FORM 10--Q SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 2004 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _______________________ to __________________ Commission file number 0-8527 DIALYSIS CORPORATION OF AMERICA ------------------------------------------------------ (Exact name of registrant as specified in its charter) Florida 59-1757642 - --------------------------------------------- ------------------- (State or other jurisdiction of incorporation (I.R.S. Employer or organization) Identification No.) 1302 Concourse Drive, Suite 204, Linthicum, Maryland 21090 ---------------------------------------------------- ---------- (Address of principal executive offices) (Zip Code) (410) 694-0500 ---------------------------------------------------- (Registrant's telephone number, including area code) 1344 Ashton Road, Hanover, Maryland 21076 --------------------------------------------------------------- (Former name, former address and former fiscal year, if changed since last report) Indicate by check whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] or No [ ] Indicate by check whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes [ ] or No [X] Common Stock Outstanding Common Stock, $.01 par value - 8,485,815 shares as of August 10, 2004. DIALYSIS CORPORATION OF AMERICA AND SUBSIDIARIES ------------------------------------------------ INDEX PART I -- FINANCIAL INFORMATION - ------ --------------------- The Consolidated Financial Statements (Unaudited) for the three months and six months ended June 30, 2004 and June 30, 2003, include the accounts of the Registrant and its subsidiaries. Item 1. Financial Statements - ------ -------------------- 1) Consolidated Statements of Income for the three months and six months ended June 30, 2004 and June 30, 2003. 2) Consolidated Balance Sheets as of June 30, 2004 and December 31, 2003. 3) Consolidated Statements of Cash Flows for the six months ended June 30, 2004 and June 30, 2003. 4) Notes to Consolidated Financial Statements as of June 30, 2004. Item 2. Management's Discussion and Analysis of Financial Condition and - ------ --------------------------------------------------------------- Results of Operations --------------------- Item 3. Quantitative and Qualitative Disclosures about Market Risk - ------ ---------------------------------------------------------- Item 4. Controls and Procedures - ------ ----------------------- PART II -- OTHER INFORMATION - ------- ----------------- Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity - ------ --------------------------------------------------------------------- Securities ---------- Item 4. Submission of Matters to a Vote of Security Holders - ------ --------------------------------------------------- Item 5. Other Information - ------ ----------------- Item 6. Exhibits and Reports on Form 8-K - ------ -------------------------------- PART I -- FINANCIAL INFORMATION --------------------------------- Item 1. Financial Statements - ---------------------------- DIALYSIS CORPORATION OF AMERICA AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED) Three Months Ended Six Months Ended June 30, June 30, ------------------------- ---------------------------- 2004 2003 2004 2003 ---- ---- ---- ---- Operating revenues: Medical service revenue $ 9,496,608 $ 7,423,946 $17,906,132 $14,161,897 Other income 92,610 79,175 309,655 152,235 ----------- ----------- ----------- ----------- 9,589,218 7,503,121 18,215,787 14,314,132 ----------- ----------- ----------- ----------- Operating cost and expenses: Cost of medical services 5,738,179 4,516,757 10,900,401 8,719,370 Selling, general and administrative expenses 2,901,470 2,377,810 5,696,940 4,526,256 Provision for doubtful accounts 200,042 159,165 348,337 255,063 ----------- ----------- ----------- ----------- 8,839,691 7,053,732 16,945,678 13,500,689 ----------- ----------- ----------- ----------- Operating income 749,527 449,389 1,270,109 813,443 Other income (expense): Interest income on officer/director note 960 902 1,921 2,030 Interest expense to parent (7,758) (418) (10,776) (418) Other income, net 21,806 23,678 44,100 36,771 ----------- ----------- ----------- ----------- 15,008 24,162 35,245 38,383 ----------- ----------- ----------- ----------- Income before income taxes, minority interest and equity in affiliate earnings 764,535 473,551 1,305,354 851,826 Income tax provision 277,665 201,086 493,773 384,351 ----------- ----------- ----------- ----------- Income before minority interest and equity in affiliate earnings 486,870 272,465 811,581 467,475 Minority interest in income of consolidated subsidiaries (130,610) (59,116) (186,442) (113,902) Equity in affiliate earnings 31,362 6,214 50,395 21,633 ----------- ----------- ----------- ----------- Net income $ 387,622 $ 219,563 $ 675,534 $ 375,206 =========== =========== =========== =========== Earnings per share: Basic $.05 $.03 $.08 $.05 ==== ==== ==== ==== Diluted $.04 $.03 $.08 $.04 ==== ==== ==== ==== See notes to consolidated financial statements. DIALYSIS CORPORATION OF AMERICA AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS June 30, December 31, 2004 2003(A) ----------- ----------- (Unaudited) ASSETS Current assets: Cash and cash equivalents $ 772,846 $ 1,515,202 Accounts receivable, less allowance of $855,000 at June 30, 2004; $785,000 at December 31, 2003 6,330,326 4,913,318 Inventories 1,268,979 1,043,710 Deferred income taxes 423,000 412,000 Officer loan and interest receivable 109,424 107,503 Prepaid expenses and other current assets 1,287,022 1,392,721 ----------- ----------- Total current assets 10,191,597 9,384,454 ----------- ----------- Property and equipment: Land 376,211 376,211 Buildings and improvements 2,333,960 2,332,904 Machinery and equipment 7,428,886 6,039,256 Leasehold improvements 4,114,630 3,548,875 ----------- ----------- 14,253,687 12,297,246 Less accumulated depreciation and amortization 5,739,602 5,030,550 ----------- ----------- 8,514,085 7,266,696 ----------- ----------- Goodwill 2,291,333 2,291,333 Other assets 696,783 661,891 ----------- ----------- Total other assets 2,988,116 2,953,224 ----------- ----------- $21,693,798 $19,604,374 =========== =========== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable $ 1,181,309 $ 1,167,213 Accrued expenses 4,365,920 3,170,269 Note and accrued interest payable to parent 893,864 Current portion of long-term debt 572,000 575,000 Income taxes payable 144,732 28,949 Payable minority interest acquisition --- 670,000 ----------- ----------- Total current liabilities 7,157,825 5,611,431 Advances from parent 341,071 234,094 Long-term debt, less current portion 1,823,880 2,097,355 Deferred income taxes --- 59,000 ----------- ----------- Total liabilities 9,322,776 8,001,880 ----------- ----------- Minority interest in subsidiaries 699,506 632,177 Commitments Stockholders' equity: Common stock, $.01 par value, authorized 20,000,000 shares: 8,485,815 shares issued and outstanding at June 30, 2004; 7,937,544 shares issued and outstanding at December 31, 2003 84,858 79,376 Capital in excess of par value 4,837,535 5,238,952 Retained earnings 6,749,123 6,073,589 Notes receivable from options exercised --- (421,600) ----------- ----------- Total stockholders' equity 11,671,516 10,970,317 ----------- ----------- $21,693,798 $19,604,374 =========== =========== (A) Reference is made to the company's Annual Report on Form 10-K for the year ended December 31, 2003 filed with the Securities and Exchange Commission in March, 2004. See notes to consolidated financial statements. DIALYSIS CORPORATION OF AMERICA AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) Six Months Ended June 30, ---------------------------- 2004 2003 ---- ---- Operating activities: Net income $ 675,534 $ 375,206 Adjustments to reconcile net income to net cash provided by (used in) operating activities: Depreciation 713,067 575,010 Amortization 1,157 1,157 Bad debt expense 348,337 255,063 Deferred income tax benefit (70,000) --- Minority interest 186,442 113,902 Equity in affiliate earnings (50,395) (21,633) Increase (decrease) relating to operating activities from: Accounts receivable (1,765,345) (1,575,368) Inventories (225,269) (266,565) Interest receivable on officer loan (1,921) (2,030) Prepaid expenses and other current assets 5,868 212,911 Accounts payable 14,096 216,776) Accrued interest on note payable to parent 8,856 --- Accrued expenses 1,315,747 469,689 Income taxes payable 115,783 --- ----------- ----------- Net cash provided by (used in) operating activities 1,271,957 (79,434) ----------- ----------- Investing activities: Purchase of minority interest in subsidiaries (670,000) (670,000) Additions to property and equipment, net of minor disposals (1,960,456) (654,797) Loans to physician affiliates --- (150,000) Distributions from affiliate 20,400 77,000 Acquisition of dialysis center --- (75,000) Other assets (9,324) 3,532 ----------- ----------- Net cash used in investing activities (2,619,380) (1,469,265) ----------- ----------- Financing activities: Advances from parent 106,977 130,513 Note payable to parent 885,008 --- Payments on long-term debt (276,475) (286,461) Exercise of stock options 5,400 11,250 Capital contributions by subsidiaries' minority members --- 141,588 Distribution to subsidiary minority members (115,843) (118,655) ----------- ----------- Net cash provided by (used in) financing activities 605,067 (121,765) ----------- ----------- Decrease in cash and cash equivalents (742,356) (1,670,464) Cash and cash equivalents at beginning of periods 1,515,202 2,571,916 Cash and cash equivalents at end of periods $ 772,846 $ 901,452 =========== =========== See notes to consolidated financial statements. DIALYSIS CORPORATION OF AMERICA AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS June 30, 2004 (Unaudited) NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Business The company is in one business segment, kidney dialysis operations, providing outpatient hemodialysis services, home dialysis services, inpatient dialysis services and ancillary services associated with dialysis treatments. The company operates 20 kidney dialysis outpatient treatment centers located in Georgia, Maryland, New