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 September 30, 1999 ------------------ OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to --------- --------- Commission file number 0-8527 ------ DIALYSIS CORPORATION OF AMERICA ------------------------------------------------------ (Exact name of registrant as specified in its charter) Florida 59-1757642 - ---------------------------- ------------------- (State or other jurisdiction (IRS Employer of incorporation) Identification No.) 27 Miller Avenue, Lemoyne, Pennsylvania 17043 ---------------------------------------- ---------- (Address of principal executive offices) (Zip Code) (717) 730-6164 --------------------------------------------------- (Registrant's telephone number, including area code) NOT APPLICABLE --------------------------------------------------------------- (Former name, former address and former fiscal year, if changed since last report) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter 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 [ ] Common Stock Outstanding Common Stock, $.01 par value - 3,546,344 shares as of October 31, 1999. DIALYSIS CORPORATION OF AMERICA AND SUBSIDIARIES INDEX PART I -- FINANCIAL INFORMATION - ------ --------------------- The Consolidated Condensed Statements of Operations (Unaudited) for the three months and nine months ended September 30, 1999 and September 30, 1998 include the accounts of the Registrant and its subsidiaries. Item 1. Financial Statements - ---- -------------------- 1) Consolidated Condensed Statements of Operations for the three months and nine months ended September 30, 1999 and September 30, 1998. 2) Consolidated Condensed Balance Sheets as of September 30, 1999 and December 31, 1998. 3) Consolidated Condensed Statements of Cash Flows for the nine months ended September 30, 1999 and September 30, 1998. 4) Notes to Consolidated Condensed Financial Statements as of September 30, 1999. Item 2. Management's Discussion and Analysis of Financial Condition and - ------ --------------------------------------------------------------- Results of Operations --------------------- PART II -- 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 CONDENSED STATEMENTS OF OPERATIONS (UNAUDITED) Three Months Ended Nine Months Ended September 30, September 30, ------------------------- ------------------------- 1999 1998 1999 1998 ---- ---- ---- ---- Revenues: Medical service revenue $ 1,551,894 $ 887,516 $ 4,174,208 $ 2,521,330 Interest and other income 89,220 111,275 279,641 351,590 ----------- ----------- ----------- ----------- 1,641,114 998,791 4,453,849 2,872,920 Cost and expenses: Cost of medical services 1,045,224 639,615 2,930,547 1,821,792 Selling, general and administrative expenses 628,569 469,430 2,065,166 1,390,942 Interest expense 17,302 19,310 50,887 58,837 ----------- ----------- ----------- ----------- 1,691,095 1,128,355 5,046,600 3,271,571 ----------- ----------- ----------- ----------- Loss before income taxes (49,981) (129,564) (592,751) (398,651) Income tax benefit (12,707) (97,363) (125,707) (187,363) ----------- ----------- ----------- ----------- Net loss $ (37,274) $ (32,201) $ (467,044) $ (211,288) =========== =========== =========== =========== Loss per share: Basic $(.01) $(.01) $(.13) $(.06) ===== ===== ===== ===== Diluted $(.01) $(.01) $(.13) $(.06) ===== ===== ===== ===== See notes to consolidated condensed financial statements. DIALYSIS CORPORATION OF AMERICA AND SUBSIDIARIES CONSOLIDATED CONDENSED BALANCE SHEETS September 30, December 31, 1999 1998(A) ----------- ----------- (Unaudited) ASSETS Current assets: Cash and cash equivalents $ 4,208,900 $ 5,366,837 Accounts receivable, less allowance of $211,000 at September 30, 1999; $144,000 at December 31, 1998 1,055,603 460,786 Inventories 244,885 179,189 Prepaid expenses and other current assets 203,410 52,934 ----------- ----------- Total current assets 5,712,798 6,059,746 Property and equipment: Land 168,358 168,358 Buildings and improvements 1,424,239 1,404,573 Machinery and equipment 1,699,024 1,381,460 Leasehold improvements 1,278,896 1,149,300 ----------- ----------- 4,750,517 4,103,691 Less accumulated depreciation and amortization 1,333,733 1,003,995 ----------- ----------- 3,236,784 3,099,696 Advances to parent 120,865 Deferred expenses and other assets 23,296 68,617 ----------- ----------- $ 8,972,878 $ 9,348,924 LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable $ 285,367 $ 243,968 Accrued expenses 380,174 292,594 Current portion of long-term debt 195,833 175,902 Income taxes payable --- 232,306 ----------- ----------- Total current liabilities 861,374 944,770 Long-term debt, less current portion 610,815 632,664 Advances from parent 37,203 --- Minority interest in subsidiaries 2,080 --- Commitments Stockholders' equity: Common stock, $.01 par value, authorized 20,000,000 shares; 3,546,344 shares issued and outstanding at September 30, 1999; 3,751,344 shares issued and 3,546,344 shares outstanding at December 31, 1998 35,463 37,513 Capital in excess of par value 3,971,514 4,044,154 Retained earnings 3,454,429 4,004,763 Treasury stock at cost; 205,000 shares --- (314,940) ----------- ----------- Total stockholders' equity 7,461,406 7,771,490 ----------- ----------- $ 8,972,878 $ 9,348,924 =========== =========== (A) Reference is made to the Company's Annual Report on Form 10-K for the year ended December 31, 1998 filed with the Securities and