey, Rauner V,
filed as Exhibit 10.15 to the Registrant's Annual Report on
Form 10-K (File No. 33-80127), and incorporated herein by
reference.
21.1* List of Subsidiaries.
23.1* Consent of Ernst & Young LLP, Chartered Accountants.
23.2* Consent of Goodman and Carr LLP (included in Exhibit 5.1).
24.1* Powers of Attorney.
</Table>
- ---------
* Filed previously.
(b) Financial Statement Schedule.
Schedule II--Valuation and Qualifying Accounts.
ITEM 17. UNDERTAKINGS
Insofar as indemnification for liabilities arising under the Securities Act
of 1933 may be permitted to directors, officers and controlling persons of the
Registrant pursuant to the foregoing provisions, or otherwise, the Registrant
has been advised that in the opinion of the Securities and Exchange Commission
such indemnification is against public policy as expressed in the Act, and is,
therefore, unenforceable. In the event that a claim for indemnification against
such liabilities (other than the payment by the Registrant of expenses incurred
or paid by a director, officer or controlling person of the Registrant in the
successful defense of any action, suit or proceeding) is asserted by such
director, officer or controlling person in connection with the securities being
registered, the Registrant will, unless in the opinion of counsel the matter has
been settled by controlling precedent, submit to a court of appropriate
jurisdiction the question whether such indemnification by it is against public
policy as expressed in the Act and will be governed by the final adjudication of
such issue.
The undersigned Registrant hereby undertakes that:
(1) For purposes of determining any liability under the Securities Act
of 1933, the information omitted from the form of prospectus filed as part
of this registration statement in reliance upon Rule 430A and contained in a
form of prospectus filed by the registrant pursuant to Rule 424 (b)(1) or
(4), or 497(h) under the Securities Act of 1933, shall be deemed to be part
of this registration statement as of the time it was declared effective.
(2) For the purpose of determining any liability under the Securities
Act of 1933, each post-effective amendment that contains a form of
prospectus shall be deemed to be a new registration statement relating to
the securities offered therein, and the offering of such securities at that
time shall be deemed to be the initial BONA FIDE offering thereof.
II-4
<Page>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, as amended, the
registrant has duly caused this Amendment No. 3 to be signed on its behalf by
the undersigned, thereunto duly authorized in the city of Toronto, province of
Ontario, Canada, on this 13th day of November, 2001.
<Table>
DYNACARE INC.
By: /s/ HARVEY A. SHAPIRO
-----------------------------------------
Harvey A. Shapiro
President and Chief Executive Officer
</Table>
Pursuant to the requirements of the Securities Act of 1933, as amended, this
Amendment No. 3 has been signed by the following persons in the capacities and
on the dates indicated.
<Table>
<Caption>
NAME TITLE DATE
---- ----- ----
/s/ HARVEY A. SHAPIRO
------------------------------------------- Chairman, President, Chief November 13, 2001
Harvey A. Shapiro Executive Officer and
Director
(Principal Executive
Officer)
------------------------------------------- Director
Paul Bellamy
*
------------------------------------------- Director November 13, 2001
William T. Brock
*
------------------------------------------- Director November 13, 2001
Dino Chiesa
*
------------------------------------------- Director November 13, 2001
Donald J. Edwards
------------------------------------------- Chairman Emeritus and
Albert J. Latner Director
*
------------------------------------------- Director November 13, 2001
Robert J. Lipsig
</Table>
II-5
<Page>
<Table>
<Caption>
NAME TITLE DATE
---- ----- ----
------------------------------------------- Director
Thomas Edward Long
*
------------------------------------------- Director November 13, 2001
Bruce V. Rauner
/s/ ZBIG S. BISKUP
------------------------------------------- Executive Vice President, November 13, 2001
Zbig S. Biskup, C.A. Chief Financial Officer and
Secretary
(Principal Financial
Officer
and Principal Accounting
Officer)
</Table>
<Table>
* /s/ HARVEY A. SHAPIRO
-------------------------------------------
By: Harvey A. Shapiro
Attorney-in-Fact
* /s/ ZBIG S. BISKUP
-------------------------------------------
By: Zbig S. Biskup, C.A.
Attorney-in-Fact
</Table>
II-6
<Page>
DYNACARE INC.