Jersey, Ohio, Pennsylvania, South Carolina and Virginia, including the management of each of a 40% owned Ohio affiliate and an unaffiliated Georgia center, and has one dialysis facility under development; has agreements to provide inpatient dialysis treatments to six hospitals; and provides supplies and equipment for dialysis home patients. See "Consolidation." Consolidation The consolidated financial statements include the accounts of Dialysis Corporation of America and its subsidiaries, collectively referred to as the "company." Intercompany accounts and transactions have been eliminated in consolidation. As of June 30, 2004, the company is a 57% owned subsidiary of Medicore, Inc., its parent. The company has a 40% interest in an Ohio dialysis center which it manages, which is accounted for on the equity method and not consolidated for financial reporting purposes. Stock Split On January 28, 2004, the company effected a two-for-one stock split. All share and per share data in the consolidated financial statements and notes have been adjusted to reflect the two-for-one split. Estimates The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. The company's principal estimates are for estimated uncollectible accounts receivable as provided for in its allowance for doubtful accounts, estimated useful lives of depreciable assets, estimates for patient revenues from non-contracted payors, and the valuation allowance for deferred tax assets based on the estimated realizability of deferred tax assets. The company's estimates are based on historical experience and assumptions believed to be reasonable given the available evidence at the time of the estimates. Actual results could differ from those estimates. DIALYSIS CORPORATION OF AMERICA AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS June 30, 2004 (Unaudited) NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--Continued Government Regulation A substantial portion of the company's revenues are attributable to payments received under Medicare, which is supplemented by Medicaid or comparable benefits in the states in which the company operates. Reimbursement rates under these programs are subject to regulatory changes and governmental funding restrictions. Laws and regulations governing the Medicare and Medicaid programs are complex and subject to interpretation. The company believes that it is in compliance with all applicable laws and regulations and is not aware of any pending or threatened investigations involving allegations of potential wrongdoing. While no such regulatory inquiries have been made, compliance with such laws and regulations can be subject to future government review and interpretation as well as significant regulatory action including fines, penalties, and exclusions from the Medicare and Medicaid programs. Cash and Cash Equivalents The company considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents. The carrying amounts reported in the balance sheet for cash and cash equivalents approximate their fair values. Although cash and cash equivalents are largely not federally insured, the credit risk associated with these deposits that typically may be redeemed upon demand is considered low due to the high quality of the financial institutions in which they are invested. Credit Risk The company's primary concentration of credit risk is with accounts receivable, which consist of amounts owed by governmental agencies, insurance companies and private patients. Receivables from Medicare and Medicaid comprised 60% of receivables at June 30, 2004 and 59% at December 31, 2003. Inventories Inventories, which consist primarily of supplies used in dialysis treatments, are valued at the lower of cost (first-in, first-out method) or market value. Prepaid Expenses and Other Current Assets Prepaid expenses and other current assets is comprised as follows: June 30, December 31, 2004 2003 ----------- ----------- Vendor volume discounts receivable $ 196,008 $ 610,150 Prepaid expenses 892,358 478,079 Receivable from management service contracts 104,926 130,916 Other 93,730 173,576 ----------- ----------- $ 1,287,022 $ 1,392,721 =========== =========== DIALYSIS CORPORATION OF AMERICA AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS June 30, 2004 (Unaudited) NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--Continued Accrued Expenses Accrued expenses is comprised as follows: June 30, December 31, 2004 2003 ----------- ----------- Due to insurance companies $ 2,486,521 $ 1,759,397 Accrued compensation 983,510 985,330 Insurance premiums payable 408,905 126,736 Other 486,984 298,806 ----------- ----------- $ 4,365,920 $ 3,170,269 =========== =========== Vendor Concentration The company purchases erythropoietin (EPO) from one supplier which comprised 35% and 36% of the company's cost of sales for the three months and six months ended June 30, 2004 and for the same periods of the preceding year. There is only one supplier of EPO in the United States, and this supplier has recently received FDA approval for an alternative product available for dialysis patients. There are no other suppliers of any similar drug available to dialysis treatment providers. Revenues from the administration of EPO comprised 27% and 28% of medical service revenue for the three months and six months ended June 30, 2004 and for the same periods of the preceding year. Revenue Recognition Net revenue is recognized as services are rendered at the net realizable amount from Medicare, Medicaid, commercial insurers, other third party payors and directly from patients. The company occasionally provides dialysis treatments on a charity basis to patients who cannot afford to pay. The amount is not significant. Goodwill Goodwill represents cost in excess of net assets acquired. The company adopted Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets" (FAS 142) effective January 1, 2002. Under FAS 142, goodwill and intangible assets with indefinite lives are no longer amortized but are reviewed annually (or more frequently if impairment indicators are present) for impairment. Pursuant to the provisions of FAS 142, the goodwill resulting from the company's acquisition of minority interests in August, 2001 and June, 2003, and the goodwill resulting from the company's acquisition of Georgia dialysis centers in April, 2002 and April, 2003, are not being amortized for book purposes and are subject to the annual impairment testing provisions of FAS 142, which testing has indicated no impairment for goodwill. See Note 9. DIALYSIS CORPORATION OF AMERICA AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS June 30, 2004 (Unaudited) NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--Continued Income Taxes Deferred income taxes are determined by applying enacted tax rates applicable to future periods in which the taxes are expected to be paid or recovered to differences between financial accounting and tax basis of assets and liabilities. Stock-Based Compensation The company follows the intrinsic value method of Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" (APB 25) and related interpretations in accounting for its employee stock options because, as discussed below, Financial Accounting Standards Board Statement No. 123, "Accounting for Stock-Based Compensation" (FAS 123) requires use of option valuation models that were not developed for use in valuing employee stock options. FAS 123 permits a company to elect to follow the intrinsic value method of APB 25 rather than the alternative fair value accounting provided under FAS 123, but requires pro forma net income and earnings per share disclosures as well as various other disclosures not required under APB 25 for companies following APB 25. The company has adopted the disclosure provisions required under Financial Accounting Standards Board Statement No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure" (FAS 148). Under APB 25, because the exercise price of the company's stock options equals the market price of the underlying stock on the date of grant, no compensation expense was recognized. Pro forma information regarding net income and earnings per share is required by FAS 123 and FAS 148, and has been determined as if the company had accounted for its employee stock options under the fair value method of that Statement. The fair value for these options was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted-average assumptions for options granted during 2004, 2003, 2002 and 2001, respectively: risk-free interest rate of 3.91%, 1.44%, 3.73%, and 5.40%; no dividend yield; volatility factor of the expected market price of the company's common stock of .66, 1.07, 1.15, and 1.14, and a weighted- average expected life of 5 years, 4.7 years, 5 years, and 4 years. The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective input assumptions including the expected stock price volatility. Because the company's employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable measure of the fair value of its employee stock options. DIALYSIS CORPORATION OF AMERICA AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS June 30, 2004 (Unaudited) NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--Continued For purposes of pro forma disclosures, the estimated fair value of options is amortized to expense over the options' vesting period. The company's pro forma information follows: Three Months Ended Six Months Ended June 30, June 30, ------------------------- ---------------------------- 2004 2003 2004 2003 ---- ---- ---- ---- Net income, as reported $ 387,622 $ 219,563 $ 675,534 $ 375,206 Stock-based employee compensation expense under fair value method, net of related tax effects (42,136) (15,414) (59,148) (30,828) ----------- ----------- ----------- ----------- Pro forma net income $ 345,486 $ 204,149 $ 616,386 $ 344,378 =========== =========== =========== =========== Earnings per share: Basic, as reported $.05 $.03 $.08 $.05 ==== ==== ==== ==== Basic, pro forma $.04 $.03 $.07 $.04 ==== ==== ==== ==== Diluted, as reported $.04 $.03 $.08 $.04 ==== ==== ==== ==== Diluted, pro forma $.04 $.02 $.07 $.04 ==== ==== ==== ==== Earnings per Share Diluted earnings per share gives effect to potential common