<PAGE>
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
----------------
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended March 31, 1999
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from to
Commission File Number: 1-4034
TOTAL RENAL CARE HOLDINGS, INC.
(Exact name of registrant as specified in its charter)
FOR THE QUARTER ENDED MARCH 31, 1999
Delaware 51-0354549
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
21250 Hawthorne Blvd., Suite 800
Torrance, California 90503-5517
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (310) 792-2600
Not Applicable
(Former name or former address, if changed since last report)
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [_]
APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY
PROCEEDINGS DURING THE PRECEDING FIVE YEARS:
Indicate by check mark whether the Registrant has filed all documents and
reports required to be filed by Sections 12, 13 or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court. Yes [_] No [_]
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes of
common stock as of the latest practicable date.
<TABLE>
<CAPTION>
Outstanding at
Class May 1, 1999
----- -----------------
<S> <C>
Common Stock, Par Value $0.001....................................... 81,172,370 shares
</TABLE>
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- --------------------------------------------------------------------------------
<PAGE>
TOTAL RENAL CARE HOLDINGS, INC.
Unless otherwise indicated in this Form 10-Q, "we," "us," "our" and similar
terms refer to Total Renal Care Holdings, Inc. and its subsidiaries.
As previously announced, we are engaged in discussions with the staff of the
SEC in connection with the filing of a registration statement covering the
resale of our 7% convertible subordinated notes. The results of these
discussions may require us to amend some of the information contained in this
Form 10-Q. For more details, see Note 1 to our condensed consolidated financial
statements.
INDEX
<TABLE>
<CAPTION>
Page
No.
----
<S> <C>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements:
Condensed Consolidated Balance Sheets as of March 31, 1999 and December
31, 1998................................................................ 1
Condensed Consolidated Statements of Income and Comprehensive Income for
the three months ended March 31, 1999 and March 31, 1998................ 2
Condensed Consolidated Statements of Cash Flows for the three months
ended March 31, 1999 and March 31, 1998................................. 3
Notes to Condensed Consolidated Financial Statements..................... 4
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations..................................................... 10
Item 3. Quantitative and Qualitative Disclosures About Market Risk......... 15
Risk Factors............................................................... 16
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K................................... 24
Signatures................................................................. 25
</TABLE>
- ---------------------
Note: Items 1, 2, 3, 4 and 5 of Part II are omitted because they are not
applicable.
<PAGE>
TOTAL RENAL CARE HOLDINGS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
March 31, December 31,
1999 1998
-------------- --------------
<S> <C> <C>
ASSETS
------
Current assets:
Cash and cash equivalents.................... $ 39,905,000 $ 41,487,000
Patient accounts receivable, less allowance
for doubtful accounts of $68,828,000 and
$61,848,000, respectively................... 441,810,000 416,472,000
Deferred income taxes........................ 34,320,000 31,917,000
Other current assets......................... 58,122,000 50,395,000
-------------- --------------
Total current assets....................... 574,157,000 540,271,000
Property and equipment, net.................... 261,189,000 233,337,000
Notes receivable............................... 31,953,000 29,257,000
Other long-term assets......................... 62,790,000 28,321,000
Intangible assets, net of accumulated
amortization of $130,936,000 and $114,982,000,
respectively.................................. 1,117,315,000 1,084,395,000
-------------- --------------
Total assets............................... $2,047,404,000 $1,915,581,000
============== ==============
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
Current liabilities:
Current portion of long-term obligations..... $ 19,435,000 $ 21,847,000
Other current liabilities.................... 149,531,000 152,617,000
-------------- --------------
Total current liabilities.................. 168,966,000 174,464,000
Long term debt and other....................... 1,324,754,000 1,227,671,000
Deferred income taxes.......................... 15,301,000 8,212,000
Minority interests............................. 26,545,000 23,422,000
Stockholders' equity:
Preferred stock, ($0.001 par value; 5,000,000
shares authorized; none outstanding)........
Common stock, voting, ($0.001 par value;
195,000,000 shares authorized; 81,153,000
and 81,030,000 shares issued and
outstanding, respectively).................. 81,000 81,000
Additional paid-in capital................... 415,581,000 413,095,000
Notes receivable from stockholders........... (364,000) (356,000)
Accumulated other comprehensive income....... (336,000)
Retained earnings............................ 96,876,000 68,992,000
-------------- --------------
Total stockholders' equity................. 511,838,000 481,812,000
-------------- --------------
Total liabilities and stockholders'
equity.................................... $2,047,404,000 $1,915,581,000
============== ==============
</TABLE>
See accompanying Notes to Condensed Consolidated Financial Statements and
Management's Discussion and Analysis of Financial Condition and Results of
Operations.
1
<PAGE>
TOTAL RENAL CARE HOLDINGS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
Three months ended March 31, 1999 and 1998
<TABLE>
<CAPTION>
Three Months
---------------------------
1999 1998
------------- ------------
<S> <C> <C>
STATEMENTS OF INCOME
Net operating revenues.................... $ 352,244,000 $258,749,000
Operating expenses:
Facilities.............................. 222,083,000 166,995,000
General and administrative.............. 22,737,000 16,910,000
Provision for doubtful accounts......... 10,478,000 6,763,000
Depreciation and amortization........... 27,025,000 19,594,000
Merger and related costs................ 79,435,000
------------- ------------
Total operating expenses............... 282,323,000 289,697,000
Operating income (loss)................. 69,921,000 (30,948,000)
Interest expense, net of capitalized
interest................................. (22,767,000) (14,517,000)
Interest income........................... 1,330,000 1,642,000
------------- ------------
Income (loss) before income taxes,
minority interests, extraordinary item
and cumulative effect of change in
accounting principle................... 48,484,000 (43,823,000)
Income taxes.............................. 18,282,000 872,000
------------- ------------
Income (loss) before minority interests,
extraordinary item and cumulative
effect of change in accounting
principle.............................. 30,202,000 (44,695,000)
Minority interests in income of
consolidated subsidiaries................ 2,318,000 1,393,000
------------- ------------
Income (loss) before extraordinary item
and cumulative effect of change in
accounting principle................... 27,884,000 (46,088,000)
Extraordinary loss, net of tax of
$1,580,000............................... 2,812,000
Cumulative effect of change in accounting
principle, net of tax of $4,300,000...... 6,896,000
------------- ------------
Net income (loss)......................... $ 27,884,000 $(55,796,000)
============= ============
Earnings (loss) per common share:
Income (loss) before extraordinary item
and cumulative effect of change in
accounting principle................... $ 0.34 $ (0.59)
Extraordinary loss, net of tax.......... (0.03)
Cumulative effect of change in
accounting principle, net of tax....... (0.09)
------------- ------------
Net income (loss)....................... $ 0.34 $ (0.71)
============= ============
Weighted average number of common shares
outstanding.............................. 81,102,000 78,926,000
============= ============
Earnings (loss) per common share--assuming
dilution:
Income (loss) before extraordinary item
and cumulative effect of change in
accounting principle................... $ 0.34 $ (0.59)
Extraordinary loss, net of tax.......... (0.03)
Cumulative effect of change in
accounting principle, net of tax....... (0.09)
------------- ------------
Net income (loss)....................... $ 0.34 $ (0.71)
============= ============
Weighted average number of common shares
and equivalents outstanding--assuming
dilution................................. 86,458,000 78,926,000
============= ============
STATEMENTS OF COMPREHENSIVE INCOME
Net income (loss)....................... $ 27,884,000 $(55,796,000)
Other comprehensive income:
Foreign currency translation........... (336,000)
------------- ------------
Comprehensive income (loss)............. $ 27,548,000 $(55,796,000)
============= ============
</TABLE>
See accompanying Notes to Condensed Consolidated Financial Statements and
Management's Discussion and Analysis of Financial Condition and Results of
Operations.
