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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
--------------------------
FORM 10-K/A
(Mark One) (AMENDMENT NO. 1)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the fiscal year ended December 31, 1998
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)
<TABLE>
<S> <C>
Delaware 51-0354549
(State or other jurisdiction of incorporation (I.R.S. Employer Identification No.)
or organization)
</TABLE>
21250 Hawthorne Boulevard, Suite 800, Torrance, California 90503-5517
(Address of principal executive offices)
Registrant's telephone number, including area code: (310) 792-2600
Securities registered pursuant to Section 12(b) of the Act: Common Stock, par
value $0.001 per share
Name of each exchange on which registered: New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act: None
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. [X] Yes [_] No
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]
The aggregate market value of the common stock of the Registrant held by non-
affiliates of the Registrant on March 15, 1999, based on the price at which the
common stock was sold as of March 15, 1999, was $738,650,481.
The number of shares of the Registrant's common stock outstanding as of March
15, 1999 was 81,054,793 shares.
Documents Incorporated by Reference
None.
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INTRODUCTORY STATEMENT
We are filing this Amendment No. 1 on Form 10-K/A for the fiscal year ended
December 31, 1998 in response to comments received by us from the Securities
and Exchange Commission regarding our Registration Statement on Form S-3 (File
No. 333-69227).
PART I
Item 1. Business.
The following should be read in conjunction with our consolidated financial
statements and the related notes contained elsewhere in this Form 10-K. This
Form 10-K contains forward-looking statements which involve risks and
uncertainties. Our actual results may differ significantly from the results
discussed in the forward-looking statements. Unless otherwise indicated, all
share and per share data in this Form 10-K reflect all Total Renal Care
Holdings, Inc., or TRCH, stock splits and all information in this Form 10-K is
as of March 15, 1999.
Overview
We are the largest worldwide independent provider of integrated dialysis
services for patients suffering from chronic kidney failure, also known as end
stage renal disease, or ESRD. We provide dialysis and ancillary services to
more than 41,300 patients through a network of 537 outpatient dialysis
facilities, including approximately 3,000 patients and 35 facilities under
management, in 34 states, Washington D.C., Puerto Rico, Guam, Argentina, and
Europe. Of our 537 facilities, 459 facilities servicing more than 37,500
patients are located in the United States. In addition, we provide inpatient
dialysis services at approximately 290 hospitals. We also offer ancillary
services including ESRD laboratory and pharmacy services, physician network
development and management, pre- and post-transplant services, ESRD clinical
research programs, and vascular access management, which is the care of the
entry site to a patient's bloodstream.
On February 27, 1998, we acquired Renal Treatment Centers, Inc., or RTC, then
the fourth largest provider of integrated dialysis services in the United
States, in a stock-for-stock exchange transaction valued at approximately $1.3
billion. The acquisition added 185 facilities servicing approximately 13,200
patients.
Business strategy
We seek to further strengthen our position as the leading independent
provider of integrated dialysis services worldwide and to maximize
profitability through the following strategies:
. Expand through strategic acquisitions, de novo developments and
management agreements
We believe that significant opportunities continue to exist for growing our
patient base through strategic acquisitions, building our own facilities, which
we refer to as de novo developments, and providing management services to
dialysis facilities, both domestically and internationally. Our strategy is to
buy, build, or manage facilities in order to leverage our operations in regions
where we already have a strong market presence or to establish a strong
presence in new markets by acquiring or developing clusters of facilities that
can support new regional operations. We also actively market our ability to
provide management services that assist dialysis facilities in improving both
their financial performance and quality of care. The table below shows our
implementation of this strategy by presenting the number of facilities added
each year through acquisitions, de novo developments and management agreements:
<TABLE>
<CAPTION>
De Novo Managed
Acquisitions Developments Centers
------------ ------------ -------
<S> <C> <C> <C>
1995...................................... 23 3 --
1996...................................... 57 9 --
1997...................................... 51 12 --
RTC merger (February 27, 1998)............ 185 -- --
1998 (excluding the RTC merger)........... 70 24 32
January 1, 1999 through March 15, 1999.... 23 3 3
</TABLE>
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. Offer an expanded range of ancillary and "Total Renal Care" services
We are committed to broadening the range of ancillary and "Total Renal Care"
services we provide to our ESRD patients. By providing additional ancillary
services, we add value for our patients by improving the quality of their care.
Such services include ESRD laboratory and pharmacy services, vascular access
management, pre- and post-transplant services, nephrology-related clinical
research and pediatric dialysis programs. We believe that by providing
comprehensive ESRD services, we can generate additional revenues with improved
margins, while also providing higher quality service to our patients.
. Achieve Quality/Value/Growth at all of our facilities
Through our Quality/Value/Growth Program, we seek to improve the quality of
care our patients receive while enhancing operating efficiencies and growing
the patient base at our existing facilities. Our Quality Management Team
strives to improve the quality and outcome of dialysis treatments at our
facilities and trains the staff of our regional facility networks. Our Value
Management Team focuses on improving financial and operational measures while
enhancing the quality of care at each center. By providing high-quality,
efficient care, we can grow our patient base at our existing facilities.