shares that were dilutive and outstanding during the period, consisting of stock options, calculated using the treasury stock method and average market price. Three Months Ended Six Months Ended June 30, June 30, ------------------------- ---------------------------- 2004 2003 2004 2003 ---- ---- ---- ---- Net income $ 387,622 $ 219,563 $ 675,534 $ 375,206 Weighted average shares-denominator basic computation 8,322,959 7,936,390 8,315,943 7,875,346 Effect of dilutive stock options 385,031 762,362 571,179 577,397 ----------- ----------- ----------- ----------- Weighted average shares, as adjusted- denominator diluted computation 8,707,990 8,698,752 8,887,122 8,452,743 =========== =========== =========== =========== Earnings per share: Basic $.05 $.03 $.08 $.05 ==== ==== ==== ==== Diluted $.04 $.03 $.08 $.04 ==== ==== ==== ==== The company had various potentially dilutive securities during the periods presented, consisting of stock options. See Note 7. DIALYSIS CORPORATION OF AMERICA AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS June 30, 2004 (Unaudited) NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--Continued Other Income Operating: Other operating income is comprised as follows: Three Months Ended Six Months Ended June 30, June 30, ------------------------- ---------------------------- 2004 2003 2004 2003 ---- ---- ---- ---- Management fee income $ 92,610 $ 79,175 $ 175,472 $ 152,235 Litigation settlement --- --- 134,183 --- ----------- ----------- ----------- ----------- $ 92,610 $ 79,175 $ 309,655 $ 152,235 =========== =========== =========== =========== Non-operating: Other non-operating income (expense) is comprised as follows: Three Months Ended Six Months Ended June 30, June 30, ------------------------- ---------------------------- 2004 2003 2004 2003 ---- ---- ---- ---- Rental income $ 47,033 $ 53,245 $ 93,696 $ 97,247 Interest income 5,417 12,149 14,006 23,964 Interest expense (40,754) (50,913) (83,351) (104,699) Other 10,110 9,197 19,749 20,259 ----------- ----------- ----------- ----------- Other income, net $ 21,806 $ 23,678 $ 44,100 $ 36,771 =========== =========== =========== =========== Estimated Fair Value of Financial Instruments The carrying value of cash, accounts receivable and debt in the accompanying financial statements approximate their fair value because of the short-term maturity of these instruments, and in the case of debt because such instruments either bear variable interest rates which approximate market or have interest rates approximating those currently available to the company for loans with similar terms and maturities. Reclassification Certain prior year amounts have been reclassified to conform with the current year's presentation. DIALYSIS CORPORATION OF AMERICA AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS June 30, 2004 (Unaudited) NOTE 2--INTERIM ADJUSTMENTS The financial summaries for the three months and six months ended June 30, 2004 and June 30, 2003 are unaudited and include, in the opinion of management of the company, all adjustments (consisting of normal recurring accruals) necessary to present fairly the earnings for such periods. Operating results for the three months and six months ended June 30, 2004 are not necessarily indicative of the results that may be expected for the entire year ending December 31, 2004. While the company believes that the disclosures presented are adequate to make the information not misleading, it is suggested that these consolidated financial statements be read in conjunction with the financial statements and notes included in the company's audited financial statements for the year ended December 31, 2003. NOTE 3--LONG-TERM DEBT The company, through its subsidiary, DCA of Vineland, LLC, and pursuant to a December 3, 1999 loan agreement, obtained a $700,000 development loan with interest at 8.75% through December 2, 2001, 11/2% over the prime rate thereafter through December 15, 2002 and 1% over prime thereafter with an interest rate of 5% at June 30, 2004 and December 31, 2003, secured by a mortgage on the company's real property in Easton, Maryland. Outstanding borrowings were subject to monthly payments of interest only through December 2, 2001, with monthly payments thereafter of $2,917 principal plus interest through December 2, 2002, and monthly payments thereafter of $2,217 principal plus interest with any remaining balance due December 2, 2007. This loan had an outstanding principal balance of $623,000 at June 30, 2004 and $636,000 at December 31, 2003. In April, 2001, the company obtained a $788,000 five-year mortgage through April, 2006, on its building in Valdosta, Georgia with interest at 8.29% until March, 2002, 7.59% thereafter until December 16, 2002, and prime plus 1/2% with a minimum of 6.0% effective December 16, 2002, with an interest rate of 6% at June 30, 2004, and December 31, 2003. Payments are $6,800 including principal and interest commencing May, 2001, with a final payment consisting of a balloon payment and any unpaid interest due April, 2006. The remaining principal balance under this mortgage amounted to approximately $695,000 at June 30, 2004, and $715,000 at December 31, 2003. The equipment financing agreement is for financing for kidney dialysis machines for the company's dialysis facilities. Financing under the equipment purchase agreement is a noncash financing activity, which is a supplemental disclosure required by Financial Accounting Standards Board Statement No. 95, "Statement of Cash Flows." There was no financing under this agreement during the first half of 2004 or the first half of 2003. The remaining principal balance under this financing amounted to approximately $1,078,000 at June 30, 2004, and $1,321,000 at December 31, 2003. The company is currently financing its equipment through its parent. See Note 5. The prime rate was 4.00% as of June 30, 2004, and December 31, 2003. For interest payments, see Note 11. DIALYSIS CORPORATION OF AMERICA AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS June 30, 2004 (Unaudited) NOTE 3--LONG-TERM DEBT--Continued The company's two mortgage agreements contain certain restrictive covenants that, among other things, restrict the payment of dividends above 25% of the company's net worth, require lenders' approval for a merger, sale of substantially all the assets, or other business combination of the company, and require maintenance of certain financial ratios. The company was in compliance with the debt covenants at June 30, 2004, and December 31, 2003. NOTE 4--INCOME TAXES Deferred income taxes reflect the net tax effect of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. For financial reporting purposes, a valuation allowance has been recognized to offset a portion of the deferred tax assets. For income tax payments, see Note 11. NOTE 5--TRANSACTIONS WITH PARENT The company's parent provides certain financial and administrative services for the company. Central operating costs are charged on the basis of time spent. In the opinion of management, this method of allocation is reasonable. The amount of expenses allocated by the parent totaled approximately $50,000 and $100,000 for the three months and six months ended June 30, 2004 and for the same periods of the preceding year. The company had an intercompany advance payable to its parent of approximately $341,000 at June 30, 2004 and $234,000 at December 31, 2003, which bears interest at the short-term Treasury Bill rate. Interest expense on intercompany advances payable was approximately $1,000 and $2,000 for the three months and six months ended June 30, 2004. Interest is included in the intercompany advance balance. The company's parent has agreed not to require repayment of the intercompany advance balance prior to July 1, 2005; therefore, the advance has been classified as long-term at June 30, 2004. On March 17, 2004, the company issued a demand promissory note to its parent for up to $1,500,000 of financing for equipment purchases with annual interest of 1.25% over the prime rate. The note was modified by increasing the maximum amount of advances that can be made to $2,000,000, and by adding to the purposes of the financing, working capital and other corporate needs. The company borrowed approximately $885,000 under this note during the first half of 2004 which had an interest rate of 5.25% as of June 30, 2004. Interest expense on the note amounted to approximately $2,000 and $7,000 for the three months and six months ended June 30, 2004. Accrued interest payable on the note amounted to approximately $9,000 as of June 30, 2004. NOTE 6--OTHER RELATED PARTY TRANSACTIONS The 20% minority interest in DCA of Vineland, LLC was held by a company owned by the medical director of that facility, who became a director of the company in 2001 and ceased being a director at the annual meeting on June 3, 2004. In April, 2000, another company owned by this physician DIALYSIS CORPORATION OF AMERICA AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS June 30, 2004 (Unaudited) NOTE 6--OTHER RELATED PARTY TRANSACTIONS--Continued acquired an interest in DCA of Vineland, resulting in DCA of Vineland being owned 51% by the company and 49% by this physician's companies. In July, 2000, one of the companies owned by this physician acquired a 20% interest in DCA of Manahawkin, Inc. (formerly known as Dialysis Services of NJ, Inc. - Manahawkin), of which subsidiary company this physician also serves as medical director. In May, 2001, the company loaned its President and CEO $95,000 to be repaid with accrued interest at prime minus 1% (floating prime) on or before maturity on May 11, 2006. This demand loan is collateralized by all of the President's stock and stock options in the company and proceeds from sale of such stock. Interest income on the loan amounted to approximately $1,000 and $2,000 for the three months and six months ended June 30, 2004 and for the same periods of the preceding year. Accrued interest on the loan was approximately $14,000 as of June 30, 2004 and $13,000 as of December 31, 2003. Minority members in subsidiaries in certain situations may fund their portion of required capital contributions by issuance of an interest bearing note