2
<PAGE>
TOTAL RENAL CARE HOLDINGS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Three months ended March 31, 1999 and 1998
<TABLE>
<CAPTION>
Three Months
----------------------------
1999 1998
------------- -------------
<S> <C> <C>
Cash flows from operating activities:
Net income (loss) ............................. $ 27,884,000 $ (55,796,000)
Adjustments to reconcile net income (loss) to
net cash provided by (used in) operating
activities:
Depreciation and amortization................ 27,025,000 19,594,000
Extraordinary item, net of tax............... 2,812,000
Provision for doubtful accounts.............. 10,478,000 6,763,000
Change in accounting principle, net of tax... 6,896,000
Compensation expense from stock option
exercise.................................... 16,000,000
Changes in working capital................... (27,070,000) (31,825,000)
------------- -------------
Total adjustments.......................... (10,433,000) 20,240,000
------------- -------------
Net cash provided by (used in) operating
activities.............................. 38,317,000 (35,556,000)
------------- -------------
Cash flows from investing activities:
Purchases of property and equipment............ (38,638,000) (12,937,000)
Cash paid for acquisitions, net of cash
acquired...................................... (77,417,000) (64,160,000)
Other.......................................... (17,666,000) (18,930,000)
------------- -------------
Net cash used in investing activities.... (133,721,000) (96,027,000)
------------- -------------
Cash flows from financing activities:
Borrowings from bank credit facility........... 84,500,000 494,000,000
Principal payments on long-term obligations.... (325,121,000)
Net proceeds from sale of common stock......... 1,992,000 17,441,000
Other.......................................... 7,330,000 4,628,000
------------- -------------
Net cash provided by financing
activities.............................. 93,822,000 190,948,000
------------- -------------
Net (decrease) increase in cash.................. (1,582,000) 59,365,000
Cash at beginning of period...................... 41,487,000 6,143,000
------------- -------------
Cash at end of period............................ $ 39,905,000 $ 65,508,000
============= =============
</TABLE>
See accompanying Notes to Condensed Consolidated Financial Statements and
Management's Discussion and Analysis of Financial Condition and Results of
Operations.
3
<PAGE>
TOTAL RENAL CARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. In our opinion the interim financial information reflects all normal
recurring adjustments which are necessary to state fairly our consolidated
financial position, results of operations, and cash flows as of and for the
periods indicated. We presume that users of the interim financial information
herein have read or have access to our audited consolidated financial
statements and Management's Discussion and Analysis of Financial Condition and
Results of Operations for the preceding fiscal year and that the adequacy of
additional disclosure needed for a fair presentation, except in regard to
material contingencies or recent significant events, may be determined in that
context. Accordingly, we have omitted footnote and other disclosures which
would substantially duplicate the disclosures contained in our Form 10-K for
the year ended December 31, 1998. We have made certain reclassifications of
prior period amounts to conform to current period classifications. The interim
financial information herein is not necessarily representative of a full year's
operations.
The information related to the activity for the three months ended March 31,
1998 has been restated for certain reclassifications and adjustments in
response to comments we have received from the SEC regarding our Registration
Statement on Form S-3 filed December 18, 1998. The accrued merger and related
costs initially reported by us in the first quarter of 1998 amounted to
$92,835,000. We have revised our financial reporting relating to certain costs
initially included in our merger and related costs and accrual resulting in a
decrease in merger and related costs of $13,400,000, partially offset by an
increase to facilities operating costs of $1,700,000 and an increase to
depreciation and amortization of $590,000 for a net decrease to our first
quarter 1998 operating expenses of $11,110,000. These reclassifications and
adjustments are more fully described in our Form 10-K for the year ended
December 31, 1998.
2. On February 27, 1998, we acquired Renal Treatment Centers, Inc., or RTC,
in a merger transaction. The merger was accounted for as a pooling of
interests. As a result, we restated our condensed consolidated financial
statements to include RTC for all periods presented. We had no transactions
with RTC prior to the combination and no adjustments were necessary to conform
RTC's accounting policies to ours. The results of operations for the separate
companies and the combined results presented in the condensed consolidated
financial statements follow:
<TABLE>
<CAPTION>
Three months ended
March 31,
-------------------------
1999 1998
------------ ------------
<S> <C> <C>
Net operating revenues
TRCH.......................................... $231,842,000 $144,088,000
RTC........................................... 120,402,000 114,661,000
------------ ------------
$352,244,000 $258,749,000
============ ============
Income (loss) before extraordinary item and
cumulative effect of change in accounting
principle
TRCH.......................................... $ 21,576,000 $(18,773,000)
RTC........................................... 6,308,000 (27,315,000)
------------ ------------
$ 27,884,000 $(46,088,000)
============ ============
Net income (loss)
TRCH.......................................... $ 21,576,000 $(21,677,000)
RTC........................................... 6,308,000 (34,119,000)
------------ ------------
$ 27,884,000 $(55,796,000)
============ ============
</TABLE>
4
<PAGE>
TOTAL RENAL CARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Merger and related costs recorded during the first quarter of 1998 in
connection with our merger with RTC included costs associated with certain of
the integration activities, transaction costs and costs of employee severance
and amounts due under employment agreements and other compensation programs. A
summary of merger and related costs and accrual activity through March 31, 1999
is as follows:
<TABLE>
<CAPTION>
Severance
Direct and Costs to
Transaction Employment Integrate
Costs Costs Operations Total
<S> <C> <C> <C> <C>
Initial expense......... $21,580,000 $ 41,960,000 $ 15,895,000 $ 79,435,000
Amounts utilized in
1998................... (22,885,000) (37,401,000) (13,137,000) (73,423,000)
Adjustment of
estimates.............. 1,305,000 (959,000) (1,593,000) (1,247,000)
----------- ------------ ------------ ------------
Accrual, December 31,
1998................... $ 3,600,000 1,165,000 4,765,000
===========
Amounts utilized--1st
quarter 1999........... (600,000) (90,000) (690,000)
------------ ------------ ------------
Accrual, March 31,
1999................... $ 3,000,000 $ 1,075,000 $ 4,075,000
============ ============ ============
</TABLE>
The remaining balance of severance and employment costs represents tax gross-
up payments expected to be paid in the second quarter of 1999. The remaining
balance of costs to integrate operations represents remaining lease payments on
RTC's vacant laboratory lease space.
3. During the quarter ended March 31, 1999, we purchased 23 centers and
additional interests from minority partners in certain of our partnerships.
Total cash consideration for these transactions was approximately $77.4
million.
We accounted for these transactions under the purchase method. The cost of
these acquisitions will be allocated primarily to intangible assets such as
patient charts, noncompete agreements and goodwill to the extent the purchase
price exceeds the value of the tangible assets, primarily capital equipment.
The results of operations on a pro forma basis, as though the above
acquisitions had been combined with us at the beginning of each period
presented for the three months ended March 31, are as follows:
<TABLE>
<CAPTION>
1999 1998
------------ ------------
<S> <C> <C>
Pro forma net operating revenues................ $357,614,000 $270,325,000
Pro forma income (loss) before extraordinary
item and cumulative effect of change in
accounting principle........................... $ 28,777,000 $(44,673,000)
Pro forma net income (loss) .................... $ 28,777,000 $(54,381,000)
Pro forma earnings (loss) per share before
extraordinary item and cumulative effect of
change in accounting principle:
Basic......................................... $ 0.35 $ (0.57)
Assuming dilution............................. $ 0.35 $ (0.57)
</TABLE>
4. In March 1998, Statement of Position No. 98-1, Accounting for the Cost of
Computer Software Developed or Obtained for Internal Use, or SOP 98-1, was
issued and we adopted SOP 98-1 in the first quarter of 1999, effective January
1, 1999. SOP 98-1 defines internal-use software and identifies whether
internal-use software costs that we incur must be expensed or capitalized.
Costs that should be capitalized include external direct costs of materials and
services, payroll and payroll related costs for employees directly associated
with the internal-use software projects and certain interest costs incurred in
the application development stage. All other internal-use software costs are
expensed as incurred.
As a result of the adoption of SOP 98-1, we capitalized certain direct costs
of materials and payroll and payroll related costs related to software projects
currently in their application development stage. The capitalized costs of
these projects are included in projects under development as a component of
property, plant and equipment, as of March 31, 1999. The impact of the adoption
is not material to our operations.
5
<PAGE>
TOTAL RENAL CARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
5. The reconciliation of the numerators and denominators used to calculate
earnings (loss) per common share for all periods presented is as follows:
<TABLE>
<CAPTION>
Three months Ended
March 31,
-------------------------
1999 1998
----------- ------------
<S> <C> <C>
Income (loss) before extraordinary item and
cumulative effect of change in accounting
principle.......................................... $27,884,000 $(46,088,000)
Interest, net of tax resulting from dilutive effect
of convertible debt................................ 1,088,000
----------- ------------
Adjusted income (loss).............................. 28,972,000 (46,088,000)
Extraordinary loss, net of tax...................... (2,812,000)
Cumulative effect of change in accounting principle,
net of tax......................................... (6,896,000)
----------- ------------
Income (loss)--assuming dilution.................... $28,972,000 $(55,796,000)
=========== ============
Applicable Common Shares
Average outstanding during the period............. 81,123,000 79,031,000
Reduction in shares in connection with notes
receivable from employees.......................... (21,000) (105,000)
----------- ------------
Weighted average number of shares outstanding
for use in computing earnings per share............ 81,102,000 78,926,000
Dilutive effect of outstanding stock options........ 477,000
Dilutive effect of convertible debt................. 4,879,000
----------- ------------
Weighted average number of shares and equivalents
outstanding for use in computing earnings per
share--assuming dilution........................... 86,458,000 78,926,000
=========== ============
Earnings (loss) per common share:
Income (loss) per common share before
extraordinary item and cumulative effect
of change in accounting principle................ $ 0.34 $ (0.59)
Extraordinary loss, net of tax.................... (0.03)
Cumulative effect of change in accounting
principle, net of tax............................ (0.09)
----------- ------------
Net income (loss) per common share.................. $ 0.34 $ (0.71)
=========== ============
Earnings (loss) per common share--assuming dilution:
Income (loss) before extraordinary item and
cumulative effect of change in accounting
principle........................................ $ 0.34 $ (0.59)
Extraordinary loss, net of tax.................... (0.03)
Cumulative effect of change in accounting
principle, net of tax............................ (0.09)
----------- ------------
Net income (loss) per common share--assuming
dilution........................................... $ 0.34 $ (0.71)
=========== ============
</TABLE>
Included in the above calculation for the three months ended March 31, 1999,
is the effect of RTC's 5 5/8% convertible subordinated notes due 2006 treated
on an "as converted" basis; however, the effect is not included for the three
months ended March 31, 1998 because it was anti-dilutive.