. Form strategic alliances with managed care organizations
We believe we are well-positioned to form strategic alliances with managed
care organizations as a result of our ability to:
(1) Cover a wide geographic area in our markets;
(2) Provide comprehensive, integrated "Total Renal Care" ESRD services; and
(3) Deliver high-quality care while reducing overall healthcare costs.
To date, we have established strategic alliances to provide integrated
dialysis and disease management services with leading managed care
organizations including Kaiser Permanente in San Diego and Northern California,
Group Health Cooperative of Puget Sound, Aetna (New Orleans), and Maxicare (New
Orleans).
The dialysis industry
End stage renal disease
ESRD is the state of advanced kidney impairment that is irreversible and
requires routine dialysis treatments or kidney transplantation to sustain life.
Dialysis is the removal of waste from the blood of ESRD patients by artificial
means. Patients suffering from ESRD generally require dialysis three times per
week for their entire lives. We estimate that the United States market for
outpatient and inpatient services to ESRD patients exceeded $16 billion in
1998.
Trends
The following are some general trends in the dialysis industry:
. Stable and predictable growth in patient base
According to figures published by the Health Care Financing Administration,
or HCFA, the number of ESRD patients requiring chronic dialysis services in the
United States has increased at an approximate compounded annual growth rate of
8% from approximately 85,000 patients in 1985 to over 250,000 patients in
March 1999.
We expect the number of ESRD patients to continue to grow at approximately
the historical rate for the foreseeable future due to:
(1) The aging of the general population;
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(2) Better treatment and longer survival of patients with diseases that
typically lead to ESRD, including diabetes and hypertension; and
(3) Improved medical and dialysis technology.
We believe that the consistent patient growth rate and the necessity of life-
long treatment for most ESRD patients translate into predictable top-line
revenue for us and the other leading dialysis service providers.
. Significant acquisition opportunities and ongoing industry consolidation
The domestic dialysis services industry has been consolidating, with the five
largest dialysis providers increasing their share of dialysis facilities from
approximately 30% in 1992 to 53% in 1997. However, the absolute number of
facilities owned by parties other than the five largest dialysis providers has
not significantly decreased due to the consistent growth in the patient and
facility bases.
We expect consolidation by the largest dialysis providers to continue due to
their ability to leverage corporate and management resources and increase
operating efficiencies. Moreover, the growth of managed care organizations has
led physician owners of private facilities to sell their facilities to the
multi-facility providers, which are better positioned to meet the challenges of
managed care, including the reporting of quality outcomes measures through
clinical information systems and the lowering of overall healthcare costs
through a reduction in hospitalizations.
. Historically stable Medicare reimbursement environment
Since 1972, reimbursement of dialysis services has been covered universally
by the federal government under Medicare regardless of age or income. Under
this system, Medicare reimbursement rates are established by Congress. Medicare
reimbursement rates for dialysis treatments essentially have been flat since
1983 and have declined over 65% in real dollars since 1972. Although this form
of reimbursement limits the allowable charge per treatment, it provides
dialysis providers with predictable and recurring per treatment revenues and
permits providers to retain any profit earned.
We believe that the fixed-rate, government-reimbursed environment of the
dialysis industry favors large providers, like ourselves, able to spread
overhead costs across a broad patient base. In addition, the multi-facility
providers have adapted to fixed reimbursement by improving operating
efficiency, offering ancillary services and accelerating consolidation.
. Attractive international dialysis market
We estimate that there are currently approximately 550,000 to 650,000 ESRD
patients outside the United States. We also believe that the international
patient base has been growing at a compounded annual growth rate of 8 to 9%. In
addition, the international markets are highly fragmented. We estimate that the
major multi-facility providers serviced only approximately 5% of all non-US
dialysis patients in 1998.
Our international expansion strategy targets countries with dialysis markets
similar to that in the United States, characterized by favorable reimbursement
environments and universal coverage of dialysis services. These countries
include Argentina, Germany, Italy, and the United Kingdom, as well as selected
other European and Far Eastern countries. We seek to improve financial
performance at acquired international facilities primarily through the
application of our purchasing and quality-assurance programs and the
streamlining of less efficient operating cost structures.
Treatment options for ESRD
Treatment options for ESRD include: (a) hemodialysis; (b) peritoneal
dialysis; and (c) kidney transplantation. ESRD patients are treated
predominantly in outpatient treatment facilities. HCFA estimates
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that, during 1997, 86.4% of the ESRD patients in the United States received
hemodialysis treatment in outpatient facilities, with 12.8% of the remaining
patients using peritoneal dialysis and 0.8% using home hemodialysis. All ESRD
patients require one of the following treatment options to sustain life:
. Hemodialysis
Hemodialysis, the most common form of ESRD treatment, generally is performed
either in a freestanding facility or in a hospital-based facility. Hemodialysis
uses an artificial kidney, called a dialyzer, to remove certain toxins, fluids
and salt from the patient's blood, combined with a machine to control external
blood flow and to monitor certain vital signs of the patient. The dialysis
process occurs across a semi-permeable membrane that divides the dialyzer into
two distinct chambers. While blood is circulated through one chamber, a pre-
mixed dialyzer fluid is circulated through the other chamber. The toxins and
excess fluid from the blood selectively cross the membrane into the dialyzer
fluid, allowing cleansed blood to return into the patient's body. Each
hemodialysis treatment usually lasts approximately three and one-half hours and
usually is performed three times per week.