payable to the company which the minority member may repay through their portion of capital distributions of the subsidiary. The 20% member in DCA of Chevy Chase, LLC funded approximately $42,000 in capital contributions during the first half of 2004, and $190,000 of such contributions during the same period of the preceding year, under a note accruing interest at prime plus 2%, with interest totaling approximately $3,000 and $6,000 for the three months and six months ended June 30, 2004 and $3,000 and $4,000 for the same periods of the preceding year, with approximately $46,000 of distributions to the member applied against the note and accrued interest during the first half of 2004, with no such distributions during the same period of the preceding year. These represent noncash investing activities, which is a supplemental disclosure required by Financial Accounts Standards Board Statement No. 95, "Statement of Cash Flows." See Note 11. NOTE 7--STOCK OPTIONS In June, 1998, the board of directors granted an option under the now expired 1995 Stock Option Plan to a board member for 10,000 shares exercisable at $1.13 per share through June 9, 2003. This option was exercised in June, 2003 with the company receiving an $11,250 cash payment for the exercise price. In April, 1999, we adopted a stock option plan pursuant to which the board of directors granted 1,600,000 options exercisable at $.63 per share to certain of our officers, directors, employees and consultants with 680,000 options exercisable through April 20, 2000 and 920,000 options exercisable through April 20, 2004, of which 120,000 options to date have been cancelled. In April, 2000, the 680,000 one-year options were exercised for which we received cash payment of $3,400 and the balance in three-year promissory notes with the interest at 6.2% and which maturity was extended to April 20, 2004. All the notes were repaid with 91,800 shares of common stock with a fair market value of approximately $521,000 on February 9, 2004. Interest income on the notes amounted to approximately DIALYSIS CORPORATION OF AMERICA AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS June 30, 2004 (Unaudited) NOTE 7--STOCK OPTIONS--Continued $3,000 for the six months ended June 30, 2004, all of which was earned during the first quarter. In March, 2003, 155,714 of the remaining 800,000 options outstanding were exercised for $97,322 with the exercise price satisfied by director bonuses accrued in 2002. In January, 2004, 130,278 of these options were exercised for $81,424 with the exercise price satisfied by director bonuses accrued in 2003. In February, 2004, 158,306 of these options were exercised for $98,941 with the exercise price satisfied by payment of 18,152 shares to the company for cancellation. In March, 2004, 355,702 of these options were exercised for $222,314 with the exercise price satisfied by the payment of 54,223 shares to the company. The exercises and share payments to the company represent noncash investing activity, which is a supplemental disclosure required by Financial Accounting Standards Board Statement No. 95, "Statement of Cash Flows." See Note 11. In January, 2001, the board of directors granted to our Chief Executive Officer and President a five-year option for 330,000 shares exercisable at $.63 per share with 66,000 options vesting at January, 2001, and 66,000 options vesting in equal annual increments on January 1 for each of the next four years. In January, 2004, 56,384 of these options were exercised for $35,240 with the exercise price satisfied by a director bonus accrued in 2003. In September, 2001, the board of directors granted five-year options for an aggregate of 150,000 shares exercisable at $.75 per share through September 5, 2006, to certain officers, directors and key employees. 30,000 of the options vested immediately with the remaining 120,000 options to vest in equal increments of 30,000 options each September 5, commencing September 5, 2002. In March, 2003, 3,570 of these options were exercised for $2,678 with the exercise price satisfied by director bonuses accrued in 2002. In January, 2004, 4,576 of these options were exercised for $3,432 with the exercise price satisfied by director bonuses accrued in 2003. These exercises represent noncash investing activity, which is a supplemental disclosure required by Financial Accounting Standards Board Statement No. 95, "Statement of Cash Flows." See Note 11. In January, 2004, 7,200 of these options were exercised with the company receiving a $5,400 cash payment for the exercise price leaving 134,654 of these options outstanding as of June 30, 2004. As of June 30, 2004, an aggregate of 90,000 of these options had vested, of which 15,346 have been exercised. In March, 2002, the board of directors granted a five-year option to an officer for 60,000 shares exercisable at $1.58 per share through February 28, 2007. The option was to vest in equal annual increments of 15,000 shares on each February 28 from 2003 through 2006. The 15,000 options that had vested in February, 2003, were exercised by the officer in October, 2003, and the remaining 45,000 options expired unvested due to the July 31, 2003 resignation of the officer. In May, 2002, the board of directors granted five-year options for an aggregate of 21,000 shares to the company's employees of which 11,000 were outstanding at June 30, 2004. Most of these options with respect to each individual employee are for 1,000 shares of common stock, with one option for 3,000 shares. These options are exercisable at $2.05 per share through May 28, 2007, with all options having vested on May 29, 2004. Options for 10,000 shares have been cancelled as a result of the termination of the employees holding those options. DIALYSIS CORPORATION OF AMERICA AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS June 30, 2004 (Unaudited) NOTE 7--STOCK OPTIONS--Continued In June, 2003, the board of directors granted to an officer a five-year option for 50,000 shares exercisable at $1.80 per share through June 3, 2008. The option vests annually in increments of 12,500 shares on each June 4 from 2004 to 2007. In August, 2003, the board of directors granted a three-year option to a director who serves on several of the company's committees including the audit committee, for 10,000 shares exercisable at $2.25 per share through August 18, 2006. The option vests in two annual increments of 5,000 shares commencing on August 19, 2004. In January, 2004, the board of directors granted a five year option to an employee for 20,000 shares exercisable at $3.09 per share through January 12, 2009. The option vests in annual increments of 5,000 shares on each January 13 from 2005 through 2008. On January 28, 2004, the company effected a two-for-one stock split of its outstanding common stock. All option amounts and exercise prices have been adjusted to reflect the stock split. Split-adjusted option exercise prices resulting in a fraction of a cent have been rounded up to the nearest cent for purposes of these notes to the financial statements of the company. In June, 2004, the board of directors granted 145,000 stock options to officers and directors exercisable at $4.02 per share through June 6, 2009. 15,000 options vested immediately and 130,000 options vest 25% annually commencing June 7, 2005. See Part II, "Other Information," Item 2, "Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities." NOTE 8--COMMITMENTS Effective January 1, 1997, the company established a 401(k) savings plan (salary deferral plan) with an eligibility requirement of one year of service and 21 year old age requirement. The company and its parent established a new 401(k) plan effective January, 2003, which allows employees, in addition to regular employee contributions, to elect to have a portion of bonus payments contributed. As an incentive to save for retirement, the company will match 10% of an employee's contribution resulting from any bonus paid during the year and may make a discretionary contribution with the percentage of any discretionary contribution to be determined each year with only employee contributions up to 6% of annual compensation considered when determining employer matching. The company's expense for employer matching contributions amounted to approximately $600 for the six months ended June 30, 2004, all during the first quarter, with no matching contributions for the same periods of the preceding year. DIALYSIS CORPORATION OF AMERICA AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS June 30, 2004 (Unaudited) NOTE 9--ACQUISITIONS In August, 2001, the company acquired the remaining 30% minority interest in DCA of So. Ga., LLC, giving the company a 100% ownership interest, for $600,000. This transaction resulted in $523,000 goodwill representing the excess of the $600,000 purchase price over the $77,000 fair value of the assets acquired. The goodwill is being amortized for tax purposes over a 15-year period. The company's decision to make this investment was based largely on the profitability of DCA of So. Ga. The party from whom the company acquired the minority interest is the medical director of another dialysis subsidiary of the company. See Note 1. In April, 2002, the company acquired a dialysis center in Royston, Georgia for $550,000. This transaction resulted in $400,000 of goodwill representing the excess of the $550,000 purchase price over the $150,000 fair value of the assets acquired. The goodwill is being amortized for tax purposes over a 15-year period. The company's decision to make this investment was based on its expectation of future profitability resulting from its review of this dialysis center's operations prior to making the acquisition. See Note 1. During the second quarter of 2003, the company acquired the assets of a Georgia dialysis center and the 30% minority interests in each of two of its existing Georgia dialysis centers for a total consideration of $1,415,000, of which $745,000 was paid initially and the remaining balance of $670,000 was paid during the second quarter of 2004. These acquisitions resulted in $1,368,000 of goodwill, representing the excess of the purchase price over the fair value of the net assets