6. During the quarter ended June 30, 1998, we entered into forward interest
rate cancelable swap agreements, with a combined notional amount of
$800,000,000. The lengths of the agreements are between three and ten years
with cancellation clauses at the swap holders' option from one to seven years.
The underlying blended rate is fixed at approximately 5.65% plus an applicable
margin based upon our current leverage ratio. At March 31, 1999, the effective
interest rate for borrowings under the swap agreement was 7.2%.
6
<PAGE>
TOTAL RENAL CARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
7. In June 1996, RTC issued $125,000,000 of 5 5/8% convertible subordinated
notes due 2006. These notes are convertible, at the option of the holder, at
any time after August 12, 1996 through maturity, unless previously redeemed or
repurchased, into our common stock at a conversion price of $25.62 principal
amount per share, subject to certain adjustments. At any time on or after July
17, 1999, all or any part of these notes will be redeemable at our option on at
least 15 and not more than 60 days' notice as a whole or, from time to time, in
part at redemption prices ranging from 103.94% to 100% of the principal amount
thereof, depending on the year of redemption, together with accrued interest
to, but excluding, the date fixed for redemption. These notes are guaranteed by
TRCH.
The following is summarized financial information of RTC:
<TABLE>
<CAPTION>
March 31, December 31,
1999 1998
------------ ------------
<S> <C> <C>
Cash and cash equivalents........................ $ 0 $ 5,396,000
Accounts receivable, net......................... 127,355,000 130,129,000
Other current assets............................. 18,906,000 19,106,000
------------ ------------
Total current assets............................ 146,261,000 154,631,000
Property and equipment, net...................... 86,734,000 75,641,000
Intangible assets, net........................... 421,469,000 406,562,000
Other assets..................................... 3,159,000 9,249,000
------------ ------------
Total assets.................................... $657,623,000 $646,083,000
============ ============
Current liabilities (includes $311,843,000 and
$306,628,000 intercompany payable to TRCH at
March 31, and December 31, 1998, respectively).. $348,631,000 $352,753,000
Long-term debt................................... 134,553,000 125,199,000
Stockholder's equity............................. 174,439,000 168,131,000
------------ ------------
Total liabilities and stockholders' equity...... $657,623,000 $646,083,000
============ ============
</TABLE>
<TABLE>
<CAPTION>
Three months ended
March 31,
-------------------------
1999 1998
<S> <C> <C>
Net operating revenues.......................... $120,402,000 $114,661,000
Total operating expenses........................ 108,258,000 136,407,000
------------ ------------
Operating income (loss)......................... 12,144,000 (21,746,000)
Interest expense, net........................... 1,802,000 3,588,000
------------ ------------
Income before income taxes...................... 10,342,000 (25,334,000)
Income taxes.................................... 4,034,000 1,981,000
------------ ------------
Net income (loss) before extraordinary item and
cumulative effect of change in accounting
principle..................................... $ 6,308,000 $(27,315,000)
============ ============
</TABLE>
8. In November 1998, we issued $345,000,000 of 7% convertible subordinated
notes due 2009, or the 7% notes, in a private placement offering. The 7% notes
are convertible, at the option of the holder, at any time into our common stock
at a conversion price of $32.81 per share. We may redeem the 7% notes on or
after November 15, 2001. The 7% notes are general, unsecured obligations junior
to all of our existing and future senior debt and, effectively, all existing
and future liabilities of us and our subsidiaries.
We subsequently filed a registration statement covering the resale of the 7%
notes which has not yet been declared effective by the SEC. As further
described in the registration statement, commencing May 18, 1999, we will
accrue certain monetary penalties on a weekly basis until the registration
statement is declared effective, as follows:
<TABLE>
<CAPTION>
Days
following
180 days
after Weekly Cumulative
closing Penalty Penalty
--------- ------- ----------
<S> <C> <C>
0-90 $17,250 $ 207,000
91-180 34,500 656,000
181-270 51,750 1,328,000
271-360 69,000 2,225,000
Thereafter 86,250
</TABLE>
Payment of these penalties is due upon the next interest due date.
7
<PAGE>
TOTAL RENAL CARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
9. Contingencies
Our Florida-based laboratory subsidiary is the subject of a third-party
carrier review relating to certain claims submitted by us for Medicare
reimbursement. We understand that similar reviews have been undertaken with
respect to other providers' laboratory activities in Florida and elsewhere. The
carrier has alleged that 99.3% of the tests performed by this laboratory for
the review period it initially identified, from January 1995 to April 1996,
were not properly supported by the prescribing physicians' medical
justification. The carrier subsequently requested billing records with respect
to the additional period from May 1996 to March 1998. The carrier has issued a
formal overpayment determination in the amount of $5.6 million and has
suspended all payments of claims related to this laboratory. The carrier has
withheld approximately $20 million to date. In addition the carrier has
informed the local offices of the Department of Justice, or DOJ, and the
Department of Health and Human Services, or HHS, of this matter.
We have consulted with outside counsel, reviewed our records, are disputing
the overpayment determination vigorously and have provided extensive supporting
documentation of our claims. We have cooperated with the carrier to resolve
this matter and have initiated the process of a formal review of the carrier's
determination. The first step in this formal review process is a hearing before
a hearing officer at the carrier, which is scheduled to begin in June 1999. We
have received minimal responses from the carrier to our repeated requests for
clarification and information regarding the continuing payment suspension. In
February 1999, our Florida-based laboratory subsidiary filed a complaint
against the carrier and HHS seeking a court order to lift the payment
suspension. We initiated this action only after serious consideration and the
unanimous approval of our board of directors, and we believe it is necessary to
bring a prompt resolution to this payment dispute. We are unable to determine
at this time:
. When this matter will be resolved or when the laboratory's payment
suspension will be lifted;
. What, if any, of the laboratory claims will be disallowed;
. What action the carrier, DOJ or HHS may take with respect to this matter;
. What the outcome of the carrier's review of the periods from May 1996
through March 1998 will be and whether it will include the initiation of
another payment suspension;
. Whether additional periods may be reviewed by the carrier; or
. Any other outcome of this investigation or our lawsuit.
Any determination adverse to us could have an adverse impact on our business,
results of operations or financial condition.
Following the announcement on February 18, 1999 of our preliminary results of
the fourth quarter of fiscal 1998 and the full year then ended, several class
action lawsuits were filed against us and certain of our officers in the U.S.
District Court for the Central District of California. The complaints are
similar and allege violations of federal securities laws arising from alleged
false and misleading statements primarily regarding our accounting for the
integration of RTC into TRCH and request unspecified monetary damages. We
believe that all of the claims are without merit and we intend to defend
ourselves vigorously. We anticipate that the attorneys' fees and related costs
of defending these lawsuits should be covered primarily by our directors and
officers insurance policies and we believe that any additional costs will not
have a material impact on our financial condition, results of operations or
cash flows.
8
<PAGE>
TOTAL RENAL CARE HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
In addition, we are subject to claims and suits in the ordinary course of
business for which we believe we will be covered by insurance. We do not
believe that the ultimate resolution of these additional pending proceedings,
whether the underlying claims are covered by insurance or not, will have a
material adverse effect on our financial condition, results of operations or
cash flows.
10. Subsequent to March 31, 1999, we completed acquisitions of 11 dialysis
facilities for consideration of approximately $50.5 million, which has been
funded by additional borrowings under our credit facilities.
9
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Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
As described in Note 2 to our condensed consolidated financial statements, we
acquired Renal Treatment Centers, Inc., or RTC, on February 27, 1998 in a
merger accounted for as a pooling of interests. Accordingly, our condensed
consolidated financial statements have been restated to include RTC for all
periods presented.