. Peritoneal dialysis
Peritoneal dialysis generally is performed by the patient at home. There are
several variations of peritoneal dialysis. The most common are continuous
ambulatory peritoneal dialysis, or CAPD, and continuous cycling peritoneal
dialysis, or CCPD. All forms of peritoneal dialysis use the patient's
peritoneal, or abdominal, cavity to eliminate fluid and toxins from the
patient.
CAPD introduces dialysis solution into the patient's peritoneal cavity
through a surgically placed catheter. Toxins in the blood continuously cross
the peritoneal membrane into the dialysis solution. After several hours, the
patient drains the used dialysis solution and replaces it with fresh solution.
This procedure usually is repeated four times per day.
CCPD is performed in a manner similar to CAPD, but uses a mechanical device
to cycle dialysis solution while the patient is sleeping or at rest.
. Transplantation
An alternative treatment that integrated dialysis service companies do not
provide is kidney transplantation. However, we do provide both pre- and post-
transplant nursing services and transplant pharmaceuticals in selected markets
through our pharmacy.
While transplantation, when successful, is generally the most desirable form
of therapeutic intervention, the shortage of suitable donors, side effects of
immunosuppressive drugs given to transplant recipients and dangers associated
with transplant surgery for certain patient populations limit the availability
of this treatment option. Only approximately 5% of all dialysis patients
received a kidney transplant in 1996 and the number of transplants performed
annually has remained relatively stable over the last ten years.
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Operations
Location and capacity of facilities
We operate 537 outpatient dialysis facilities. We own, either directly,
through wholly-owned subsidiary corporations or through joint ventures with
non-physicians, 451 of these facilities. Of the remaining facilities, 32 are
partially owned by us with physicians in the United States, and 19 are
partially owned by us with physicians in Italy, and 35 are managed by us. Our
facilities are located as follows:
<TABLE>
<CAPTION>
No. of
State Facilities
- ----- ----------
<S> <C>
AL...................... 1
AZ...................... 8
CA...................... 92
CO...................... 14
DC...................... 4
DE...................... 1
FL...................... 38
GA...................... 26
Guam.................... 1
HI...................... 4
IL...................... 13
IN...................... 3
KS...................... 8
LA...................... 8
MD...................... 15
MI...................... 9
MN...................... 29
MO...................... 5
NC...................... 30
NE...................... 1
NJ...................... 7
NM...................... 2
NV...................... 3
<CAPTION>
No. of
State Facilities
- ----- ----------
<S> <C>
NY........................ 19
OH........................ 3
OK........................ 15
PA........................ 22
Puerto Rico............... 2
RI........................ 3
SC........................ 2
SD........................ 4
TX........................ 42
UT........................ 3
VA........................ 15
WA........................ 5
WI........................ 1
WY........................ 1
---
Subtotal................ 459
---
<CAPTION>
Country
-------
<S> <C>
Argentina................. 52
Germany................... 3
Italy..................... 19
United Kingdom............ 4
---
Subtotal................ 78
---
Total................... 537
===
</TABLE>
We also provide acute inpatient dialysis services to approximately 290
hospitals. Network-wide, we provide training, supplies and on-call support
services to all of our CAPD and CCPD patients.
We believe we have adequate capacity within our existing facilities network
to accommodate greater patient volume. In addition, we currently are expanding
capacity at certain of our facilities by adding additional dialysis stations to
meet growing demand and building de novo facilities where existing facilities
cannot be expanded.
Operation of facilities
Our dialysis facilities are designed specifically for outpatient hemodialysis
and generally contain, in addition to space for dialysis treatments, a nurses'
station, a patient weigh-in area, a supply room, a water treatment space used
to purify the water used in hemodialysis treatments, a dialyzer reprocessing
room (where, with both the patient's and physician's consent, the patient's
dialyzer is sterilized for reuse), staff work areas, offices and a staff lounge
and kitchen. Many of our facilities also have a designated area for training
patients in home dialysis. Each facility also offers amenities for the
patients, for example a color television with headsets at each dialysis
station.
In accordance with conditions for participation in the Medicare ESRD program,
each facility has a qualified medical director. See the subheading "Physician
relationships." Each facility also has an
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administrator, typically a registered nurse, who supervises the day-to-day
operations of the facility and its staff. The staff of each facility typically
consists of registered nurses, licensed practical or vocational nurses, patient
care technicians, a social worker, a registered dietician, a unit clerk and
bio-medical technicians.