Exchange Commission in March 1999. See notes to consolidated condensed financial statements. DIALYSIS CORPORATION OF AMERICA AND SUBSIDIARIES CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS (UNAUDITED) Nine Months Ended September 30, -------------------------- 1999 1998 ---- ---- Operating activities: Net loss $ (467,044) $ (211,288) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation 330,004 236,252 Amortization 1,267 1,267 Bad debt expense 72,119 104,754 Stock option compensation 153,000 --- Gain on sale of securities --- (12,780) Increase (decrease) relating to operating activities from: Accounts receivable (666,936) 83,843 Inventories (65,696) (22,652) Prepaid expenses and other current assets (148,476) (52,084) Accounts payable 41,399 (22,589) Accrued expenses 87,580 (42,104) Income tax payable (232,306) (1,655,164) ----------- ----------- Net cash used in operating activities (895,089) (1,592,545) Investing activities: Redemption of minority interest in subsidiaries --- (385,375) Additions to property and equipment, net of minor disposals (326,492) (571,446) Proceeds from sale of securities --- 252,780 Sale of minority interest in subsidiaries 4,040 --- Deferred expenses and other assets 44,054 (6,482) ----------- ----------- Net cash used in investing activities (278,398) (710,523) Financing activities: Advances from parent 158,068 (158,859) Repurchase of stock --- (63,605) Payments on long-term debt (142,518) (115,118) ----------- ----------- Net cash provided by (used in) financing activities 15,550 (337,582) ----------- ----------- Decrease in cash and cash equivalents (1,157,937) (2,640,650) Cash and cash equivalents at beginning of period 5,366,837 8,102,920 ----------- ----------- Cash and cash equivalents at end of period $ 4,208,900 $ 5,462,270 =========== =========== See notes to consolidated condensed financial statements. DIALYSIS CORPORATION OF AMERICA AND SUBSIDIARIES NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS September 30, 1999 (Unaudited) NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Consolidation The consolidated financial statements include the accounts of Dialysis Corporation of America ("DCA") and its subsidiaries, collectively referred to as the "Company." All material intercompany accounts and transactions have been eliminated in consolidation. The Company is a 68% owned subsidiary of Medicore, Inc. (the "Parent"). See Note 5. Government Regulation Most 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. Although the Company is not aware of any future rate changes, significant changes in reimbursement rates could have a material effect on the Company's operations. The Company believes that it is presently in compliance with all applicable laws and regulations. Interest and Other Income Interest and other income is comprised as follows: Three Months Ended Nine Months Ended September 30, September 30, ----------------------- ----------------------- 1999 1998 1999 1998 Rental income $ 38,446 $ 25,569 $ 106,848 $ 92,015 Interest income 46,853 68,268 148,350 235,299 Other income 3,921 17,438 24,443 24,276 --------- --------- --------- --------- $ 89,220 $ 111,275 $ 279,641 $ 351,590 ========= ========= ========= ========= Earnings per Share Diluted earning per share gives effect to potential common shares that were dilutive and outstanding during the period, such as stock options and warrants, calculated using the treasury stock method and average market price. No potentially dilutive securities were included in the diluted earnings per share computation for the three months or nine months ended September 30, 1999 or for the same periods of the preceding year, as a result of exercise prices and the net loss, and to include them would be anti- dilutive. Following is a reconciliation of amounts used in the basic and diluted computations: Three Months Ended Nine Months Ended September 30, September 30, ------------------------- ------------------------- 1999 1998 1999 1998 ---- ---- ---- ---- Net loss $ (37,274) $ (32,201) $ (467,044) $ (211,288) =========== =========== =========== =========== Weighted average shares 3,546,344 3,648,083 3,546,344 3,650,245 ========= ========= ========= ========= Loss per share: Basic $(.01) $(.01) $(.13) $(.06) ===== ===== ===== ===== Diluted $(.01) $(.01) $(.13) $(.06) ===== ===== ===== ===== The Company has various potentially dilutive securities, including stock options and warrants. See Notes 6 and 7. DIALYSIS CORPORATION OF AMERICA AND SUBSIDIARIES NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS--(Continued) September 30, 1999 (Unaudited) NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--Continued Comprehensive Income In 1998, the Company adopted Financial Accounting Standards Board State- ment No. 130, "Reporting Comprehensive Income" (FAS 130). This statement establishes rules for the reporting of comprehensive income (loss) and its components. Comprehensive loss consists of the net loss for the three months and nine months ended September 30, 1999, and for the same period of the preceding year included the net loss and an unrealized securities gain and related reclassification adjustments. Three Months Ended Nine Months Ended September 30, September 30, ------------------------ ------------------------ 1999 1998 1999 1998 Net loss $ (37,274) $ (32,201) $ (467,044) $ (211,288) Other comprehensive income (loss), net of tax: Unrealized holding gain (loss) arising during period, net of tax --- --- --- 40,699 Less: reclassification adjustment, net of tax, for gain included in net income --- (40,699) --- (40,699) ---------- ---------- ---------- ---------- Total other comprehensive income (loss) --- (40,699) --- --- ---------- ---------- ---------- ---------- Comprehensive loss $ (37,274) $ (72,900) $ (467,044) $ (211,288) ========== ========== ========== ========== Reclassifications Certain reclassifications have been made to the 1998 financial state- ments to conform to the 1999 presentation. New Pronouncements In June, 1998, the Financial Accounting Standards Board issued Financial Accounting Standards Board Statement No. 133, "Accounting for Derivative Instruments and Hedging Activities" (FAS 133). FAS 133 is effective for fiscal years beginning after June 15, 2000. FAS 133 establishes accounting and reporting standards for derivative instruments and for hedging activities and requires, among other things, that all derivatives be recognized as either assets or liabilities in the statement of financial position and that these instruments be measured at fair value. The Company is in the process of determining the impact that the adoption of FAS 133 will have on its consolidated financial statements. NOTE 2--INTERIM ADJUSTMENTS The financial summaries for the three months and nine months ended September 30, 1999 and September 30, 1998 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 nine months ended September 30, 1999 are not necessarily indicative of the results that may be expected for the entire year ending December 31, 1999. While the Company believes that the disclosures presented are adequate to make the information not misleading, it is suggested that these Consoli- dated Condensed 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, 1998. DIALYSIS CORPORATION OF AMERICA AND SUBSIDIARIES NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS--(Continued) September 30, 1999 (Unaudited) NOTE 3--LONG TERM DEBT In December 1988, the Company obtained a $480,000 fifteen-year mortgage through November 2003 on its building in Lemoyne, Pennsylvania with interest at 1% over the prime rate. The remaining principal balance under this mortgage amounted to approximately $133,000 and $160,000 at September 30, 1999 and December 31, 1998, respectively. Also in December 1988, the Company obtained a $600,000 mortgage on its building in Easton, Maryland on the same terms as the Lemoyne property. The remaining principal balance under this mortgage amounted to approximately $167,000 and $200,000 at September 30, 1999 and December 31, 1998, respectively. The Company has equipment purchase agreement for certain kidney dialysis machines at its facilities with interest at rates ranging from 4.13% to 11.84% pursuant to various schedules extending through May 2005. Additional financing of $141,000 and $185,000 during the nine months ended September 30, 1999 and September 30, 1998, respectively, represents a noncash financing activity which is a supplemental disclosure required by FAS 95. The remaining principal balance under this agreement amounted to approximately $507,000 and $449,000 at September 30, 1999 and December 31, 1998, respec- tively. The prime rate was 8.25% as of September 30, 1999 and 7.75% as of December 31, 1998. Interest payments on long-term debt amounted to approximately $9,000 and $40,000 for the three months and nine months ended September 30, 1999 and $15,000 and $49,000 for the same periods of the preceding year. 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 deferred tax assets. Income tax payments amounted to $11,000 and $223,000 for the three months and nine months ended September 30, 1999 and $21,000 and $1,561,000 for the same period of the preceding year. NOTE 5--TRANSACTIONS WITH PARENT The Parent provides certain administrative services to the Company including office space and general accounting assistance, the costs of which are allocated on the basis of direct usage, when identifiable, or on the basis of time spent. The amount of expenses allocated by the Parent totaled approximately $50,000 and $150,000 for the three months and nine months ended September 30, 1999, and $60,000 and $180,000 for the same periods of the preceding year. The Company has an intercompany advance payable to the Parent of approximately $37,000 at September 30, 1999 and had an intercompany advance receivable from the Parent of approximately $121,000 at December 31, 1998, with intercompany advance balances bearing interest at the short-term Treasury Bill rate. Interest income on net intercompany advances amounted to approximately $1,500 for the nine months ended September 30, 1999 and interest expense on net intercompany advances amounted to approximately $1,000 and $6,000 for the three months and nine months ended September 30, 1998. Interest on intercompany balances is included in the intercompany advance balance. The Parent has agreed not to require repayment of the intercompany advance payable balance prior to October 1, 2000; therefore, the advance has been classified as long-term at September 30, 1999. DIALYSIS CORPORATION OF AMERICA AND SUBSIDIARIES NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS--(Continued) September 30, 1999 (Unaudited) NOTE 6--STOCK OPTIONS In April 1999, the Company adopted a stock option plan pursuant to which the board of directors granted 800,000 options exercisable at $1.25 per share to certain of its officers, directors, employees and consultants with 340,000 options exercisable through April 20, 2000 and 460,000 options exercisable through April 20, 2004. The Company recorded expense of $153,000 on 340,000 of these options pursuant to FAS 123 and APB 25. In November 1995, the Company adopted a stock option plan for up to 250,000 options. Pursuant to this plan, in November, 1995, the board of directors granted 210,000 options to certain of its officers, directors, employees and consultants of which 4,500 options were outstanding at Sep- tember 30, 1999. These options are exercisable for a period of five years through November 9, 2000 at $1.50 per share. On June 10, 1998 the board of directors granted a five-year non-qualified stock option to a new board member for 5,000 shares exercisable at $2.25 per share through June 9, 2003. In August 1996, the board of directors granted 15,000 options to the medical directors at its three kidney dialysis centers of which 10,000 options were outstanding at September 30, 1999. These options were originally exercisable for a period of three years through August 18, 1999 at $4.75 per share with the exercise price for 5,000 of the options having been reduced to $2.25 per share on June 10, 1998. NOTE 7--COMMON STOCK Pursuant to a 1996 public offering, 1,150,000 shares of common stock were issued, including 150,000 shares from exercise of the underwriters' overallotment option, and there are 2,300,000 redeemable common stock purchase warrants to purchase one common share each with an exercise price of $4.50 originally exercisable through April 16, 1999 and extended to March 31, 2000. The underwriters received options to purchase 100,000 shares of common stock and 200,000 common stock purchase warrants, with the options exercisable at $4.50 per unit through April 16, 2001 with the underlying warrants being substantially identical to the public warrants except that they are exercisable at $5.40 per share through April 16, 2001. NOTE 8--COMMITMENTS AND CONTINGENCIES 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 a 21 year old age requirement. The Company has made no contributions under this plan as of September 30, 1999. NOTE 9--SALE OF SUBSIDIARIES' ASSETS On October 31, 1997, the Company concluded a sale ("Sale") of its Florida operations consisting of the assets of two subsidiaries and an inpatient agreement of another subsidiary pursuant to an Asset Purchase Agreement. Consideration for the assets sold was $5,065,000 consisting of $4,585,000 in cash and $480,000 of the purchaser's common stock. In February 1998, the Company acquired, in a transaction accounted for as a purchase, the remaining 20% minority interests in two of the subsidiaries whose assets were sold for an aggregate of $625,000, which included one-half of the common shares originally received as part of the consideration of the Sale. The remaining shares were sold in September 1998 for approximately $253,000 resulting in a gain of approximately $13,000. DIALYSIS CORPORATION OF AMERICA AND SUBSIDIARIES NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS--(Continued) September 30, 1999 (Unaudited) NOTE 10--REPURCHASE OF COMMON STOCK In September 1998, the Company announced its intent to repurchase up to an additional 300,000 shares of its common stock at current market prices after having acquired 100,000 shares in June 1997 for $206,000. The Company repurchased 105,000 shares for approximately $109,000 during 1998. The Company did not repurchase any additional shares during the first half of 1999. All treasury shares were cancelled during the second quarter of 1999 resulting in reductions of $2,050 in common stock, $229,560 in capital in excess of par value and $83,290 in retained earnings. NOTE 11--PROPOSED MERGER AND ACQUISITION On October 20, 1999, the Company entered into an Agreement and Plan of Merger with MainStreet IPO.com, Inc. ("MSI") and its wholly-owned subsidiary, MainStreet Acquisition Inc. ("MainStreet"). The merger will be effected by MainStreet merging into DCA with DCA surviving, changing its name to MainStreet, and becoming a wholly-owned subsidiary of MSI. The company's shareholders will receive, on a one-for-one basis, shares of common stock of MSI, which company is in the process of preparing a registration statement for filing with the SEC covering the issuance of approximately 1,396,000 shares of its common stock, plus an indeterminate number of shares for resale by certain affiliates of the Company, MSI and certain private investors of MSI. The registration statement is to be filed in the near future in conjunction with the Company's proxy statement seeking its shareholder approval of the merger and related transactions. Immediately prior to the proposed merger, the Company will be selling all of its assets to Dialysis Acquisition Corp., a wholly-owned subsidiary of its parent, Medicore, Inc., with this subsidiary also assuming all liabilities of the Company. The proposed sale of assets and merger trans- actions are subject to a variety of contingencies, most importantly shareholder approval. Should the Company's shareholders approve the transactions, Medicore will own 100% of the dialysis operations, and the Company's shareholders will become shareholders of MSI. MSI is a recently established company which has developed a central website to provide business entities with the necessary tools