Results of Operations
Three months ended March 31, 1999 compared to the three months ended March 31,
1998.
The information related to the activity for the three months ended March 31,
1998 has been restated for certain reclassifications and adjustments in
response to comments we have received from the SEC regarding our Registration
Statement on Form S-3 filed December 18, 1998. The accrued merger and related
costs initially reported by us in the first quarter of 1998 amounted to
$92,835,000. We have revised our financial reporting relating to certain costs
initially included in our merger and related costs and accrual resulting in a
decrease in merger and related costs of $13,400,000, partially offset by an
increase to facilities operating costs of $1,700,000 and an increase to
depreciation and amortization of $590,000 for a net decrease to our first
quarter 1998 operating expenses of $11,110,000. These reclassifications and
adjustments are more fully described in our Form 10-K for the year ended
December 31, 1998.
Net operating revenues. Net operating revenues consist primarily of dialysis
and ancillary fees from patient treatments and reflect the amounts expected to
be realized from the government, third-party payors, patients, hospitals and
others for services provided. Net operating revenues increased $93,495,000 to
$352,244,000 in the first quarter of 1999 from $258,749,000 in the first
quarter of 1998, representing a 36.1% increase. Of this increase, $68,649,000
was due to increased treatments from acquisitions, existing facility growth and
from de novo developments. The remaining increase of $24,846,000 resulted from
an increase in net operating revenues per treatment which increased from
$235.31 in the first quarter of 1998 to $253.16 in the first quarter of 1999.
The increase in net operating revenue per treatment was mainly attributable to
an increase in ancillary services intensity and pricing of $13,339,000,
primarily in the the administration of EPO of $9,979,000, an increase in
services reimbursed by private payors of $6,846,000, who pay at higher rates,
stemming from the extension of the period during which Medicare is secondary
payor and private payors are primary payor for an additional twelve-month
period, and an increase in corporate and ancillary program fees of $4,661,000,
primarily from the expansion of laboratory services to former RTC facilities of
$3,251,000.
Facility operating expenses. Facility operating expenses consist of costs and
expenses specifically attributable to the operation of dialysis facilities,
including operating and maintenance costs of such facilities, equipment, direct
labor, and supply and service costs relating to patient care. Facility
operating expenses increased $55,088,000 to $222,083,000 in the first quarter
of 1999 from $166,995,000 in the first quarter of 1998 and as a percentage of
net operating revenues, facility operating expenses decreased to 63.1% in the
first quarter of 1999 from 64.5% in the first quarter of 1998. This decrease
was attributable to an increase in revenue rates, improvements in operating
costs per treatment from our Quality/Value/Growth program, and a one-time $1.7
million charge incurred in the first quarter of 1998 for a write-down of
inventory acquired in the RTC transaction.
General and administrative expenses. General and administrative expenses
include headquarters expense and administrative, legal, quality assurance,
information systems and centralized accounting support functions. General and
administrative expenses increased $5,827,000 to $22,737,000 in the first
quarter of 1999 from $16,910,000 in the first quarter of 1998 and as a
percentage of net operating revenues, general and administrative expenses
remained at 6.5% in both quarters.
Provision for doubtful accounts. The provision for doubtful accounts is
influenced by the amount of net operating revenues generated from non-
governmental payor sources in addition to the relative percentage of accounts
receivable by aging category. The provision for doubtful accounts increased
$3,715,000 to $10,478,000 in the first quarter of 1999 from $6,763,000 in the
first quarter of 1998. As a percentage of net operating revenues, the provision
for doubtful accounts increased to 3.0% in the first quarter of 1999 from
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2.6% in the first quarter of 1998. This increase was due to an increase in the
non-governmental payor mix caused by the Medicare as secondary payor extension.
Depreciation and amortization. Depreciation and amortization increased
$7,431,000 to $27,025,000 in the first quarter of 1999 from $19,594,000 in the
first quarter of 1998. As a percentage of net operating revenues, depreciation
and amortization increased to 7.7% in the first quarter of 1999 from 7.6% in
the first quarter of 1998. The increase is primarily attributable to an
increase over the prior period in the relative number of international
acquisitions which generate goodwill with a shorter amortization period as
compared to domestic acquisitions.
Merger and related costs.
Merger and related costs recorded during the first quarter of 1998 include
costs associated with certain integration activities, transaction costs and
costs of employee severance and amounts due under employment agreements and
other compensation programs, in connection with our merger with RTC.
A summary of merger and related costs and accrual activity through March 31,
1999 is as follows:
<TABLE>
<CAPTION>
Direct Transaction Severance and Costs to Integrate
Costs Employment Costs Operations Total
------------------ ---------------- ------------------ ------------
<S> <C> <C> <C> <C>
Initial expense......... $ 21,580,000 $ 41,960,000 $ 15,895,000 $ 79,435,000
Amounts utilized in
1998................... (22,885,000) (37,401,000) (13,137,000) (73,423,000)
Adjustment of
estimates.............. 1,305,000 (959,000) (1,593,000) (1,247,000)
------------ ------------ ------------ ------------
Accrual, December 31,
1998................... $ 3,600,000 1,165,000 4,765,000
============
Amounts utilized--1st
quarter 1999........... (600,000) (90,000) (690,000)
------------ ------------ ------------
Accrual, March 31,
1999................... $ 3,000,000 $ 1,075,000 $ 4,075,000
============ ============ ============
</TABLE>
The remaining balance of severance and employment costs represents tax gross-
up payments expected to be paid in the second quarter of 1999. The remaining
balance of costs to integrate operations represents remaining lease payments on
RTC's vacant laboratory lease space.
Operating income. Operating income increased $100,869,000 to $69,921,000 in
the first quarter of 1999 from an operating loss of $30,948,000 in the first
quarter of 1998. Operating income before merger and related costs increased
$21,434,000 to $69,921,000 from $48,487,000 in the first quarter of 1998. As a
percentage of net operating revenues, operating income before merger and
related costs increased to 19.9% in the first quarter of 1999 from 18.7% in the
first quarter of 1998 primarily due to increased revenues, and a decrease in
facility operating expense partially offset by an increase in the provision for
doubtful accounts and in depreciation and amortization expense.
Interest expense. Interest expense increased $8,250,000 to $22,767,000 in the
first quarter of 1999 from $14,517,000 in the first quarter of 1998. The
increase in interest expense was due to an increase in borrowings made under
our credit facilities to fund acquisitions.
Interest income. Interest income is generated as a result of the short-term
investment of surplus cash from operations and excess proceeds from borrowings
under our credit facilities. Interest income decreased $312,000 to $1,330,000
in the first quarter of 1999 from $1,642,000 in the first quarter of 1998 and
as a percentage of net operating revenues, interest income decreased to 0.4% in
the first quarter of 1999 from 0.6% in the first quarter of 1998. This decrease
is primarily the result of lower average balances of cash and cash equivalents
during the first quarter of 1999 as compared to the first quarter of 1998.
Provision for income taxes. Provision for income taxes increased $17,410,000
to $18,282,000 for the first quarter of 1999 from $872,000 in the first quarter
of 1998. The effective tax rate was 39.6% for the first quarter of 1999
compared to 39.8% in the first quarter of 1998, after minority interest but
before merger and related costs. The decrease in the effective tax rate was due
to a reduction in the blended state tax rate and less amortization of non-
deductible goodwill as a percentage of taxable income.
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Minority interests. Minority interests represent the pretax income earned by
minority partners who directly or indirectly own minority interests in our
partnership affiliates and the net income in certain of our corporate
subsidiaries. Minority interests increased $925,000 to $2,318,000 from
$1,393,000 in the first quarter of 1998. As a percentage of net operating
revenues, minority interest increased slightly to 0.7% in the first quarter of
1999 from 0.5% in the first quarter of 1998.
Liquidity and capital resources
Sources and uses of cash
Our primary capital requirements have been the funding of our growth through
acquisitions and de novo developments and equipment purchases. Net cash
provided by operating activities was $38.3 million for the first quarter of
1999 and net cash used in operating activities was $35.6 million for the first
quarter of 1998. Net cash provided by operating activities consists of our net
income (loss), increased by non-cash expenses such as depreciation,
amortization, non-cash interest and the provision for doubtful accounts, and
adjusted by changes in components of working capital, primarily accounts
receivable.
Accounts receivable, net of allowance for doubtful accounts, increased during
the first quarter of 1999 by $25.3 million, of which approximately $13.0
million was due to the increase in our revenues and approximately $6.9 million
was due to a payment suspension imposed on our Florida-based laboratory by its
Medicare carrier. The remaining $5.4 million was primarily due to an increase
in receivables in our international business, mostly due to a slow down in
payment by certain large health care unions in Argentina.