All of our facilities offer high-flux and high-efficiency hemodialysis, which
most physicians practicing at our facilities deem suitable for most of their
patients. High-flux and high-efficiency hemodialysis utilize machinery that
allow patients to dialyze in a shorter period of time per treatment because
such methods cleanse the blood at a faster rate than conventional hemodialysis.
Many of our facilities also offer conventional hemodialysis. We consider the
equipment installed in our facilities to be among the most technologically
advanced equipment currently available to the dialysis industry.
Many of our facilities also offer various forms of home dialysis, primarily
CAPD and CCPD. Home dialysis services consist of providing equipment and
supplies, training, patient monitoring and follow-up assistance to patients who
prefer and are able to receive dialysis treatments in their homes. Patients and
their families or other patient assistants are trained by a registered nurse to
perform either CAPD or CCPD at home. Our training programs for home dialysis
generally last two to three weeks. During 1998, approximately 12% of our
patients received peritoneal dialysis.
Inpatient dialysis services
We provide inpatient dialysis services, excluding physician professional
services, to patients in approximately 290 hospitals. We render these services
for a per-treatment fee individually negotiated with each hospital. When a
hospital requests our services, we administer the dialysis treatment at the
patient's bedside or in a dedicated treatment room in the hospital. Examples of
cases in which such inpatient services are required include patients with acute
kidney failure resulting from trauma or similar causes, patients in the early
stages of ESRD and ESRD patients who require hospitalization for other reasons.
Ancillary services--"Total Renal Care"
We provide a comprehensive range of ancillary services to ESRD patients,
including:
. EPO and other pharmaceuticals. The most significant ancillary service
that we provide is the administration of pharmaceuticals, including
erythropoietin, or EPO, calcium and iron supplements, upon a physician's
prescription. EPO is a genetically-engineered form of a naturally
occurring protein which stimulates the production of red blood cells and
is used in connection with all forms of dialysis to treat anemia, a
medical complication frequently experienced by ESRD patients.
. ESRD laboratory services and facilities. We own two licensed clinical
laboratories, located in Florida and Minnesota, specializing in ESRD
patient testing. Our laboratories provide both routine laboratory tests,
some of which are included in the Medicare composite rate for dialysis,
and non-routine laboratory tests for which an additional fee is charged.
Our laboratories provide these tests for both our own and other ESRD
patients throughout the United States. The types of laboratory tests
performed at the ESRD laboratories consist of: (a) blood tests to monitor
the ESRD condition, some of the costs of which are reimbursed as part of
the dialysis composite rate; and (b) blood tests ordered for diseases
that the patient has in addition to ESRD. In addition, our Minnesota
laboratory provides certain highly-specialized tests, including
therapeutic drug monitoring, bone deterioration and renal stone
monitoring and certain pre- and post-kidney transplant testing. Our
Florida laboratory has additional capacity available to accommodate our
expanding patient base. See the subheading "Investigations" under the
heading "Risk factors."
. Pharmacy. We opened a licensed pharmacy in California in February 1995
and acquired an additional pharmacy in Texas in May 1998 that provide a
comprehensive prescription oral drug program to ESRD patients receiving
treatments at certain of our facilities. The pharmacies also provide
immuno- suppressive medications that are required to maintain the viabil-
ity of a transplant patient's new kidney.
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. Vascular access management. We are the majority owner of an entity that
provides vascular access management services to ESRD patients. Clotting
of the hemodialysis vascular access, the entry site to the bloodstream
for the dialysis procedure, is one of the most common causes of
hospitalization for ESRD patients. Our vascular access management program
uses diagnostic and preventive procedures to help keep the access point
functioning.
. Transplant services. We have a pre- and post-kidney transplant services
program in which transplant nurses and coordinators train and counsel
patients and their families while also assisting them in the continuous
monitoring required for this population.
. ESRD clinical research programs. Our commitment to improve outcomes,
reduce costs and enhance the quality of life for ESRD patients includes
participating in research and development of new products and services.
Total Renal Research, or TRR, which operated for over 17 years as the
Drug Evaluation Unit, became our subsidiary in 1997. TRR conducts Phase I
through Phase IV clinical trials on devices, drugs and new technologies
in the renal and renal-related fields. This clinical research
organization has conducted over 200 clinical trials, working with over 50
drug companies and ten device companies, over the last 12 years.
. Pediatric ESRD services. We are committed to bringing our quality
programs and expertise to a national network of pediatric dialysis
centers, and we believe we are currently the only non-hospital based
provider of comprehensive services to pediatric ESRD patients.
. Ancillary testing. Other ancillary services include doppler flow testing
of the effectiveness of the patient's vascular access for dialysis and
blood transfusions, electrocardiograms, studies that examine the degree
of bone deterioration, and nerve conduction studies that examine the
degree of deterioration of nerves.