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
<Table>
<Caption>
CHARGED TO
BALANCE AT COSTS AND BALANCE AT
DESCRIPTION BEGINNING OF YEAR EXPENSES CREDITS END OF YEAR
- ----------- ----------------- ------------ ------------ ------------
Year ended December 31, 1998:
Fee reduction reserve and allowance
for doubtful accounts............... $(6,458,072) $(13,648,625) $ 14,905,660 $ (5,201,037)
Deferred income tax asset valuation
allowance........................... $(4,857,538) $ -- $ 300,554 $ (4,556,984)
Year ended December 31, 1999:
Fee reduction reserve and allowance
for doubtful accounts............... $(5,201,037) $(17,241,132) $ 14,856,378 $ (7,585,791)
Deferred income tax asset valuation
allowance........................... $(4,556,984) $ -- $ 914,848 $ (3,642,136)
Year ended December 31, 2000:
Fee reduction reserve and allowance
for doubtful accounts............... $(7,585,791) $(30,529,832) $ 21,349,431 $(16,766,192)
Deferred income tax asset valuation
allowance........................... $(3,642,136) $ -- $ 2,463,710 $ (1,178,426)
</Table>
S-1
<Page>
INDEX TO EXHIBITS
<Table>
<Caption>
Exhibit No. Description of Document
- ----------- -----------------------
1.1* Form of Underwriting Agreement.
3.1(a) Articles of Incorporation of the Company as amended, filed
as Exhibit 3.1(a) to the Registrant's Registration Statement
on Form F-1 (Registration No. 333-12650), and incorporated
herein by reference.
3.1(b)* Articles of Amalgamation.
3.2(a) By-laws No. 1 and 2 of the Company dated January 30, 1998,
filed as Exhibit 3.2(a) to the Registrant's Registration
Statement on Form F-1 (Registration No. 333-12650), and
incorporated herein by reference.
3.2(b) By-law No. 3 of the Company dated November 22, 2000, filed
as Exhibit 3.2(b) to the Registrant's Annual Report on
Form 10-K (File No. 33-80127), and incorporated herein by
reference.
4.1 Indenture, dated as of January 24, 1996, between the Company
and The Chase Manhattan Bank, as Trustee, filed as
Exhibit 4.1 to the Registrant's Registration Statement on
Form F-1 (Registration No. 333-12650), and incorporated
herein by reference.
4.2 First Supplemental Indenture, dated as of February 3, 1999,
between the Company and The Chase Manhattan Bank, as
Trustee, filed as Exhibit 4.2 to the Registrant's
Registration Statement on Form F-1 (Registration
No. 333-12650), and incorporated herein by reference.
4.3 Form of Common Share Certificate, filed as Exhibit 4.3 to
the Registrant's Registration Statement on Form F-1
(Registration No. 333-12650), and incorporated herein by
reference.
4.4 Registration Rights Agreement dated March 4, 1997, by and
among Dynacare Inc., Golder, Thoma, Cressey, Rauner Fund V
LP, Albert J. Latner, MELCO Holdings Corp., SDLCO Holdings
Ltd., EPLCO Holdings Ltd., EPLCO Realty Group Ltd., JILCO
Holdings Ltd. and AJLCO Realty Limited, filed as
Exhibit 4.4 to the Registrant's Registration Statement on
Form F-1 (Registration No. 333-12650), and incorporated
herein by reference.
4.5 Amendment No. 1 to the Registration Rights Agreement
referred to in Exhibit 4.4 above, filed as Exhibit 4.5 to
the Registrant's Annual Report on Form 10-K (File
No. 33-80127), and incorporated herein by reference.
4.6* Registration Rights Amending Ageement dated December 23,
2000 by and among Golder, Thoma, Cressey, Rauner V, L.P. and
GTCR Associates V (collectively, "GTCR"), Albert J. Latner,
AJLCO Realty Limited, Ditlent Holdings SPRL, SDLCO Holdings
Ltd., Arfall Holdings SPRL, SPLCO Holdings Ltd., Asteroid
Holdings SPRL, EPLCO Realty Group Ltd., MELCO Holdings
Corp., Mooster Holdings SPRL, JILCO Holdings Ltd., Kakao
Holdings SPRL and Joshua Latner (collectively, the "Latner
Group;" and together with GTCR, the "Stockholders").