Net cash used in investing activities was $133.7 million for the first
quarter of 1999 and $96.0 million for the first quarter of 1998. Our principal
uses of cash in investing activities have been related to acquisitions,
purchases of new equipment and leasehold improvements for our facilities, as
well as the development of new facilities. Net cash provided by financing
activities was $93.8 million for the first quarter of 1999 and $190.9 million
for the first quarter of 1998 primarily consisting of borrowings from our two
credit facilities. As of March 31, 1999, we had working capital of $405.2
million, including cash of $39.9 million.
We believe that we will have sufficient liquidity to fund our debt service
obligations and our growth strategy over at least the next twelve months.
Expansion
In the quarter ended March 31, 1999, we developed seven new facilities, two
of which we manage, and we expect to develop approximately 33 additional de
novo facilities in the remainder of 1999. We anticipate that our capital
requirements for purchases of equipment and leasehold improvements for
facilities, including de novo facilities, will be approximately $85 to
$95 million in aggregate for 1999.
During the quarter ended March 31, 1999, we paid cash of approximately $77.4
million to acquire 23 facilities and additional interests from minority
partners in certain of our partnerships. Subsequent to March 31, 1999, we
completed acquisitions of 11 dialysis facilities for consideration of
approximately $50.5 million, which has been funded by additional borrowings
under our credit facilities.
Credit facilities
As of March 31, 1999 the principal amount outstanding under our revolving
facility was $438 million and under our term facility was $396 million. The
term facility requires annual principal payments of $4.0 million,
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<PAGE>
with the $360.0 million balance due on maturity. As of March 31, 1999, we had
$512 million available for borrowing under the revolving facility.
The credit facilities contain financial and operating covenants including,
among other things, requirements that we maintain certain financial ratios and
satisfy certain financial tests, and impose limitations on our ability to make
capital expenditures, to incur other indebtedness and to pay dividends. As of
the date of this filing, we are in compliance with all such covenants.
Interest rate swaps
During the quarter ended June 30, 1998, we entered into forward interest rate
cancelable swap agreements with a combined notional amount of $800.0 million.
The lengths of the agreements are between three and ten years with cancellation
clauses at the swap holder's option from one to seven years. The underlying
blended interest rate is fixed at approximately 5.65% plus an applicable margin
based upon our current leverage ratio. Currently, the effective interest rate
for these swaps is 7.2%.
Subordinated notes
The $125.0 million outstanding 5 5/8% convertible subordinated notes due 2006
issued by RTC bear interest at the rate of 5 5/8%, payable semi-annually and
require no principal payments until 2006. The 5 5/8% notes are convertible into
shares of our common stock at an effective conversion price of $25.62 per share
and are redeemable by us beginning in July 1999.
In November 1998 we issued 7% convertible subordinated notes due 2009 in the
aggregate principal amount of $345.0 million. The 7% notes are convertible at
any time, in whole or in part, into shares of our common stock at a conversion
price of $32.81 and will be redeemable after November 16, 2001. We used the net
proceeds from the sale of the 7% notes to pay down debt under the revolving
facility, which may be reborrowed.
Year 2000 considerations
Since the summer of 1998, all of our departments have been meeting with our
information systems department to determine the extent of our Y2K exposure.
Project teams have been assembled to work on correcting Y2K problems and to
perform contingency planning to reduce our total exposure. Our goal is to have
all corrective action and contingency plans in place by the third quarter of
1999.
Software applications and hardware. Each component of our software
application portfolio, or SAP, must be examined with respect to its ability to
properly handle dates in the next millennium. As part of our software
assessment plan, key users will test each and every component of our SAP. These
tests will be constructed to make sure each component operates properly with
the system date advanced to the next millennium.
The major phases of our software assessment plan are as follows:
. Complete SAP inventory;
. Implement Y2K compliant software as necessary;
. Analyze which computers have Y2K problems and the cost to repair;
. Test all vendors' representations; and
. Fix any computer-specific problems.
Our billing and accounts receivable software is known to have a significant
Y2K problem. We have already addressed this issue by obtaining a new, Y2K
compliant version of this software. We expect to complete conversion to this
Y2K compliant version by the end of the third quarter of 1999.
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<PAGE>
Operating systems. We are also reviewing our operating systems to assess
possible Y2K exposure. We use several different network operating systems, or
NOS, for multi-user access to the software that resides on the respective
servers. Each NOS must be examined with respect to its ability to properly
handle dates in the next millennium. Key users will test each component of our
SAP with a compliant version of the NOS. One level beneath the NOS is a special
piece of software that comes into play when the computer is "booted" that
potentially has a Y2K problem and that is the basic input output system
software, or BIOS. The BIOS takes the date from the system clock and uses it in
passing the date to the NOS which in turn passes the date to the desktop
operating system. The system clock poses another problem in that some system
clocks were only capable of storing a two-digit year while other computer
clocks stored a four-digit year. This issue affects each and every computer we
have purchased. To remedy these problems, we plan to inventory all computer
hardware using a Y2K utility program to determine whether we have a BIOS or a
system clock problem. We then intend to perform a BIOS upgrade or perform a
processor upgrade to a Y2K compliant processor.
Dialysis centers, equipment and suppliers. The operations of our dialysis
centers can be affected by the Y2K problem so a contingency plan must be in
place to prevent the shutdown of these centers. Each center will be responsible
for completing a survey of the possible consequences of a failure of the
information systems of our vendors and formulating a contingency plan by the
third quarter of 1999. Divisional vice presidents will then review these plans
to assure compliance.
All of our biomedical devices, including dialysis machines that have a
computer chip in them will be checked thoroughly for Y2K compliance. We have
contacted or will contact each of the vendors of the equipment we use and ask
them to provide us with documentation regarding Y2K compliance. Where it is
technically and financially feasible without jeopardizing any warranties, we
will test our equipment by advancing the clock to a date in the next
millennium.
In general, we expect to have all of our biomedical devices Y2K compliant by
the third quarter of 1999. We have not yet been able to estimate the costs of
upgrading or replacing certain of our biomedical devices as we do not yet know
which of these machines, if any, are not currently Y2K compliant.
In addition to factors noted above which are directly within our control,
factors beyond our direct control may disrupt our operations. If our suppliers
are not Y2K complaint, we may experience inventory shortages and run short of
critical supplies. If the utilities companies, transportation carriers and
telecommunications companies which service us experience Y2K difficulties, our
operations will also be adversely affected and some of our facilities may need
to be closed. We are in the process of taking steps to reduce the impact on our
operations in such instances and implementing contingency plans to address any
possible unavoidable affect which these difficulties would have on our
operations.
To address the possibility of a physical plant failure, we are contacting the
landlords of each of our facilities to insure that they will provide access to
our staff and any other key service providers. We are also providing written
notification to our utilities companies of the locations, schedules and
emergency services required of each of our dialysis facilities. In case a
physical plant failure should result in an emergency closure of any of our
facilities, we are currently:
.Confirming that backup hospital affiliation agreements are up-to-date and
complete;
.Reviewing appropriate elements of our disaster preparedness plan with our
staff and patients;
. Adopting/modifying emergency treatment orders and rationing plans with
our medical directors to provide patient safety; and
.Conducting patient meetings with social workers and dieticians.
To minimize the affect of any Y2K non-compliance on the part of suppliers, we
are currently taking steps to:
. Identify our critical suppliers and survey each of them to assess their
Y2K compliance status;
. Identify alternative supply sources where necessary;
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<PAGE>
. Identify Y2K compliant transportation/shipping companies and establish
agreements with them to cover situations where our current supplier's
delivery systems go down;
. Include language in contracts with new suppliers addressing Y2K
performance obligations, requirements and failures;
. Stock our dialysis facilities with one week of additional inventory; the
orders will be placed two weeks before January 2000, to ensure receipt;
. Require critical distributors to carry additional inventory earmarked for
us; and
. Prepare a critical supplier contact/pager list for Y2K emergency supply
problems and ensure that contact persons will be on call 24 hours a day.
Our financial exposure from all sources of SAP and operating system Y2K
issues as well as from dialysis center, equipment and supplier Y2K issues known
to date ranges from approximately $500,000 to $1,200,000, none of which has
been expended.
General. The extent and magnitude of the Y2K problem as it will affect us,
both before, and for some period after, January 1, 2000, are difficult to
predict or quantify for a number of reasons. Among the most important are our
lack of control over systems that are used by the third parties who are
critical to our operations, such as telecommunications and utilities companies,
the complexity of testing interconnected networks and applications that depend
on third-party networks and the uncertainty surrounding how others will deal
with liability issues raised by Y2K-related failures. Moreover, the estimated
costs of implementing our plans for fixing Y2K problems do not take into
account the costs, if any, that might be incurred as a result of Y2K-related
failures that occur despite our implementation of these plans.