Physician relationships
A key factor in the success of a dialysis facility is our relationship with
local nephrologists. We currently have relationships with more than 600
nephrologists in our markets. As is often true in the dialysis industry, one or
a few physicians account for all or a significant portion of a dialysis
facility's patient referral base. The loss of one or more key referring
physicians at a particular facility could materially reduce the revenue of that
facility. In addition, our selection of a location for a de novo dialysis
facility is determined in part by the physician or nephrologist selected to
serve as our medical director. An ESRD patient generally seeks treatment at a
facility that is near to his or her home and at which his or her nephrologist
has practice privileges. Consequently, in order to continue to receive
physician referrals of ESRD patients, we rely on our ability to meet the needs
of referring physicians.
The conditions of participation in the Medicare ESRD program mandate that
treatment at a dialysis facility be "under the general supervision of a
director who is a physician." We have engaged qualified physicians or groups of
qualified physicians to serve as medical directors for each of our facilities.
Generally, the medical director must be board eligible or board certified in
internal medicine or nephrology and have had at least 12 months of experience
or training in the care of patients at dialysis facilities. At some facilities,
we also contract with one or more physicians to serve as assistant or associate
medical directors or to direct specific programs, such as home dialysis
training.
Medical directors, associate medical directors and assistant medical
directors enter into written contracts with us for a fixed period of time which
specify their duties and establish their compensation. The compensation of the
medical directors and other physicians under contract is separately negotiated
for each facility and generally depends upon competitive factors in the local
market, the physician's professional qualifications, the specific duties and
responsibilities of the physician, and the size and utilization of the facility
or relevant program.
Generally, we have non-competition agreements with our medical directors or
referring physicians. In all cases in which we acquire a facility from one or
more physicians, or where one or more physicians own interests in facilities as
partners, co-shareholders, or members of a limited liability corporation with
us, these
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physicians have agreed to refrain from owning interests in competing facilities
within a defined geographic area for various periods.
While infrequent, we have from time to time experienced competition from a
dialysis facility established by a former medical director following the
termination of his or her relationship with us. The agreements with medical
directors at approximately 6% of our facilities will expire within the next two
years. We may not be successful in renewing or extending these agreements on
terms acceptable to us. If we are unable to renew or extend our agreement with
the medical director at a particular facility, the revenues of that facility
could be materially reduced.
Quality
We believe our leading reputation for quality care is a significant
competitive advantage in attracting patients and physicians and in pursuing
growth in the managed care environment. We engage in organized and systematic
efforts to measure, maintain and improve the quality of services we deliver
through the following quality assurance programs:
. Quality Management Program. We have implemented a Quality Management
Program designed to measure outcomes and improve the quality of our
services. Our Quality Management Program and Clinical Information System
have been developed under the direction of our senior vice president,
quality management and chief medical officer, who is a clinical professor
of medicine at the University of California Medical Center in
San Francisco. The Quality Management Program is implemented by our
corporate director of quality management and over 30 regional quality
management coordinators. We also have a corporate director of integrated
quality development who supervises areas that affect the quality of our
service like education, training and infection control, adding another
dimension to our integrated approach to quality. In addition, our
regional biomedical quality management coordinators audit the technical
and biomedical quality of our facilities. This corporate quality
management team works with each facility's multi-disciplinary quality
management team, including the medical director, to implement the
program. The Quality Management Program involves all areas of our
services, monitoring and evaluating all of our activities with a focus on
continuous improvement. We also compile patient hospitalization and
related patient treatment outcomes data and have developed standards to
evaluate such data as part of our national Quality Management Program.
. Clinical Information System. To support the Quality Management Program
and in response to current payor demands for cost-effective healthcare
treatments with measurable outcomes, we have developed a proprietary PC-
based, networked Clinical Information System that provides facilities and
managed care organizations with detailed patient outcome reports and
critical clinical information. The Clinical Information System has been
installed in many of our facilities. Furthermore, we have connected
Kaiser's information system to our Clinical Information System at our
three Kaiser-dedicated centers in San Diego.
. H.O.M.E.R. We have entered into a strategic alliance with a software
company to further the development of Health Outcomes Management,
Evaluation & Research, or H.O.M.E.R., a system that relates treatment
parameters to patient problems, creating a versatile outcomes database
for clinical patient encounters. We believe this system will enhance our
Clinical Information System through its patient-centered, clinical
management module and will provide operating efficiencies through its
financial module.
. Physician Advisory Boards. We have several Physician Advisory Boards
consisting of nephrologists from facilities located in different regions
of the country who advise management on our various programs. An Academic
Advisory Board, containing representatives from each university program
with which we have a relationship, gives senior management access to
prominent academic leaders and leading nephrologists who provide advice
on quality and clinical issues. In addition, certain community physicians
participate on a Physician Advisory Board made up of two components: (a)
a Guideline
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Development Committee that provides assistance with clinical guideline
development, quality management, and other related issues; and (b) a
Laboratory Advisory Committee that provides feedback on all matters
concerning our two clinical laboratories. These boards meet periodically
to discuss quality and related operational issues. We believe our
reputation for providing quality care is a competitive advantage in
attracting new patients and new referring physicians.