to perform direct public offering of their securities. Another company, CEO Letter, LLC, which will become a wholly-owned subsidiary of MSI at the time of the merger, provides chief executive officers of public companies the forum to discuss their companies to the multitude of potential internet investors. Item 2. Management's Discussion and Analysis of Financial Condition and - ------ --------------------------------------------------------------- Results of Operations --------------------- Forward-Looking Information The statements contained in this Quarterly Report on Form 10-Q that are not historical are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of the 1934. The Private Securities Litigation Reform Act of 1995 contains certain safe harbors for forward-looking statements. Certain of the forward-looking statements include management's expectations, intentions, beliefs and strategies regarding the future of the Company's growth and operations, the character and development of the dialysis industry, anticipated revenues, the Company's need for and sources of funding for expansion opportunities and construction, expenditures, costs and income and similar expressions concerning matters that are not considered historical facts. Forward-looking statements also include the Company's statements regarding liquidity, anticipated cash needs and availability, and anticipated expense levels in "Management's Discussion and Analysis of Financial Condition and Results of Operations." Such forward-looking statements are subject to substantial risks and uncertainties that could cause actual results to materially differ from those expressed in the statements, including the general economic, market and business conditions, opportunities pursued or not pursued by the Company, competition, changes in federal and state laws or regulations affecting the Company, and other factors discussed periodically in the Company's filings. Many of the foregoing factors are beyond the control of the Company. Among the factors that could cause actual results to differ materially are the factors detailed in the risks discussed in the "Risk Factors" section included in the Company's Registration Statement Form SB-2, as filed with the Securities and Exchange Commission (effective April 17, 1996), and Form S-3, effective July 1, 1999, and as amended or supplemented. Accordingly, readers are cautioned not to place undue reliance on such forward-looking statements, which speak only as of the date made and which the Company undertakes no obligation to revise to reflect events after the date made. Essential to the Company is Medicare reimbursement which is a fixed rate determined by the Health Care Financing Administration ("HCFA"). The level of the Company's revenues and profitability may be adversely affected by potential legislation resulting in rate cuts. Additionally, operating costs tend to increase over the years without any comparable increases, if any, in the prescribed dialysis treatment reimbursement rates, which usually remain fixed and have decreased over the years. There also may be reductions in commercial third-party reimbursement rates. The dialysis industry is highly competitive and subject to extensive regulation. There are a variety of anti-kickback regulations, extensive prohibitions relating to self-referrals, violations of which are punishable by criminal or civil penalties, including exclusion from Medicare and other governmental programs. Although the Company has never been challenged under these regulations and believes it complies in all material respects with such laws and regulations, there can be no assurance that there will not be unanticipated changes in healthcare programs or laws or that it will not be required to change its practice or experience material adverse effects as a result of any such challenges or changes. Significant competitive factors include quality of care and service, convenience of location and pleasant environment. Additionally, there is intense competition for retaining qualified nephrologists, who normally are the main source of patients for and are responsible for the supervision of the dialysis centers. There is also substantial competition for obtaining qualified nurses and technical staff. Major companies, some of which are public companies or divisions of public companies, have many more centers, physicians and financial resources than does the Company, and by virtue of such have a significant advantage in competing for acquisitions of dialysis facilities in areas targeted by the Company. The Company's future growth depends primarily on the availability of suitable dialysis centers for acquisition or development in appropriate and acceptable areas, and the Company's ability to compete with larger companies with greater personnel and financial resources to develop these new potential dialysis centers at costs within the budget of the Company. Its ability to retain qualified nephrologists, nursing and technical staff at reasonable rates is also a significant factor. Management continues to negotiate with nephrologists for the acquisition or development of new dialysis facilities, as well as with hospitals and other health care maintenance entities. The Company opened a center in Carlisle, Pennsylvania in July 1997. It opened its fourth center in Manahawkin, New Jersey and received regulatory approval as a Medicare provider during the