With respect to third-party non-governmental payors, we are in the process of
determining where our exposure is and developing contingency plans to prevent
the interruption of cash flow. With respect to Medicare payments, neither HCFA
nor its financial intermediaries have any contingency plan in place. However,
HCFA has mandated that its financial intermediaries submit a draft of their
contingency plans to it by March 1999 and that they be prepared to ensure that
no interruption of Medicare payments results from Y2K-related failures of their
systems. With respect to MediCal, the largest of our third-party state payors,
we are already submitting our claims with a four-digit numerical year in
accordance with the current system. We are currently working with our other
state payors individually to determine the extent of their Y2K compliance.
Although we currently are not aware of any material operational issues
associated with preparing our internal computer systems, facilities and
equipment for Y2K, we cannot assure you, due to the overall complexity of the
Y2K issues and the uncertainty surrounding third party responses to Y2K issues,
that we will not experience material unanticipated negative consequences and/or
material costs caused by undetected errors or defects in our or third party
systems or by our failure to adequately prepare for the results of such errors
or defects, including costs or related litigation, if any. The impact of such
consequences could have a material adverse effect on our business, financial
condition or results of operations.
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
There have been no material changes in our market risk exposure from that
reported in our Form 10-K for the fiscal year ended December 31, 1998.
15
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RISK FACTORS
In addition to the other information set forth in this Form 10-Q, you should
note the following risks related to our business.
Dependence on Medicare and Medicaid--Future declines in reimbursement rates
would affect a substantial portion of our revenues.
We are reimbursed for dialysis services primarily at fixed rates established
in advance under the Medicare end stage renal disease, or ESRD, program.
Reductions in these rates could materially reduce our net operating revenues
and profits because approximately 49% of our net operating revenues in the
first quarter of 1999 was generated from patients who had Medicare as the
primary payor. Since 1983, Congress has changed the Medicare composite
reimbursement rate from a national average of $138 per treatment in 1983 to a
low of $125 per treatment on average in 1986 and to approximately $126 per
treatment on average at present. We cannot predict whether future rate changes
will be made. Also, increases in operating costs that are subject to inflation,
such as labor and supply costs, may occur without a compensating increase in
reimbursement rates.
Approximately 23% of our net operating revenues in the first quarter of 1999
was generated from erythropoietin, or EPO, from all payors. Consequently, any
reduction in the rate of EPO reimbursement through Medicare and Medicaid
programs could materially reduce our net income. From time to time, EPO
reimbursement programs have been, and in the future may be, subject to various
legislative or administrative proposals to reduce the EPO reimbursement rate.
For example, the Department of Health and Human Services, or HHS, and the
Clinton administration have endorsed a 10% reduction in Medicare reimbursement
for EPO. We cannot predict whether future rate or reimbursement method changes
will be made. If such changes are implemented, they could have a material
adverse effect on our business, results of operations or financial condition.
Medicare separately reimburses us for other in-center prescription drugs that
we administer to dialysis patients at the rate of 95% of the actual average
wholesale price of each drug. The Clinton administration has proposed a
reduction in the reimbursement rate for outpatient prescription drugs to 83% of
actual average wholesale price. We cannot predict whether Congress will approve
this rate change, or whether other reductions in reimbursement rates for
outpatient prescription drugs will be made. If such changes are implemented,
they could have a material adverse effect on our business, results of
operations or financial condition.
All of the states in which we operate dialysis facilities currently provide
benefits to qualified patients to supplement their Medicare entitlement.
Approximately 5% of our net operating revenues in the first quarter of 1999 was
generated from patients who had Medicaid or a comparable state program as the
primary payor. The Medicaid programs are subject to statutory and regulatory
changes which may have the effect of decreasing program payments, increasing
costs or modifying the way we operate our dialysis business.
Possible changes in Medicare's method of reimbursement--If certain services
that currently are separately reimbursed are included in the Medicare composite
reimbursement rate or Medicare changes its ESRD program to a capitated
reimbursement system, our revenues and profits could be materially reduced.
We cannot predict whether certain services which Medicare currently
reimburses separately may in the future be included in the Medicare composite
rate. If, in the future, Medicare includes in its composite reimbursement rate
any of the ancillary services presently reimbursed separately, we could not
seek separate reimbursement for these services. This would reduce our revenue
to the extent there was not a corresponding increase in the Medicare composite
rate.
The Health Care Financing Administration, or HCFA, already has initiated a
pilot demonstration project to test the feasibility of allowing managed care
plans to participate in the Medicare ESRD program on a capitated basis. Under a
capitated plan we would receive a fixed periodic payment for servicing all of
our Medicare-
16
<PAGE>
eligible ESRD patients regardless of certain fluctuations in the number of
services provided in that period or the number of patients treated.
Other sources of reimbursement--Restrictions on our ability to charge for
current services at current rates could materially affect our business.
Approximately 46% of our net operating revenues in the first quarter of 1999
was generated from patients who had sources other than Medicare and Medicaid as
their primary payor. These sources include payments from third-party, non-
government payors, at rates that generally exceed the Medicare and Medicaid
rates, payments from hospitals which we contract with to provide inpatient
dialysis treatments and payments from governments and private payors in
overseas markets. Any restriction on our ability to charge for our domestic-
market services at rates in excess of those Medicare pays would adversely
affect our business, results of operations and financial condition. We also
have nonexclusive agreements with certain third-party payors, and the
termination of certain of these agreements could have an adverse effect on our
business, results of operations or financial condition.
Source of EPO--Only one company manufactures EPO. Interruption of supply or
cost increases could materially reduce our net income and affect our ability to
care for our patients.
EPO is produced by a single manufacturer, Amgen Corporation. In the future,
Amgen may be unwilling or unable to supply us with EPO. Additionally, shortages
in the raw materials or other resources necessary to manufacture EPO, or simply
an arbitrary decision on the part of this sole supplier, may increase the
wholesale price of EPO. Interruptions of the supply of EPO or increases in the
price we pay for EPO could have a material adverse effect on our financial
condition as well as our ability to provide appropriate care to our patients.
Operations subject to government regulation--Our failure to meet current or
future government regulations could cause us to incur sanctions or could
prevent us from participating in certain government programs or operating in
certain geographical areas.
Our dialysis operations are subject to extensive federal, state and local
governmental regulations in the U.S. and to extensive government regulation in
virtually every country in which we operate. U.S. and non-U.S. regulations are
designed to accomplish the same objectives: the provision of quality healthcare
for patients, the maintenance of occupational, health, safety and environmental
standards and the provision of accurate reporting and billing for government
payments and/or reimbursement. Any loss of federal certifications,
authorization to participate in the Medicare or Medicaid programs, or licenses
under the laws of any state or governmental authority in which we generate
substantial revenue would adversely impact our business. Our industry will
continue to be subject to intense governmental regulation at the state and
federal levels, the scope and effect of which are difficult to predict. This
regulation could adversely impact us in a material way. In addition, various
governmental authorities periodically may review or challenge us. This could
have a material adverse effect on our business, results of operations or
financial condition.
In addition, each foreign country in which we operate has its own payment and
reimbursement rules and procedures. Our failure to understand these
reimbursement systems could cause us to assess the performance of our
operations in other countries incorrectly or cause us to overpay for
acquisitions of dialysis centers. Some countries prohibit foreign interests
from owning healthcare providers, or establish other regulatory barriers to
direct foreign ownership. Failure to comply with these regulations could have a
material adverse effect on our business, results of operations or financial
condition. In addition, foreign regulators may challenge the relationships we
have structured, or may structure in the future, to overcome these regulatory
barriers.
. Our failure to comply with fraud and abuse statutes could result in
sanctions
Neither our arrangements with the medical directors of our facilities nor the
minority ownership interests of referring physicians in certain of our dialysis
facilities meet all of the requirements of published safe harbors
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to the illegal remuneration provisions of the Social Security Act and similar
state laws. These laws impose civil and criminal sanctions on persons who
receive or make payments for referring a patient for treatment that is paid for
in whole or in part by Medicare, Medicaid or similar state programs.
Transactions structured within published safe harbors are deemed not to violate
these provisions. Transactions that do not fall within a relevant safe harbor
may be subject to greater scrutiny by enforcement agencies. If we are
challenged under these statutes, we may have to change our practices or
relationships with our medical directors or with referring physicians holding
minority ownership interests.
California and several other states we do business in have laws that prohibit
a physician from making referrals for laboratory services to entities with
which they, or their immediate family members, have a financial interest. We
currently operate a large number of facilities in California which account for
a significant percentage of our business. It is possible that the California
statute could apply to laboratory services incidental to dialysis services. If
so, we would be required to restructure some relationships with referring
physicians who serve as medical directors of our facilities and with the
physicians who hold minority interests in some of our facilities.