acquired. The goodwill is being amortized for tax purposes over a 15-year period. The company's decision to make these acquisitions was based on its expectation of profitability resulting from management's evaluation of the operations of these dialysis centers. The party from whom the 30% minority interests were purchased was the medical director of one of the facilities at which the 30% interest was acquired and is the medical director of two other of the company's Georgia dialysis facilities. See Note 1. NOTE 10--LOAN TRANSACTIONS The company customarily funds the establishment and operations of its dialysis facility subsidiaries, usually until they become self-sufficient, including subsidiaries in which medical directors hold interests ranging from 20% to 49%. Except in limited circumstances, such funding is generally made without formalized loan documents, as the operating agreements for the subsidiaries provide for cash flow and other proceeds to first pay any such financing that the company provides, exclusive of any tax payment distributions. One such loan exists with DCA of Vineland, LLC. In April, 2000, a company owned by the medical director of DCA of Vineland acquired an interest in DCA of Vineland for $203,000, which was applied to reduce the company's loan. The outstanding principal indebtedness of the company's loan was approximately $189,000 at June 30, 2004 and $425,000 at December 31, 2003. See Note 6. DIALYSIS CORPORATION OF AMERICA AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS June 30, 2004 (Unaudited) NOTE 11--SUPPLEMENTAL CASH FLOW INFORMATION The following represents non-cash financing and investing activities and other cash flow information: Six Months Ended June 30, ---------------------------- 2004 2003 ---- ---- Interest paid (see Note 3) $ 80,000 $ 86,000 Income taxes paid (see Note 4) 453,000 336,000 Options exercise bonus (191,238 shares 2004; 159,284 shares 2003) (see Note 7) 120,000 100,000 Subsidiary minority member capital contributions funded by notes (see Note 6) 42,000 190,000 Subsidiary minority member distributions applied against notes and accrued interest (see Note 6) 46,000 --- Share payment (514,008 options exercised; 72,375 shares paid) for stock option exercises (see Note 7) 321,000 --- Payment of note receivable of 91,800 shares of common stock (see Note 7) 521,000 --- Item 2. Management's Discussion and Analysis of Financial Condition and - ------ --------------------------------------------------------------- Results of Operations --------------------- Management's Discussion and Analysis of Financial Condition and Results of Operations, commonly known as MD&A, is our attempt to provide a narrative explanation of our financial statements, and to provide our shareholders and investors with the dynamics of our business as seen through our eyes as management. Generally, MD&A is intended to cover expected effects of known or reasonably expected uncertainties, expected effects of known trends on future operations, and prospective effects of events that have had a material effect on past operating results. Our discussion of MD&A should be read in conjunction with our unaudited consolidated financial statements, including the notes, included elsewhere in this Quarterly Report on Form 10-Q. Overview Dialysis Corporation of America provides dialysis services, primarily kidney dialysis treatments through 20 outpatient dialysis centers, including a 40% owned Ohio affiliate and one unaffiliated dialysis center which it manages, to patients with chronic kidney failure, also known as end-stage renal disease or ESRD. We provide dialysis treatments to dialysis patients of six hospitals and medical centers through acute inpatient dialysis services agreements with those entities. We provide homecare services, including home peritoneal dialysis through method II services, the latter relating to providing patients with supplies and equipment. The following table shows the number of in-center, home peritoneal and acute inpatient treatments performed by us through the dialysis centers we operate, including the two centers we manage, one in which we have a 40% ownership interest, and those hospitals and medical centers with which we have inpatient acute service agreements for the periods presented: Three Months Ended Six Months Ended June 30, June 30, ------------------------- ---------------------------- 2004 2003 2004 2003 ---- ---- ---- ---- In center 30,034 25,846 57,783 48,831 Home peritoneal 3,493 1,829 5,327 3,491 Acute 1,982 1,891 4,161 3,963 ------ ------ ------ ------ 35,509(1) 29,566(1) 67,271(1) 56,285(1) _______________ (1) Treatments by the two managed centers included: in-center treatments of 3,205 and 6,088, for the three months and six months ended June 30, 2004 and 2,820 and 5,246 for the three months and six months ended June 30, 2003; no home peritoneal treatments; and acute treatments of 35 and 47, for the three months and six months ended June 30, 2004, 34 and 87 for the three months and six months ended June 30, 2003. We also provide ancillary services associated with dialysis treatments, including the administration of EPO for the treatment of anemia in our dialysis patients. EPO is currently available from only one manufacturer, and no alternative drug has been available to us for the treatment of anemia in our dialysis patients. If our available supply of EPO were reduced either by the manufacturer or due to excessive demand, our revenues and net income would be adversely affected. The manufacturer of EPO could implement price increases which would adversely affect our net income. This manufacturer has developed another anemia drug that could possibly substantially reduce our revenues and profit from the treatment of anemia in our patients. ESRD patients must either obtain a kidney transplant or obtain regular dialysis treatments for the rest of their lives. Due to a lack of suitable donors and the possibility of transplanted organ rejection, the most prevalent form of treatment for ESRD patients is hemodialysis through a kidney dialysis machine. Hemodialysis patients usually receive three treatments each week with each treatment lasting between three and five hours on an outpatient basis. Although not as common as hemodialysis in an outpatient facility, home peritoneal dialysis is an available treatment option, representing the third most common type of ESRD treatment after outpatient hemodialysis and kidney transplantation. Approximately 56% and 57% of our medical service revenues were derived from Medicare and Medicaid reimbursement for the three months and six months ended June 30, 2004, compared to 61% and 60% for the same periods of the preceding year, with rates established by CMS, and which rates are subject to legislative changes. Over the last two years, Medicare reimbursement rates have not increased. Dialysis is typically reimbursed at higher rates from private payors, such as a patient's insurance carrier, as well as higher payments received under negotiated contracts with hospitals for acute inpatient dialysis services. The following table shows the breakdown of our revenues by type of payor for the periods presented: Three Months Ended Six Months Ended June 30, June 30, ------------------------- ---------------------------- 2004 2003 2004 2003 ---- ---- ---- ---- Medicare 48% 53% 49% 51% Medicaid and comparable programs 8 8 8 9 Hospital inpatient dialysis services 5 7 6 8 Commercial insurers and other private payors 39 32 37 32 --- --- --- --- 100% 100% 100% 100% Our medical service revenues are derived primarily from four sources: outpatient hemodialysis services, home peritoneal dialysis services, inpatient hemodialysis services and ancillary services. The following table shows the breakdown of our medical service revenues (in thousands) derived from our primary revenue sources and the percentage of total medical service revenue represented by each source for the periods presented: Three Months Ended Six Months Ended June 30, June 30, ----------------------------- ---------------------------- 2004 2003 2004 2003 ------------- ------------- ------------- ------------- Outpatient hemodialysis services $ 4,932 52% $ 3,651 49% $ 9,019 50% $ 6,960 49% Home peritoneal dialysis services 606 6% 309 4% 1,016 6% 598 4% Inpatient hemodialysis services 521 6% 489 7% 1,110 6% 1,021 7% Ancillary services 3,438 36% 2,975 40% 6,761 38% 5,583 40% ------- ---- ------- ---- ------- ---- ------- ---- $ 9,497 100% $ 7,424 100% $17,906 100% $14,162 100% ======= ==== ======= ==== ======= ==== ======= ==== The healthcare industry is subject to extensive regulation by federal and state authorities. There are a variety of fraud and abuse measures to combat waste, including anti-kickback regulations and extensive prohibitions relating to self-referrals, violations of which are punishable by criminal or civil penalties, including exclusion from Medicare and other governmental programs. Unanticipated changes in healthcare programs or laws could require us to restructure our business practices which, in turn, could materially adversely affect our business, operations and financial condition. We have developed a Corporate Integrity Program to assure that we provide the highest level of patient care and services in a professional and ethical manner consistent with applicable federal and state laws and regulations. Among the different programs is our Compliance Program, which has been implemented to assure our compliance with fraud and abuse laws and to supplement our existing policies relating to claims submission, cost report preparation, initial audit and human resources, all geared towards a cost-efficient operation beneficial to patients and shareholders. Dialysis Corporation of America's future growth depends primarily on the availability of suitable dialysis centers for development or acquisition in appropriate and acceptable areas, and our ability to manage the development costs for these potential dialysis centers while competing with larger companies, some of which are public companies or divisions of public companies with greater numbers of personnel and financial resources available for acquiring and/or developing dialysis centers