. Patient satisfaction. Since 1991, we have retained an independent
consulting firm to conduct annual patient satisfaction surveys. These
surveys track and identify trends in patient satisfaction indicators that
are in turn shared with management, medical directors and patients for
discussion. We recently have decided to provide twice-yearly surveys,
with rapid feedback to the facilities, in order to enhance this vital
area of our Quality Management Program.
Value
Value Management Team
Our Value Management Team is led by a corporate vice president and a group of
corporate directors who assist our local and regional operations managers in
improving facility operations. The team also includes value management
coordinators who work with and train our local and regional managers to analyze
staffing levels, monitor drug and supply utilization and review other
operational measures. The Value Management Team and Quality Management Team
work together to ensure that facilities improve both the quality of services
provided and the efficiency with which those services are provided.
Best Demonstrated Practices Program
We have implemented a Best Demonstrated Practices Program as part of our
Quality/Value/Growth Program. This program creates value by benchmarking the
practices of top performing facilities, analyzing their processes and
disseminating this information to all of our facilities to improve the quality
of care while enhancing operating efficiencies. Our Best Demonstrated Practices
Program assesses the performance of each dialysis center in our entire facility
network across a variety of growth, quality, operational, financial and
customer satisfaction measures. Once a facility has demonstrated proficiency
with a certain practice, information and operational systems supporting this
practice are developed and disseminated throughout the organization by our
quality management coordinators, regional operations managers and value
management coordinators. Some of the key areas of focus are quality
measurements, patient satisfaction, staffing levels and supply utilization.
Growth
Our disciplined growth strategy focuses on establishing strong regional
networks of facilities through acquisitions, de novo developments and
management agreements. The regional networks allow us to realize efficiencies
in current operations and to leverage our infrastructure as we expand the
number of facilities we operate. We implement our ancillary services and
Quality/Value/Growth Program at all of our new facilities. Our growth strategy
also focuses on adding additional hospital inpatient contracts in order to
increase the number of patients to whom we provide inpatient dialysis services.
Since 1995, we have added 201 facilities through acquisitions, exclusive of the
merger with RTC in which we added 185 facilities, 48 facilities through de novo
developments, and 35 facilities through management contracts.
Acquisitions
Our acquisition strategy is to leverage our operating infrastructure in
existing regions by acquiring centers where we already have a strong market
presence and to establish a strong presence in new markets by acquiring
clusters of facilities that can support new regional operations. In reviewing a
potential acquisition, our evaluation includes analyzing financial pro formas,
reviewing the local competitive market and assessing the target facility's
reputation for providing quality care.
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We typically are able to improve an acquired facility's financial performance
and quality of care by:
. Reducing supply and labor costs;
. Eliminating a majority of the general and administrative and private
company expenses;
. Offering additional ancillary services; and
. Implementing our Quality/Value/Growth Program.
De novo developments
We seek continually to identify locations for de novo developments. We
develop new facilities to:
. Further enhance our regional networks;
. Capitalize on referrals by local nephrologists;
. Better serve the managed care market; and
. Accommodate the growing number of ESRD patients.
By developing 51 facilities since 1995, three of which we manage, we believe
that we have gained an expertise in the design, construction and operation of
new dialysis facilities.
The development of a typical outpatient facility generally requires $1.0
million to $1.2 million for initial construction and equipment and $200,000 to
$300,000 for working capital. Based on our experience, a de novo facility
typically takes six to nine months to open from the date of the signing of the
lease, achieves operating profitability by the ninth to eighteenth month of
operation and reaches maturity within three years.
In some markets, we have had difficulty finding suitable locations for de
novo developments. The inability to find a suitable location for a particular
de novo development may result in a lost opportunity to capture additional
market share in that area.
Management agreements
During 1998, we entered into 32 management agreements to assist academic
medical centers, community and county hospitals, non-profit organizations and
privately owned dialysis facilities to improve both their financial performance
and the quality of care they provide. Many of these dialysis facility operators
seek our expertise to help manage their operations more effectively due to:
. The rising costs of providing dialysis services without corresponding
increases in prices from government payors; and
. Our ability to bring programs like our Quality/Value/Growth Program to
local facilities, which would be prohibitively expensive for an
individual operator to develop and implement.
These management agreements are a cost-effective form of expansion for us
because they require little capital and utilize our existing local
infrastructure.
Academic alliances
Academic alliances help us remain on the leading edge of advances in the care
of ESRD patients by fostering relationships with ESRD specialists in the
academic field. We focus on affiliating with leading nephrologic research
institutions to stay abreast of the most current and important ESRD patient
care issues. We support the research efforts of leading academic nephrologists
by providing these institutions selective access to our Clinical Information
System which contains data on much of our large patient base. We have an
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Academic Advisory Board which meets semi-annually to review clinical programs
and to discuss ways in which we and our community physicians can work together
on critical research to improve the well being of the growing ESRD patient
population. We are actively pursuing alliances with academic medical centers
and currently work with the following academic institutions to provide the
highest quality care for their ESRD patients:
Children's Memorial Hospital/Northwestern University--Chicago, IL
Children's National Medical Center--Washington, D.C.