fourth quarter of 1998 and opened its fifth center in Chambersburg, Pennsylvania during the first quarter of 1999. Another center being developed in New Jersey is expected to commence operations in the first quarter of 2000. There is no certainty as to when the new center will commence operations, or the number of stations or patient treatments which will result, or if the new center will ultimately be profitable. Newly established dialysis centers, although contributing to increased revenues, initially adversely affect results of operations due to start-up costs and expenses with a smaller developing patient base. Year 2000 Readiness The Year 2000 computer information processing challenge associated with the upcoming millennium change concerns the ability of computerized informa- tion systems to properly recognize date sensitive information, with which many companies, public and private, are faced to ensure continued proper operations and reporting of financial condition. Failure to correct and comply with the Year 2000 change may cause systems that cannot recognize the new date and millenium information to generate erroneous data or to fail to operate. Management is fully aware of the Year 2000 issues, has made its assessments, which included testing each component of software and hardware systems to insure each component operates properly with the date advanced to the year 2000, developing awareness and educating employees and patients regarding the Year 2000 issue and advising them of contingency plans, in case of total operating failure, which would include transferring the patients to our backup hospitals or referring to other non-affiliated dialysis centers. The education phase will be ongoing to assure staff and patients of the nature of the Year 2000 issue and the contingency plans then available. We have recently installed a new Year 2000 compliant accounting package, providing us with our own independent system of bookkeeping, accounting and financial records and reducing our reliance on our Parent's system and staff. This new system's cost for equipment, software and training was approximately $40,000. We believe that our operations and systems are currently Year 2000 compliant. One of the most significant risks in our operations with respect to the upcoming millenium change relates to billing and collection from third-party payors, and, in particular, Medicare. We receive a substantial portion of our revenues from Medicare for treatment of dialysis patients and related services. HCFA, through whom the Medicare program and payments are effected, has indicated it has done and continues to accomplish all it can to insure the Medicare ESRD program continues operating smoothly and that dialysis providers, like the Company, may continue to timely bill electronically for patient services with Medicare payments to be made timely. In 1998, we installed a new electronic billing software program that was developed according to Medicare's compliance guidelines, which guidelines require not only system but also Year 2000 compatibility. The software designer has successfully tested the software for Year 2000 compliance and we initiated electronic Medicare billing in January, 1999 without any problems. Other third-party payors, such as insurance companies, are presently and will continue to be billed with hard copy. The costs of the software modifica- tions have been minimal, approximately $1,000, and we do not anticipate that any costs involved in any future Year 2000 compliance will be material or that they will have a material adverse effect on our business. With respect to non-information technology systems, which typically include embedded technology, such as microcontrollers, the major equipment used in patient dialysis treatment is not date sensitive and should not pose any threat of a system breakdown due to the Year 2000 issue. Most of our dialysis equipment is new. We retain technicians who test and maintain dialysis operations equipment. In addition to addressing our own internal software system and equip- ment, we have communicated with all of our suppliers, service providers and other key third parties, including banks, hospitals, insurance companies, drug and medical equipment and soft good suppliers, utilities, waste removal and water and sewer services with whom we deal to determine the extent of their Year 2000 compliance, what actions they are taking to assess and address that issue, and whether they will be compliant by the end of 1999. To the extent such third parties are materially adversely affected by the Year 2000 issue and their problem has not been timely corrected, our opera- tions could be affected. We have received written assurance from most of these third parties indicating that they are Year 2000 compliant or are working on it and expect to be by the end of 1999. Assuming a worse case scenario that our critical suppliers have a millenium problem and limit, delay or are unable to deliver supplies for patient treatment, which could have a material adverse impact on our business and financial condition, we are identifying other sources of supplies and, if necessary, will overstock certain critical supplies, as well as order several more weeks in advance, request major suppliers to carry more inventory earmarked for us, and maintain specific contacts with those suppliers. Year 2000 Readiness (continued) Another area that could significantly