in areas targeted by us. Additionally, there is intense competition for qualified nephrologists who would serve as medical directors of dialysis facilities, and be responsible for the supervision of those dialysis centers. There is no assurance as to when any new dialysis centers or inpatient service contracts with hospitals will be implemented, or the number of stations, or patient treatments such center or service contract may involve, or if such center or service contract will ultimately be profitable. It has been our experience that newly established dialysis centers, although contributing to increased revenues, have adversely affected our results of operations in the short term due to start-up costs and expenses and a smaller patient base. Results of Operations The following table shows our results of operations (in thousands) and the percentage of medical service revenue represented by each line item for the periods presented: Three Months Ended Six Months Ended June 30, June 30, ----------------------------- ---------------------------- 2004 2003 2004 2003 --------------- --------------- --------------- --------------- Medical service revenue $ 9,497 100.0% $ 7,424 100.0% $17,906 100.0% $14,162 100.0% Other income 93 .9 79 1.1 310 1.7 152 1.1 ------- ----- ------- ----- ------- ----- ------- ----- Total operating revenues 9,590 100.9 7,503 101.1 18,216 101.7 14,314 101.1 Cost of medical services 5,738 60.4 4,516 60.8 10,901 60.9 8,720 61.6 Selling, general and administrative expenses 2,901 30.5 2,378 32.0 5,697 31.8 4,526 32.0 Provision for doubtful accounts 200 2.1 159 2.1 348 1.9 255 1.8 ------- ----- ------- ----- ------- ----- ------- ----- Total operating costs and expenses 8,839 93.0 7,053 95.0 16,946 94.6 13,501 95.3 ------- ----- ------- ----- ------- ----- ------- ----- Operating income 750 7.9 450 6.1 1,270 7.1 813 5.7 Other, net 15 .2 24 .3 35 .2 38 .3 ------- ----- ------- ----- ------- ----- ------- ----- Income before income taxes, minority interest and equity in affiliate earnings 765 8.1 474 6.4 1,305 7.3 851 6.0 Income tax provision 278 2.9 201 2.7 494 2.8 384 2.7 ------- ----- ------- ----- ------- ----- ------- ----- Income before minority interest and equity in affiliate earnings 487 5.2 273 3.7 811 4.5 467 3.3 Minority interest in income of consolidated subsidiaries (131) (1.4) (59) (.8) (186) (1.0) (114) (.8) Equity in affiliate earnings 31 .3 6 .1 50 .3 22 .2 ------- ----- ------- ----- ------- ----- ------- ----- Net income $ 388 4.1% $ 220 3.0% $ 675 3.8% $ 375 2.7% ======= ===== ======= ===== ======= ===== ======= ===== Medical service revenues increased approximately $2,073,000 (28%) and $3,744,000 (26%) for the three months and six months ended June 30, 2004, compared to the same periods of the preceding year with the increase largely attributable to a 21% increase in total dialysis treatments performed by the company from 26,712 during the second quarter of 2003 to 32,269 during the second quarter of 2004, and a 20% increase in total dialysis treatments performed by the company from 50,952 during the first half of 2003 to 61,136 during the first half of 2004. This increase reflects increased revenues of approximately $558,000 and $959,000 for our Pennsylvania dialysis centers, including $248,000 revenues during the second quarter of 2004 for our new Pottstown center; increased revenues of $182,000 and $213,000 for our New Jersey centers; increased revenues of $180,000 and $472,000 for our Georgia centers; increased revenues of approximately $149,000 and $554,000 for our Maryland centers, including $11,000 revenues during the second quarter of 2004 for our new Rockville center; increased revenues of approximately $340,000 and $676,000 for our Ohio center; revenues of approximately $247,000 and $381,000 for our new Virginia center; and revenues of approximately $417,000 and $489,000 for our new South Carolina center. Other operating income increased by approximately $13,000 and $158,000 for the three months and six months ended June 30, 2004 compared to the same period of the preceding year. This includes a litigation settlement of $134,000 during the first quarter of 2004 and an increase in management fee income of $13,000 and $23,000 for the three months and six months ended June 30, 2004 pursuant to management services agreements with our 40% owned Toledo, Ohio affiliate and our unaffiliated Georgia center. Cost of medical services sales as a percentage of sales decreased to 60% and 61% for the three months and six months ended June 30, 2004, compared to 61% and 62% for the same periods of the preceding year, largely due to a decrease in payroll costs as a percentage of medical service sales. Approximately 27% and 28% of our medical services revenues for the three months and six months ended June 30, 2004 and for the same periods of the preceding year was derived from the administration of EPO to our dialysis patients. This drug is only available from one manufacturer in the United States. Price increases for this product without our ability to increase our charges would increase our costs and thereby adversely impact our earnings. We cannot predict the timing, if any, or extent of any future price increases by the manufacturer, or our ability to offset any such increases. Selling, general and administrative expenses, those corporate and facility costs not directly related to the care of patients, including, among others, administration, accounting and billing, increased by approximately $523,000 and $1,171,000 for the three months and six months ended June 30, 2004, compared to the same periods of the preceding year. This increase reflects operations of our new dialysis centers in Pennsylvania, South Carolina, Virginia, and Maryland, and increased support activities resulting from expanded operations. Selling, general and administrative expenses as a percentage of medical services revenues increased to approximately 31% and 32% for the three months and six months ended June 30, 2004, compared to 32% for the same periods of the preceding year, including expenses of new centers incurred prior to Medicare approval for which there were no corresponding medical service revenues. Provision for doubtful accounts increased approximately $41,000 and $93,000 for the three months and six months ended June 30, 2004 compared to the same periods of the preceding year. The provision amounted to 2% of sales for the three months and six months ended June 30, 2004 and for the same periods of the preceding year. Medicare bad debt recoveries of $30,000 were recorded during the first half of 2003, all during the first quarter, with no such recoveries recorded during the first half 2004. The provision for doubtful accounts reflects our collection experience with the impact of that experience included in accounts receivable presently reserved, plus recovery of accounts previously considered uncollectible from our Medicare cost report filings. The provision for doubtful accounts is determined under a variety of criteria, primarily aging of the receivables and payor mix. Accounts receivable are estimated to be uncollectible based upon various criteria including the age of the receivable, historical collection trends and our understanding of the nature and collectibility of the receivables, and are reserved for in the allowance for doubtful accounts until they are written off. Other non-operating income (expense) decreased approximately $2,000 for the three months ended June 30, 2004 and increased approximately $7,000 for the six months ended June 30, 2004, compared to the same periods of the preceding year. This includes a decrease in interest income of $7,000 and $10,000, a decrease in rental income of $6,000 and $4,000, and a decrease in interest expense of $10,000 and $21,000 reflecting lower average interest rates on variable rate debt and reduced average borrowings. Interest expense to our parent, Medicore, Inc., increased $7,000 and $10,000 for the three months and six months ended June 30, 2004 compared to the same periods of the preceding year as a result of an increase in the intercompany advance payable to our parent and borrowings under a demand promissory note payable to our parent. The prime rate was 4.00% at June 30, 2004, and December 31, 2003. See Notes 1, 3 and 5 of "Notes to the Consolidated Financial Statements." Although operations of additional centers have resulted in additional revenues, certain of these centers are still in the developmental stage and, accordingly, their operating results will adversely impact our overall results of operations until they achieve a patient count sufficient to sustain profitable operations. We experienced same-center growth in total treatments of approximately 11% for the six months ended June 30, 2004 compared to the same periods of the preceding year, and same-center revenues grew approximately 20%. Management continues to search for ways to operate more efficiently and reduce costs through process improvements. In addition, we are reviewing technological improvements and intend to make capital investments to the extent we are confident such improvements will improve patient care and operating performance. Minority interest represents the proportionate equity interests of minority owners of our subsidiaries whose financial results are included in our consolidated results. Equity in affiliate earnings represents our proportionate interest in the earnings of our 40% owned Ohio affiliate whose operating results improved for the three months and six months ended June 30, 2004 compared to the same period of the preceding year. Liquidity and Capital Resources Working capital totaled approximately $3,034,000 at June 30, 2004, which reflected a decrease of $739,000 (20%) during the six months ended June 30, 2004. Included in the changes in components of working capital was a decrease in cash and cash equivalents of $742,000, which included net cash provided by operating activities of $1,272,000; net cash used in investing activities of $2,619,000 (including additions to property and equipment of $1,960,000, acquisition payments to a minority member in two of our subsidiary dialysis centers for the remaining balance due of $670,000 to acquire an aggregate of 30% of such member's interest in each of such subsidiaries, and $20,000 distributions received from our 40% owned Ohio affiliate); and net cash provided by financing activities of $605,000 (including an increase in advances payable to our parent of $107,000, notes payable to our parent of $885,000, debt repayments of $276,000, distributions to subsidiary minority members of $116,000, and $5,000 of receipts from the exercise of stock options). Our Easton, Maryland building has a mortgage to secure a development loan for our Vineland, New Jersey subsidiary, which loan is guaranteed by us. This loan had a remaining principal balance of $623,000 at June 30, 2004 and $636,000 at December 31, 2003. In April, 2001, we obtained a $788,000 five- year mortgage on our building in Valdosta, Georgia, which had an outstanding principal balance of approximately $695,000 at June 30, 2004 and $715,000 at December 31, 2003. See Note 3 to "Notes to Consolidated Financial Statements." We have an equipment financing agreement for kidney dialysis machines for our facilities, which had an outstanding balance of approximately $1,078,000 at June 30, 2004, and $1,321,000 at December 31, 2003. There was no additional equipment financing during the first quarter of 2004. See Note 3 to "Notes to Consolidated Financial Statements." During the first half of 2004, we borrowed approximately $885,000 to finance dialysis equipment purchases under a demand promissory note to our parent. See Note 5 to "Notes to Consolidated Financial Statements." We opened centers in Warsaw, Virginia; Aiken, South Carolina; Pottstown, Pennsylvania; and Rockville, Maryland during the first half of 2004. We are in the process of developing a new dialysis center in Virginia. Payment of the balance due of $670,000 on the purchase of minority interests in two of our Georgia dialysis centers was made during the second quarter of 2004. See Note 9 to "Notes to Consolidated Financial Statements." Capital is needed primarily for the development of outpatient dialysis centers. The construction of a 15 station facility, typically the size of our dialysis facilities, costs in the range of $600,000 to $750,000 depending on location, size and related services to be provided, which includes equipment and initial working capital requirements. Acquisition of an existing dialysis facility is more expensive than construction, although acquisition would provide us with an immediate ongoing operation, which most likely would be generating income. Although our expansion strategy focuses primarily on construction of new centers, we have expanded through acquisition of dialysis facilities and continue to review potential acquisitions. Development of a dialysis facility to initiate operations takes four to six months and usually up to 12 months or longer to generate income. We consider some of our centers to be in the developmental stage since they have not developed a patient base sufficient to generate and sustain earnings. We are seeking to expand our outpatient dialysis treatment facilities and inpatient dialysis care and are presently in different phases of negotiations with physicians for the development of additional outpatient centers. Such expansion requires capital. We have been funding our expansion through internally generated cash flow. Our future expansion may require us to seek outside financing. While we anticipate that financing will be available either from a financial institution or our parent company, Medicore, which is currently providing us with financing, no assurance can be given that we will be successful in implementing our growth strategy or that adequate financing will be available to support our expansion. Critical Accounting Policies and Estimates The SEC has issued cautionary advice to elicit more precise disclosure in this Item 2, MD&A, about accounting policies management believes are most critical in portraying our financial results and in requiring management's most difficult subjective or complex judgments. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make judgments and estimates. On an on-going basis, we evaluate our estimates, the most significant of which include establishing allowances for doubtful accounts, a valuation allowance for our deferred tax assets and determining the recoverability of our long-lived assets. The basis for our estimates are historical experience and various assumptions that are believed to be reasonable under the circumstances, given the available information at the time of the estimate, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily available from other sources. Actual results may differ from the amounts estimated and recorded in our financial statements. We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements. Revenue Recognition: Revenues are recognized net of contractual provisions. Contractual provisions are the difference between our gross billed revenues and what we expect to collect. We receive payments through reimbursement from Medicare and Medicaid for our outpatient dialysis treatments coupled with patients' private payments, individually and through private third-party insurers. A substantial portion of our revenues are derived from the Medicare ERSD program, which outpatient reimbursement rates are fixed under a composite rate structure, which includes the dialysis services and certain supplies, drugs and laboratory tests. Certain of these ancillary services are reimbursable outside of the composite rate. Medicaid reimbursement is similar and supplemental to the Medicare program. Our acute inpatient dialysis operations are paid under contractual arrangements, usually at higher contractually established rates, as are certain of the private pay insurers for outpatient dialysis. We have developed a sophisticated information and computerized coding system, but due to the complexity of the payor mix and regulations, we sometimes receive more or less than the amount expected when the services are provided. We reconcile any differences at least quarterly. Allowance for Doubtful Accounts: We maintain an allowance for doubtful accounts for estimated losses resulting from the inability of our patients or their insurance carriers to make required payments. Based on historical information, we believe that our allowance is adequate. Changes in general economic, business and market conditions could result in an impairment in the ability of our patients and the insurance companies to make their required payments, which would have an adverse effect on cash flows and our results of operations. The allowance for doubtful accounts is reviewed monthly and changes to the allowance are updated based on actual collection experience. We use a combination of percentage of sales and the aging of accounts receivable to establish an allowance for losses on accounts receivable. Valuation Allowance for Deferred Tax Assets: The carrying value of deferred tax assets assumes that we will be able to generate sufficient future taxable income to realize the deferred tax assets based on estimates and assumptions. If these estimates and assumptions change in the future, we may be required to adjust our valuation allowance for deferred tax assets which could result in additional income tax expense. Long-Lived Assets: We state our property and equipment at acquisition cost and compute depreciation for book purposes by the straight-line method over estimated useful lives of the assets. In accordance with SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate the carrying amount of the asset may not be recoverable. Recoverability of assets to be held and used is measured by comparison of the carrying amount of an asset to the future cash flows expected to be generated by the asset. If the carrying amount of the asset exceeds its estimated future cash flows, an impairment charge is recognized to the extent the carrying amount of the asset exceeds the fair value of the asset. These computations are complex and subjective. Goodwill and Intangible Asset Impairment: In assessing the recoverability of our goodwill and other intangibles we must make assumptions regarding estimated future cash flows and other factors to determine the fair value of the respective assets. This impairment test requires the determination of the fair value of the intangible asset. If the fair value of the intangible assets is less than its carrying value, an impairment loss will be recognized in an amount equal to the difference. If these estimates or their related assumptions change in the future, we may be required to record impairment charges for these assets. We adopted Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets," (FAS 142) effective January 1, 2002, and are required to analyze goodwill and indefinite lived intangible assets for impairment on at least an annual basis. Impact of Inflation Inflationary factors have not had a significant effect on our operations. A substantial portion of our revenue is subject to reimbursement rates established and regulated by the federal government. These rates do not automatically adjust for inflation. Any rate adjustments relate to legislation and executive and Congressional budget demands, and have little to do with the actual cost of doing business. Therefore, dialysis services revenues cannot be voluntarily increased to keep pace with increases in nursing and other patient care costs. Increased operating costs without a corresponding increase in reimbursement rates may adversely affect our earnings in the future. Item 3. Quantitative and Qualitative Disclosures About Market Risk We do not consider our exposure to market risks, principally changes in interest rates, to be significant. Sensitivity of results of operations to interest rate risks on our investments is managed by conservatively investing funds in liquid interest bearing accounts of which we held approximately $764,000 at June 30, 2004. Interest rate risk on debt is managed by negotiation of appropriate rates for equipment financing and other fixed rate obligations based on current market rates. There is an interest rate risk associated with our variable rate mortgage obligations, which