Erie County Medical Center/SUNY Buffalo--Buffalo, NY
Georgetown University--Washington, D.C.
Harbor/UCLA Medical Center--Los Angeles, CA
Louisiana State University--New Orleans, LA
The Regional Kidney Disease Program/Minneapolis Medical Research
Foundation--Minneapolis, MN
The Rogosin Institute/Cornell University Medical Center--New York, NY
The University of California at Los Angeles--Los Angeles, CA
The University of Minnesota--Minneapolis, MN
The University of Southern California--Los Angeles, CA
Alliances with managed care organizations and physicians
Managed care organizations
We believe we are well-positioned to form strategic alliances with managed
care organizations as a result of our ability to:
. Provide access to a large number of dialysis facilities in a single
geographic region. Our regional clusters offer managed care payors broad
facility networks able to support a large portion of each managed care
payor's ESRD patient population.
. Provide comprehensive, integrated "Total Renal Care" ESRD services. Our
array of ancillary services allow managed care payors to contract for
much of their ESRD patients' healthcare needs through a single contract
with us.
. Deliver high-quality care while reducing overall healthcare
costs. Through our Quality/Value/Growth Program, managed care payors are
assured that their patients will receive high-quality care resulting in
lower costs through a reduction in hospital and other healthcare
expenses.
The clustering of our facilities has allowed us to offer managed care payors
broad facility networks that can support a large segment of each managed care
payor's ESRD patient populations within each of our markets. As a result of our
managed care programs and the acquisition of RTC, we have approximately 350
contracts with managed care payors including Kaiser Permanente in San Diego and
Northern California, Group Health Cooperative of Puget Sound, Aetna (New
Orleans), and Maxicare (New Orleans).
Physicians/Networks
We seek to organize and manage networks of nephrologists which further
enhance the ability of these nephrologists to provide integrated ESRD services.
We have entered into long-term management contracts with leading nephrologists
who work in partnership with us to provide high-quality, integrated ESRD
services while reducing total costs. These physician networks market the
services of participating nephrologists to preferred provider organizations,
insurance companies, health maintenance organizations and other third-party
payors for ESRD services, both on a discounted fee-for-service basis and on a
prepaid basis. Through a long-term management services agreement, we are
responsible for providing billing, information systems and other services to
the physician networks in return for a management fee.
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RTC merger
On February 27, 1998, we acquired RTC, then the fourth largest provider of
integrated dialysis services in the United States, in a stock-for-stock
exchange transaction valued at approximately $1.3 billion. The acquisition
added 185 facilities serving approximately 13,200 patients and strengthened our
position as the largest independent dialysis services provider worldwide. The
acquisition provided us with the following benefits:
. Critical mass, stronger regional networks and greater geographic reach;
. Enhanced purchasing and operating efficiencies;
. Improved ability to make strategic acquisitions; and
. A platform for international expansion.
RTC's operations added 13 new markets to our existing domestic operations and
increased our penetration in 11 existing markets. Following the acquisition, we
have strong market positions in: California, Colorado, Florida, Georgia,
Kansas, Maryland, Minnesota, North Carolina, Oklahoma, Pennsylvania and Texas.
Integrating acquired operations such as RTC involves significant challenges,
including the sustainability of synergies or cost savings already achieved, and
may lead to unanticipated costs or a diversion of management's attention. See
the heading "Risks inherent in growth strategy" in the section "Risk factors."
After the merger, we announced that we had undertaken a detailed review of
RTC's accounts receivable and other balance sheet accounts in connection with
the completion of the audit of RTC's financial statements for the fiscal year
ended December 31, 1997. As a result of this review, we filed a Form 10-K/A for
RTC's year ended December 31, 1996 and three 10-Q's for each of RTC's quarters
in 1997, which restated RTC's previously audited and unaudited financial
statements. See our Current Report on Form 8-K dated April 30, 1998. Our
analysis of RTC's accounts receivable continued into the first quarter of 1999.
After concluding this analysis, we provided for an additional allowance for
doubtful accounts of $11.5 million related to the acquired RTC accounts
receivable. As a result, the merger benefits are less than we expected.
Corporate compliance program
We have implemented a company-wide corporate compliance program as part of
our commitment to comply fully with all applicable laws and regulations and to
maintain high standards of conduct by all of our employees. This program
undergoes continuous review and is enhanced as necessary. A purpose of the
program is to heighten the awareness of our employees and affiliated
professionals of the importance of complying with all applicable laws and
regulations in an increasingly complicated regulatory environment and to ensure
that steps are taken to resolve instances of non-compliance promptly as they
are identified.