. Our practices may be subject to challenge under Stark I and Stark II
The Omnibus Budget Reconciliation Act of 1989 includes certain provisions,
known as Stark I, that restrict physicians from making referrals for clinical
laboratory services to entities with which they or their immediate family
members have a "financial relationship." It is unclear whether certain
laboratory services that we provide, which are incidental to dialysis services,
fall within the Stark I prohibition. The Omnibus Budget Reconciliation Act of
1993 includes certain provisions, known as Stark II, that restrict physicians
from making referrals for certain "designated health services" to entities with
which they or their immediate family members have a "financial relationship."
It is unclear whether some of the services which we provide fall within the
Stark II prohibitions.
Violations of Stark I and Stark II are punishable by civil penalties, which
may include exclusion or suspension of the provider from future participation
in Medicare and Medicaid programs and substantial fines. Regulatory authorities
might challenge our practices under these laws.
Reimbursement of transportation costs--ESRD patients may stop using our
services if state programs stop reimbursing their transportation costs.
At present, the Medicaid programs of several states we do business in,
including California, pay the transportation costs relating to ESRD treatments
of Medicaid-eligible ESRD patients. If this practice is changed or deemed to
violate applicable federal or state law, our patients may no longer receive
this service. We cannot predict the effect this would have on the desire or
ability of patients to use our services.
Investigations--We continuously are subject to regulatory scrutiny and payments
of revenues under investigation may be suspended and possibly never collected.
In the ordinary course of business, our operations continuously are subject
to regulatory scrutiny, supervision and control. This regulatory scrutiny often
includes inquiries, investigations, examinations, audits, site visits and
surveys, both routine and non-routine. If we are found to have engaged in
improper practices, regulatory authorities could seek civil, administrative, or
criminal fines, penalties or restitutionary relief, and reimbursement
authorities could also seek our suspension or exclusion from participation in
their programs.
Our Florida-based laboratory subsidiary is the subject of a third-party
carrier review relating to certain claims the laboratory submitted for Medicare
reimbursement. We understand that other providers' laboratory activities in
Florida and elsewhere are the subject of similar reviews. The carrier has
alleged that 99.3% of the tests this laboratory performed for the review period
it initially identified, from January 1995 to April 1996, were not properly
supported by the prescribing physicians' medical justification. The carrier
subsequently requested billing records with respect to the additional period
from May 1996 to March 1998. The carrier has issued a formal overpayment
determination in the amount of $5.6 million and has suspended all payments of
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<PAGE>
claims related to this laboratory. The carrier has withheld approximately $20
million to date. In addition, the carrier has informed the local offices of the
Department of Justice and HHS of this matter. In February 1999, our Florida-
based laboratory subsidiary filed a complaint against the carrier and HHS
seeking a court order to lift the payment suspension. Any determination adverse
to us in this, or other potential, future investigations, could have an adverse
impact on our business, results of operations or financial condition.
Risks inherent in growth strategy--The acquisition, development and management
of additional dialysis facilities vital to our business strategy may strain our
existing resources and present integration problems or may never be completed.
Our business strategy depends significantly on our ability to acquire,
develop or manage, and successfully integrate additional dialysis facilities.
This strategy subjects us to the risk that:
. Suitable acquisition candidates may not be available;
. We may not be able to consummate future acquisitions on acceptable terms;
. We may not be able to integrate future acquisitions successfully;
. We may be inaccurate in assessing the value, strengths and weaknesses of
acquisition candidates;
. We may not be able to fulfill our obligations under management agreements;
. We may be inaccurate in identifying suitable locations to develop
additional facilities;
. Businesses that we acquire may never achieve revenues and profitability
that justify our investment in them; and
. Additional financing may not be available to finance future acquisitions.
Our inability to acquire or develop facilities in a cost-effective manner
could adversely affect our ability to expand our business and enhance our
results of operations and financial condition. In addition, integrating
acquired or managed operations, particularly newly acquired regional networks,
large scale acquisitions, such as our acquisition of Renal Treatment Centers,
Inc., or RTC, and multi-facility management agreements, present a significant
challenge and may lead to unanticipated costs or a diversion of management's
attention from day-to-day operations. Despite the pooling of TRCH's and RTC's
historical operating results, we have conducted operations as a combined entity
only since February 1998. This pooling of the historic results of operations
and financial condition of TRCH and RTC on a stand-alone basis may differ from
our actual combined results in the future.
Our growth is expected to place significant demands on our financial and
management resources and will require us to develop further the management
skills of our managers and supervisors, and to continue to train, motivate and
effectively manage our employees. There are risks that:
. Our operations and future acquisitions may require additional personnel,
assets and cash expenditures and we may not be able to manage effectively
the expansion of our operations;
. We may not be able to anticipate and respond to all of the changing
demands that our expanding operations, including our acquisition of RTC,
will and could continue to have on our management, and information,
financial and operating systems; and
. Acquisitions could result in disruptions and unanticipated expenses.
Our failure to meet the challenges of expansion and to manage our prior and
future growth could have an adverse effect on our business, results of
operations or financial condition.
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<PAGE>
Dependence on physician referrals--The loss of key referring physicians could
reduce our patient base and our revenues.
We depend upon referrals of ESRD patients from physicians specializing in
nephrology and practicing in the communities we serve. As generally is true in
the dialysis industry, one or a few physicians refer all or a significant
portion of the patients at each facility. The loss of one or more key referring
physicians at a particular facility could materially reduce the revenues of
that facility. Referring physicians own minority interests in certain of our
dialysis facilities. If these interests are deemed to violate applicable
federal or state law, these physicians may be forced to dispose of their
ownership interests. We cannot predict the effect these dispositions would have
on our continuing relationships with these physicians or our business.
Operations outside the United States--Certain attributes of foreign companies
may disrupt their integration into our operations.
We are entering certain international markets for the first time and we may
not be able to integrate international acquisitions effectively. Certain
attributes of foreign companies and their operations may disrupt their
integration into our operations. These attributes include:
. Differences in accepted clinical standards and practices;
. Differences in management styles and practices;
. The unfamiliarity of foreign companies with United States generally
accepted accounting principles; and
. Local laws that restrict or limit employee discharges and disciplinary
actions.
Any failure to integrate efficiently foreign acquisitions or to realize
expected synergies and cost savings could have a material adverse effect on our
business, results of operations and financial condition.
Outstanding debt--The large amount of our total outstanding debt and our
obligation to service that debt could divert funds from operations, limit our
ability to obtain financing for future needs and expose us to interest rate
risks, and covenants in our credit facilities may prevent us from taking
advantage of business opportunities.
We are highly leveraged, which means that the amount of our outstanding debt
is large compared to the net book value of our assets, and have substantial
repayment obligations under our outstanding debt. As of March 31, 1999 we had:
. Total consolidated debt of approximately $1.3 billion; and
. Stockholders' equity of approximately $512 million.
In addition, as of March 31, 1999, our borrowing availability under our
credit facilities was approximately $512 million.
Our debt agreements contain numerous financial and operating covenants that
limit our ability, and the ability of most of our subsidiaries, to undertake
certain transactions. These covenants require that we meet certain interest
coverage, net worth and leverage tests. Our debt agreements also permit us and
our subsidiaries to incur or guarantee additional debt, subject to certain
limitations in the case of the credit facilities.
Our level of debt and the limitations imposed on us by our debt agreements
could have other important consequences to you, including the following:
. We will have to use a portion of our cash flow from operations for debt
service, rather than for our operations;
. We may not be able to obtain additional debt financing for future working
capital, capital expenditures, acquisitions or other corporate purposes;
20
<PAGE>
. The debt under our credit facilities is at a variable interest rate,
making us vulnerable to increases in interest rates; and
. We could be less able to take advantage of significant business
opportunities, including acquisitions, and react to changes in market or
industry conditions.
Financing change of control offer--We may not have the ability to raise the
funds necessary to repurchase our notes upon a change of control as required by
the indentures governing our notes.
Upon a change of control, generally the sale or transfer of a majority of our
voting stock or almost all of our assets, our note holders may require us to
repurchase all or a portion of their notes. If a change of control occurs, we
may not be able to pay the repurchase price for all of the notes submitted for
repurchase. In addition, the terms of some of our existing debt agreements,
including our credit facilities, generally prohibit us from purchasing any
notes until all debt under these agreements is paid in full. Future credit
agreements or other agreements relating to debt may contain similar provisions.
We may not be able to secure the consent of our lenders to repurchase the notes
or refinance the borrowings that prohibit our repurchasing the notes. If we do
not obtain a consent or repay the borrowings, we could not repurchase the
notes. Our failure to repurchase submitted notes would be an event of default
under the indentures. This would, in turn, be a further default under certain
of our existing or future debt agreements, including our credit facilities.