impact our operations in providing dialysis treatment to patients relates to third-party providers, specif- ically, the utility companies providing water, a necessary resource for dialysis treatments, and electricity. These providers and services are beyond our control, and we do not have a separate generator for electricity nor other sources for water. Should any of these utilities fail to provide services, such would seriously adversely impact our operations and our patients in such affected areas. Our continuing plans to reduce the impact of such utility shortages or outages includes notification to our utilities companies of our dialysis center locations, schedules and emergency services required and a 24-hour contact as well as notification to each of our landlords to assure access to the facility for our staff and key service providers. We may experience material unanticipated negative consequences beginning in the Year 2000 due to Year 2000 problems that have gone undetected. Although we believe our assessment and implementation of our Year 2000 issues have been satisfactorily completed, there are many uncertainties involved, which include two primary areas. One is our ability to deal with Year 2000 contingencies that may arise that we were unaware of, and second is how third parties with whom we deal have dealt with the Year 2000 issue. Accordingly, the results of our Year 2000 program and the extent of any impact on our results of opera- tions could vary materially from what we have disclosed. The complexity of the Year 2000 issues does not allow us the ability to predict with any significant accuracy or to qualify its impact upon us for the following reasons: o third party systems, whether suppliers, utilities or others, are beyond our control, although critical to our operations, such as water and electrical supply and governmental (HCFA) payors o complexity of testing interconnected systems and networks that depend on third-party systems o uncertainty of costs we might incur as a result of Year 2000 failures that occur despite implementation of our program to deal with the issues Results of Operations Medical service revenue increased approximately $664,000 (75%) and $1,653,000 (66%) during the three months and nine months ended September 30, 1999 compared to the same periods of the preceding year. This increase reflected increased revenues of the Company's Pennsylvania dialysis centers of approximately $468,000 and $1,222,000 for the three months and nine months ended September 30, 1999, including revenues of approximately $230,000 and $578,000 for the Company's Chambersburg, Pennsylvania dialysis center which commenced operations in January 1999. Also included in the increase in revenues are revenues of approximately $196,000 and $431,000 from the Manahawkin, New Jersey center which commenced operations in the fourth quarter of 1998. Although the operations of the new centers have resulted in additional revenues, they are in the developmental stage and, accordingly, their operating results will adversely affect the Company's results of operations until they achieve a sufficient patient count to cover fixed operating costs. Interest and other income decreased approximately $22,000 and $72,000 for the three months and nine months ended September 30, 1999 compared to the same periods of the preceding year largely due to a decrease in interest earned as a result of a decrease in invested funds. Cost of medical services sales amounted to 67% and 70% for the three months and nine months ended September 30, 1999 compared to 72% for the same periods of the preceding year with improvements at existing centers more than offsetting higher costs at the Company's new dialysis centers which are still in their developmental stage. Selling, general and administrative expenses increased approximately $159,000 and $674,000 for the three months and nine months ended September 30, 1999 compared to the same periods of the preceding year. This increase reflected the commencement of operations at the Company's new dialysis centers, costs in the second quarter of 1999 of approximately $93,000 associated with the Company's decision not to go through with plans to construct a facility in New Jersey, and $153,000 in compensation expense in issuance of stock options in April, 1999 (see Note 6 to "Notes to Consolidated Condensed Financial Statements"). Selling general and admin- istrative expenses as a percent of medical services revenue amounted to 41% and 49% for the three months and nine months ended September 30, 1999 compared to 53% and 55% for the same periods of the preceding year. Results of Operations (continued) Interest expense decreased approximately $2,000 for the three months ended September 30, 1999 and decreased approximately $8,000 for the nine months ended September 30, 1999 compared to the same periods of the preceding year, which included reductions in interest expense to Medicore of $1,000 and $6,000. The overall decrease included increases in interest on equipment financing obligations, which were more than offset by decreases in interest on other debt agreements due to decreases in average outstanding borrowings. Liquidity and Capital Resources Working capital totaled $4,851,000 at September 30, 1999, which reflected a decrease of approximately $264,000 during the nine months ended September 30, 1999. Included in the changes in components of working