totaled approximately $1,318,000 at June 30, 2004, and our demand promissory note payable to our parent, Medicore, which amounted to approximately $885,000 at June 30, 2004. We have exposure to both rising and falling interest rates. Assuming a relative 15% decrease in rates on our period-end investments in interest bearing accounts and a relative 15% increase in rates on our period-end variable rate debt would have resulted in a negative impact of approximately $6,000 on our results of operations for the six months ended June 30, 2004. We do not utilize financial instruments for trading or speculative purposes and do not currently use interest rate derivatives. Item 4. Controls and Procedures As of the end of the period of this quarterly report on Form 10-Q for the second quarter ended June 30, 2004, management carried out an evaluation, under the supervision and with the participation of our Chief Executive Officer and President, and the Vice President of Finance and Principal Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Rule 13a-15 of the Securities Exchange Act of 1934 (the "Exchange Act"). The disclosure controls and procedures are designed to ensure that information required to be disclosed by a company in the reports that it files under the Exchange Act, as is this quarterly report on Form 10-Q, is recorded, processed, summarized and reported within required time periods specified by the SEC's rules and forms. Based upon that evaluation, our Chief Executive Officer and President, and our Vice President of Finance and Principal Financial Officer concluded that our disclosure controls and procedures are effective in timely alerting them to material information relating to us, including our consolidated subsidiaries, required to be included in our periodic SEC filings. There were no significant changes in our internal controls over financial reporting during our most recent fiscal quarter that have materially affected or are reasonably likely to materially affect, internal controls over financial reporting, including any corrective actions with regard to significant deficiencies and material weaknesses, of which there were none. PART II -- OTHER INFORMATION ------------------------------ Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of - ------ -------------------------------------------------------------- Equity Securities. ------------------ Equity Securities Sold by the Company During the Second Quarter Ended June 30, 2004 and Not Registered Under the Securities Act The only issuance of equity securities by the company during the second quarter ended June 30, 2004, was the grant in June, 2004, of five-year options exercisable at $4.02 per share expiring June 6, 2009, to the company's six directors and one executive officer for an aggregate of 145,000 shares of common stock. Three of the independent directors received non- qualified options for 5,000 shares each which vested immediately. The remaining options for 130,000 shares are incentive options and vest in equal 25% increments each year commencing June 7, 2005. These options were granted under Section 4(2) of the Securities Act of 1933, as amended (the "Securities Act"), the non-public offering exemption from the registration requirements of the Securities Act, since the optionees are directors and/or executive officers of the company, each of whom is knowledgeable and has access to information concerning the company and its operations, financial condition and management. The options, as are the shares of common stock obtainable upon exercise of the options, are not publicly transferable absent registration under the Securities Act unless an exemption from such registration is available. Any shares obtained upon exercise of the options will be "restricted" securities as defined in Rule 144(a)(3) of the Securities Act, and will have a legend on each certificate indicating the limitation of public transferability together with stop transfer instructions placed against such shares with the company's transfer agent. Purchases of Equity Securities By or On Behalf of the Company During the Second Quarter Ended June 30, 2004 The company has a common stock repurchase program, which was announced in September, 2000, for the repurchase of up to 600,000 shares at the then current market prices of approximately $.90 (post January, 2004 split, $.45) per share. The repurchase program was reiterated in September, 2001, and continues. The maximum number of shares that may yet be purchased under the plan is 240,000 shares. There were no repurchases of any equity securities during the second quarter months of April, May and June, 2004. Repurchases are unlikely at the current market prices. The closing price of our common stock on August 10, 2004 was $4.06. Item 4. Submissions of Matters to a Vote of Security Holders. - ------ ----------------------------------------------------- We held our annual meeting of stockholders on June 3, 2004 at our parent's offices in Hasbrouck Heights, New Jersey relating to the election of six directors and ratification of the appointment of our independent auditors, Moore Stephens, P.C. Proxies were not solicited, since our parent, Medicore, Inc., owns 4,821,244 shares (approximately 57%) of our voting equity. Each nominee, Messrs. Thomas K. Langbein, Stephen W. Everett, Bart Pelstring, Robert W. Trause, Alexander Bienenstock, and Peter D. Fischbein, were elected with 6,283,025 affirmative votes, approximately 74% of the 8,485,815 outstanding shares. There were no votes withheld for any of the nominees, and no broker non-votes. The shareholders also ratified the appointment of our auditors, Moore Stephens, P.C., for fiscal 2004 by the same vote submitted for directors, with no votes cast against approval, no abstentions, and no broker non-votes. Item 5. Other Information. - ------ ------------------ Effective August 16, 2004, Don Waite will become Vice President of Finance and the company's Chief Financial Officer. From 1999 to 2004, Mr. Waite was Chief Financial Officer, Vice President and Partner of Nephrology Specialty Group, Inc., which established and operated a small chain of outpatient dialysis clinics, which it sold in 2004 to an international dialysis services company. For the period of 1989 to 1999, Mr. Waite was the Area Manager for a division of a major international dialysis services provider. Item 6. Exhibits and Reports on Form 8-K. - ------ --------------------------------- (a) Exhibits Part I Exhibits 31 Rule 13a-14(a)/15d-14(a) Certifications 31.1 Certifications of the Chief Executive Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934. 31.2 Certifications of Principal Financial Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934. 32 Section 1350 Certifications 32.1 Certifications of the Chief Executive Officer and the Principal Financial Officer pursuant to Rule 13a-14(b) of the Securities Exchange Act of 1934 and U.S.C. Section 1350. Part II Exhibits None (b) Reports on Form 8-K Current reports on Form 8-K were filed as follows: (i) A report dated March 31, 2004, filed April 1, 2004, relating to Item 5, "Other Events and Required FD Disclosure" reporting a new executive office lease. SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. DIALYSIS CORPORATION OF AMERICA /s/ DANIEL R. OUZTS By:-------------------------------- DANIEL R. OUZTS, Vice President, Finance, Principal Financial Officer Dated: August 13, 2004 EXHIBIT INDEX ------------- Exhibit No. 31 Rule 13a-14(a)/15d-14(a) Certifications 31.1 Certifications of the Chief Executive Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934. 31.2 Certifications of Principal Financial Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934. 32 Section 1350 Certifications 32.1 Certifications of the Chief Executive Officer and the Principal Financial Officer pursuant to Rule 13a-14(b) of the Securities Exchange Act of 1934 and U.S.C. Section 1350. Exhibit 31.1 CERTIFICATIONS I, Stephen W. Everett, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Dialysis Corporation of America; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; (b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures as of the end of the period covered by this report based on such evaluation; and (c) Disclosed in this quarterly report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of the internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls. /S/ Stephen W. Everett Date: August 13, 2004 ----------------------------------- STEPHEN W. EVERETT, Chief Executive Officer Exhibit 31.2 CERTIFICATIONS I, Daniel R. Ouzts, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Dialysis Corporation of America; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; (b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures as of the end of the period covered by this report based on such evaluation; and (c) Disclosed in this quarterly report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of the internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls. /S/ Daniel R. Ouzts Date: August 13, 2004 ----------------------------------- DANIEL R. OUZTS, Vice President of Finance and Principal Financial Officer Exhibit 32.1 CERTIFICATIONS OF CHIEF EXECUTIVE OFFICER AND PRINCIPAL FINANCIAL OFFICER PURSUANT TO SECTION 13a-14(b) OF THE SECURITIES EXCHANGE ACT OF 1934 AND 18 U.S.C. SECTION 1350 In connection with the Quarterly Report of Dialysis Corporation of America (the "Company") on Form 10-Q for the second quarter ended June 30, 2004 as filed with the Securities and Exchange Commission on the date therein specified (the "Report"), the undersigned, Stephen W. Everett, Chief Executive Officer of the Company, and Daniel R. Ouzts, Vice President of Finance and Principal Financial Officer, certify pursuant to 18 U.S.C. Section 1350 that, to the best of our knowledge: (1) The Report fully complies with the requirements of Section 13(a) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. /s/ Stephen W. Everett ----------------------------------- STEPHEN W. EVERETT, Chief Executive Officer and President /s/ Daniel R. Ouzts ----------------------------------- DANIEL R. OUZTS, Vice President of Finance and Principal Financial Officer Dated: August 13, 2004