5.1* Opinion of Goodman and Carr LLP, Canadian counsel to the
Company.
10.1 Amended and Restated Employee Stock Option Plan, filed as
Exhibit 4.5 to the Registrant's Registration Statement on
Form S-8 (Registration No. 333-61834), and incorporated
herein by reference.
10.2 Amended and Restated Stock Option Incentive Plan, filed as
Exhibit 4.4 to the Registrant's Registration Statement on
Form S-8 (Registration No. 333-61834), and incorporated
herein by reference.
10.3* Amended and Restated Agreement between Dynacare Inc. and
Albert J. Latner.
</Table>
<Page>
<Table>
<Caption>
Exhibit No. Description of Document
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10.4 Amended and Restated Employment Agreement of Harvey A.
Shapiro, filed as Exhibit 10.4 to the Registrant's Annual
Report on Form 10-K (File No. 33-80127), and incorporated
herein by reference.
10.5 Amended and Restated Employment Agreement of Osama I.
Sherif, filed as Exhibit 10.5 to the Registrant's Annual
Report on Form 10-K (File No. 33-80127), and incorporated
herein by reference.
10.6 Amended and Restated Employment Agreement of Zbig S. Biskup,
filed as Exhibit 10.6 to the Registrant's Annual Report on
Form 10-K (File No. 33-80127), and incorporated herein by
reference.
10.7 Termination Agreement of Michael Latner filed as
Exhibit 10.7 to the Registrant's Annual Report on Form 10-K
(File No. 33-80127), and incorporated herein by reference.
10.8 Lease Agreement between AEW/Midway Industrial, L.P. and
J.J./DL, L.P., a Texas limited partnership dated March 14,
2000, filed as Exhibit 10.8 to the Registrant's Registration
Statement on Form F-1 (Registration No. 333-12650), and
incorporated herein by reference.
10.9 Lease Agreement between FH Healthcare Development, Inc. and
United/Dynacare LLC dated July 22, 1999, filed as Exhibit
10.9 to the Registrant's Registration Statement on Form F-1
(Registration No. 333-12650), and incorporated herein by
reference.
10.10 Lease Agreement between Wright Runstad Properties L.P., and
Dynacare Inc. dated January 11, 1995, filed as
Exhibit 10.10 to the Registrant's Registration Statement on
Form F-1 (Registration No. 333-12650), and incorporated
herein by reference.
10.11* ISDA Master Agreement between Citibank Canada, Dynacare Inc.
and Dynacare Northwest Inc. dated February 29, 2000.
10.12* Canadian Revolving Working Capital Facility, Letter
Agreement between The Toronto-Dominion Bank and The Dynacare
Health Group Inc. dated September 26, 2001 and Letter
Agreement between The Toronto-Dominion Bank and Dynacare
Gamma Laboratory Partnership dated September 26, 2001.
10.13 Credit Agreement dated as of September 12, 2000 among
Dynacare Laboratories Inc., the lending institutions thereto
and Keybank National Association, filed as Exhibit 10.13 to
the Registrant's Registration Statement on Form F-1
(Registration No. 333-12650), and incorporated herein by
reference.
10.14 Amalgamation Agreement among Sdlcodyn Inc., Eplcodyn
Holdings Inc., Eplcodyn Realty Inc., Melcodyn Inc. and
Jilcodyn Holdings Inc. and Dynacare Inc., filed as Exhibit
10.14 to the Registrant's Annual Report on Form 10-K (File
No. 33-80127), and incorporated herein by reference.
10.15 Indemnity Agreement among Albert J. Latner, certain parties
related to him, Dynacare Inc., Golder, Thoma, Cressey,
Rauner Fund V L.P. and Golder, Thoma, Cressey, Rauner V,
filed as Exhibit 10.15 to the Registrant's Annual Report on
Form 10-K (File No. 33-80127), and incorporated herein by
reference.
21.1* List of Subsidiaries.
23.1* Consent of Ernst & Young LLP, Chartered Accountants.
23.2* Consent of Goodman and Carr LLP (included in Exhibit 5.1).
24.1* Powers of Attorney.
</Table>
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* Filed previously.