capital was a decrease in cash and cash equivalents of $1,158,000, which included net cash used in operating activities of $895,000, net cash used in investing activities of $278,000 (including additions to property and equipment of $326,000, primarily related to new centers), and net cash provided by financing activities of $16,000 (including an increase in advances from Parent of $158,000 and debt repayments of $142,000). During 1988, the Company obtained mortgages totaling $1,080,000 on its two buildings, one in Lemoyne, Pennsylvania and the other in Easton, Maryland. The mortgages had a combined remaining balance of $300,000 and $360,000 at September 30, 1999 and December 31, 1998, respectively. The bank has liens on the real and personal property of the Company, including a lien on all rents due and security deposits from the rental of these properties. See Note 3 to Notes to Consolidated Condensed Financial Statements." The Company has an equipment purchase agreement for kidney dialysis machines for its dialysis facilities which had a remaining balance of $507,000 and $449,000 at September 30, 1999 and December 31, 1998, respectively, which included additional equipment financing of approximately $141,000 and $185,000 during the nine months ended September 30, 1999 and September 30, 1998, respectively. See Note 3 to "Notes to Consolidated Condensed Financial Statements." The Company believes that current levels of working capital, will enable it to successfully meet its liquidity demands for at least the next twelve months. The Company, having operated on a larger scale in the past, is seeking to expand its outpatient dialysis treatment facilities and inpatient dialysis care. Such expansion, whether through acquisitions of existing centers, or the development of its own dialysis centers, requires capital, which was the basis for the Company's security offering in 1996 and sale of its Florida dialysis operations in 1997. The Company opened its fifth center in Chambersburg, Pennsylvania in January 1999. The professional corporation providing medical director services to the Manahawkin, New Jersey center, the professional association which is to provide medical director services to another New Jersey center presently being developed and the professional corporation providing medical director services to the Carlisle and Chambersburg, Pennsylvania facilities have a 20% interest in those subsidi- aries. No assurance can be given that the Company will be successful in implementing its growth strategy or that remaining funds from its securities offering and Florida dialysis operations sale will be adequate or that sufficient outside financing would be available to fund expansion. See Notes 7 and 9 to "Notes to Consolidated Condensed Financial Statements." New Accounting Pronouncement In June, 1998, the Financial Accounting Standards Board issued Financial Accounting Standards Board Statement No. 133, "Accounting for Derivative Instruments and Hedging Activities" (FAS 133). FAS 133 is effective for fiscal years beginning after June 15, 2000. FAS 133 establishes accounting and reporting standards for derivative instruments and for hedging activities and requires, among other things, that all derivatives be recognized as either assets or liabilities in the statement of financial position and that these instruments be measured at fair value. The Company is in the process of determining the impact that the adoption of FAS 133 will have on its consolidated financial statements. Proposed Merger and Acquisition On October 20, 1999, the Company entered into an Agreement and Plan of Merger pursuant to which another company would merge into the Company and own approximately 80% of the Company which also provides for a simultaneous sale of the Company's assets to its Parent in consideration for approximately 90% of the Parent's ownership on the Company, the Parent's assumption of the Company's long-term debt and other liabilities, and the Parent's waiver of most proceeds from the potential exercise of outstanding warrants and underwriters' options. See Note 11 to "Notes to Consolidated Condensed Financial Statements." Impact of Inflation Inflationary factors have not had a significant effect on the Company's operations. A substantial portion of the Company's 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 supply costs or nursing and other patient care costs. PART II -- OTHER INFORMATION ---------------------------- Item 6. Exhibits and Reports on Form 8-K. - ------ --------------------------------- (a) Exhibits Part I Exhibits (27) Financial Data Schedule (for SEC use only) Part II Exhibits None (b) Reports on Form 8-K (i) Item 4, "Changes in Registrant's Certifying Accountant," filed August 13, 1999 (ii) Amendment to Item 4, "Changes in Registrant's Certifying Accountant," filed August 27, 1999 (iii) Item 5, "Other Events," re: extension of warrant exercise period and letter of intent for sale of assets and proposed merger, filed September 10, 1999 (iv) Item 5, "Other Events," re: execution of Agreement and Plan of Merger and Asset Purchase Agreement filed on October, 21, 1999 No financial statements were filed with any of the current reports on Form 8-K. 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, Controller and Chief Financial Officer Dated: November 12, 1999 EXHIBIT INDEX Exhibit No - ------- Part I Exhibits (27) Financial Data Schedule (for SEC use only)