This further default could result in this debt becoming immediately payable in
full. We might not have sufficient assets to satisfy all of our obligations
under our credit facilities and the notes.
Antitakeover provisions--Provisions in our charter documents may deter a change
of control which our stockholders may otherwise determine to be in their best
interests.
Our certificate of incorporation and bylaws and the Delaware General
Corporation Law, or DGCL, include provisions which may deter hostile takeovers,
delay or prevent changes in control or changes in our management, or limit the
ability of our stockholders to approve transactions that they may otherwise
determine to be in their best interests. These provisions include:
. A provision requiring that our stockholders may take action only at a
duly called annual or special meeting of our stockholders and not by
written consent;
. A provision requiring a stockholder to give at least 60 days' advance
notice of a proposal or director nomination that the stockholder desires
to present at any annual or special meeting of stockholders; and
. A provision granting our board of directors the authority to issue up to
five million shares of preferred stock and to determine the rights and
preferences of the preferred stock without the need for further
stockholder approval. The existence of this "blank-check" preferred stock
could discourage an attempt to obtain control of us by means of a tender
offer, merger, proxy contest or otherwise. Furthermore, this "blank-
check" preferred stock may have other rights, including economic rights,
senior to our common stock. Therefore, issuance of the preferred stock
could have an adverse effect on the market price of our common stock.
We may, in the future, adopt other measures that may have the effect of
delaying, deferring or preventing an unsolicited takeover, even if such a
change in control were at a premium price or favored by a majority of
unaffiliated stockholders. We may adopt certain of these measures without any
further vote or action by our stockholders.
Year 2000 issues--We may experience material unanticipated negative
consequences beginning in the year 2000 due to undetected computer defects.
The "Year 2000," or Y2K, issue concerns the potential exposures related to
the automated generation of incorrect information from the use of computer
programs which have been written using two digits, rather than
21
<PAGE>
four, to define the applicable year of business transactions. We are not
currently aware of any material operational issues associated with preparing
our internal computer systems, facilities and equipment for Y2K. We cannot
assure you, however, due to the overall complexity of the Y2K issues and the
uncertainty surrounding third party responses to Y2K issues, that undetected
errors or defects in our or third party systems or our failure to prepare
adequately for the results of those errors or defects will not cause us
material unanticipated problems or costs.
The extent and magnitude of the Y2K problem as it will affect us, both
before, and for some period after, January 1, 2000, are difficult to predict or
quantify for a number of reasons. Among the most important are:
. Our lack of control over third party systems that are critical to our
operations, including those of telecommunications and utilities companies
and governmental and non-governmental payors;
. The complexity of testing interconnected networks and applications that
depend on third-party networks; and
. The uncertainty surrounding how others will deal with liability issues
raised by Y2K-related failures.
Moreover, the estimated costs of implementing our plans for fixing Y2K
problems do not take into account the costs, if any, that we might incur as a
result of Y2K-related failures that occur despite our implementation of these
plans.
While we are developing contingency plans to address possible computer
failure scenarios, we recognize that there are "worst case" scenarios which may
occur and are largely outside our control. There are risks associated with
extended failures of regional infrastructures, such as power, water, and
telecommunications systems, the interruption of Medicare reimbursement payments
or payments from other third-party payors, and the failure of equipment or
software that could impact patient safety or health despite the assurances of
third parties. In addition, our internal systems could fail resulting in our
inability to generate billing statements and invoices or the internal data
necessary to support our billing process. This, in turn, could result in an
interruption of our cash flow. We are addressing these and other failure
scenarios in our contingency planning effort and are engaging third parties in
discussions regarding how to manage common failure scenarios, but we cannot
currently estimate the likelihood or the potential cost of such failures.
Currently, we do not believe that any reasonably likely worst case scenario
will have a material impact on our revenues or operations. Reasonably likely
worst case scenarios include continued expenditures for remediation, continued
expenditures for replacement or upgrade of equipment, continued efforts
regarding contingency planning, increased staffing for the periods immediately
preceding and after January 1, 2000 and the possible implementation of
alternative payment schemes with our payors.
Goodwill amortization--If our assumptions regarding the beneficial life of our
goodwill prove to be inaccurate, or subsequently change, our current earnings
may be overstated and future earnings also may be affected.
Included in our balance sheet is an amount designated as "goodwill" that
represents 48% of our assets and 219% of our stockholders' equity at March 31,
1999. Goodwill arises when an acquiror pays more for a business than the fair
value of the tangible and separately measurable intangible net assets.
Generally accepted accounting principles require the amortization of goodwill
and all other intangible assets over the period benefited. The current annual
average useful life is 33 years for our goodwill and 21 years for all of our
intangible assets that relate to business combinations. We have determined that
most acquisitions after December 31, 1996 will continue to provide a benefit to
us for no less than 40 years after the acquisition. In making this
determination, we have reviewed with our independent accountants the
significant factors that we considered in arriving at the consideration we paid
for, and the expected period of benefit from, acquired businesses.
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If the factors we considered, and which give rise to a material portion of
our goodwill, result in an actual beneficial period which is shorter than our
determined useful life, earnings reported in periods immediately following
certain acquisitions would be overstated. In addition, in later years, we would
be burdened by a continuing charge against earnings without the associated
benefit to income. Earnings in later years could also be affected significantly
if we subsequently determine that the remaining balance of goodwill has been
impaired.
Forward-looking Statements
We believe that this Form 10-Q contains statements that are forward-looking
statements within the meaning of the federal securities laws. These include
statements about our expectations, beliefs, intentions or strategies for the
future, which we indicate by words or phrases such as "anticipate," "expect,"
"intend," "plan," "will," "believe" and similar language. These statements
involve known and unknown risks, including risks resulting from economic and
market conditions, the regulatory environment in which we operate, competitive
activities and other business conditions, and are subject to uncertainties and
assumptions set forth elsewhere in this Form 10-Q. Our actual results may
differ materially from results anticipated in these forward-looking statements.
We base our forward-looking statements on information currently available to
us, and we assume no obligation to update these statements.
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<PAGE>
PART II
OTHER INFORMATION
Items 1, 2, 3, 4 and 5 are not applicable.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
27.1 Financial Data Schedule--three months ended March 31, 1999 and three
months ended March 31, 1998.X
- ---------------------
X Filed herewith.
(b) Reports on Form 8-K
None.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
TOTAL RENAL CARE HOLDINGS, INC.
By: /s/ John E. King
--------------------------------
John E. King
Senior Vice President, Finance and
Chief Financial Officer
Date: May 17, 1999
John E. King is signing in the dual capacities as (i) Chief Financial Officer
and (ii) a duly authorized officer of the Company.
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<PAGE>
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
Exhibit
Number Description
------- -----------
<C> <S>
27.1 Financial Data Schedule--three months ended March 31, 1999 and three
months ended March 31, 1998.X
</TABLE>
- ---------------------
X Filed herewith.
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<S> <C> <C>
<PERIOD-TYPE> 3-MOS 3-MOS
<FISCAL-YEAR-END> DEC-31-1999 DEC-31-1998
<PERIOD-START> JAN-01-1999 JAN-01-1998
<PERIOD-END> MAR-31-1999 MAR-31-1998
<CASH> 39,905,000 0
<SECURITIES> 0 0
<RECEIVABLES> 510,638,000 0
<ALLOWANCES> 68,828,000 0
<INVENTORY> 27,260,000 0
<CURRENT-ASSETS> 574,157,000 0
<PP&E> 261,189,000 0
<DEPRECIATION> 0 0
<TOTAL-ASSETS> 2,047,404,000 0
<CURRENT-LIABILITIES> 168,996,000 0
<BONDS> 0 0
0 0
0 0
<COMMON> 81,000 0
<OTHER-SE> 511,757,000 0
<TOTAL-LIABILITY-AND-EQUITY> 2,047,404,000 0
<SALES> 352,244,000 258,749,000
<TOTAL-REVENUES> 352,244,000 258,749,000
<CGS> 0 0
<TOTAL-COSTS> 282,323,000 289,697,000
<OTHER-EXPENSES> 0 0
<LOSS-PROVISION> 10,478,000 6,763,000
<INTEREST-EXPENSE> 22,767,000 14,517,000
<INCOME-PRETAX> 46,166,000 (45,216,000)
<INCOME-TAX> 18,282,000 872,000
<INCOME-CONTINUING> 27,884,000 (46,088,000)
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 2,812,000
<CHANGES> 0 6,896,000
<NET-INCOME> 27,884,000 (55,796,000)
<EPS-PRIMARY> 0.34 (0.71)
<EPS-DILUTED> 0.34 (0.71)
</TABLE>