The program has been authorized and mandated by our board of directors and
combines existing company policies and practices with new procedures designed
to address areas of particular sensitivity. As part of the program, we adopted
a code of conduct to be followed by each of our employees and affiliated
professionals. All management personnel have reviewed and agreed to abide by
this code of conduct. The program is administered by our chief compliance
officers and a compliance committee consisting of certain of our officers and
senior managers. The compliance committee reports to our board of directors.
Sources of revenue reimbursement
The following table provides information for the periods indicated regarding
the percentage of our net operating revenues, including RTC for all periods,
provided by (a) the Medicare ESRD program; (b) Medicaid;
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(c) private/alternative payors, such as private insurance and private funds;
(d) hospital inpatient dialysis services; and (e) international operations.
<TABLE>
<CAPTION>
Year Ended
December 31,
-------------------
1996 1997 1998
----- ----- -----
<S> <C> <C> <C>
Medicare................................................ 60.1% 56.4% 51.3%
Medicaid................................................ 4.3 5.0 4.3
Private/alternative payors.............................. 30.4 30.8 35.9
Hospital inpatient dialysis services.................... 5.2 4.8 4.3
International operations................................ 3.0 4.2
----- ----- -----
Total................................................. 100.0% 100.0% 100.0%
===== ===== =====
</TABLE>
Medicare reimburses dialysis providers for the treatment of individuals who
are diagnosed with ESRD and are eligible for participation in the Medicare ESRD
program, regardless of age or financial circumstances. For each treatment,
Medicare pays 80% of the amount set by the Medicare reimbursement system. In
most cases, a secondary payor, usually Medicare supplemental insurance or the
state Medicaid program, pays approximately 20% of the amount set by the
Medicare reimbursement system. All of the states in which we operate dialysis
facilities provide Medicaid benefits to qualified recipients to supplement
their Medicare entitlement.
If a patient does not qualify for Medicaid based on financial need and does
not purchase secondary insurance through a private insurer, the dialysis
provider may not be reimbursed for the 20% portion of the ESRD composite rate
Medicare does not pay. However, a recent Congressional action will allow
dialysis providers to pay their patients' premiums for secondary insurance.
These premiums are generally less than the 20% co-payment that a private
insurer would pay. Dialysis providers would be allowed to capture, as
incremental profit, the difference between the premiums paid to these secondary
insurers and the reimbursement amounts received from them. We plan to pay for a
patient's secondary insurance premium only if the patient does not qualify for
Medicaid and the patient demonstrates an inability to pay for this insurance.
Dialysis providers will be able to pay directly their patients' premiums for
secondary insurance beginning upon the enactment of regulations implementing
the Congressional action, which is expected in the third quarter of 1999.
ESRD patients receiving dialysis become eligible for Medicare coverage at
various times:
. ESRD patients 65 years of age or older who are not covered by an employer
group health plan are immediately eligible for Medicare coverage.
. ESRD patients 65 years of age or older who are covered by an employer
group health plan are eligible for Medicare coverage after a 30-month
coordination period.
. ESRD patients under 65 years of age who are not covered by an employer
group health plan must wait 90 days after beginning dialysis treatments
to be eligible for Medicare benefits. During the first 90 days of
treatment, the patient, Medicaid or a private insurer is responsible for
payment. In the case of the individual covered by private insurance, this
responsibility is limited to the terms of the policy, with the patient
being responsible for the balance.
. ESRD patients under 65 years of age who are covered by an employer group
health plan must wait 33 months after beginning dialysis treatments
before Medicare becomes the primary payor. During the first 33 months of
treatments, the employer group health plan is responsible for payment at
its negotiated rate or, in the absence of such a rate, at our usual and
customary rates. The patient is responsible for any deductibles and co-
payments under the terms of the employer group health plan.
. ESRD patients with an employer group health plan electing home dialysis
training during the first 90 days of dialysis have Medicare as their
primary payor after 30 months. If an ESRD patient without an employer
group health plan begins home dialysis training during the first three
months of dialysis, Medicare immediately becomes the primary payor.
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In August 1993, the Omnibus Budget Reconciliation Act of 1993, or OBRA 93,
became effective. HCFA originally interpreted certain provisions of OBRA 93 to
require employer group health sponsored insurance plans, or private payors, to
be the primary payor for patients who became dually entitled to Medicare
benefits because they developed ESRD after they had earlier been entitled to
Medicare due to age or disability. In July 1994, HCFA instructed the Medicare
fiscal intermediaries to apply the provisions of OBRA 93 retroactively to
August 10, 1993. Accordingly, we billed the responsible private payors as the
primary payors and recognized these revenues, at the generally higher private
rates, as services were rendered for periods after August 10, 1993.
In April 1995, HCFA issued instructions of clarification to the fiscal
intermediaries which stated that it had misinterpreted the OBRA 93 provisions,
and that Medicare would continue as the primary payor despite a patient
obtaining dual eligibility status under the Medicare ESRD provisions.
Accordingly, we began recognizing revenues at Medicare rates for all such
patients going forward from April 1995. We also adjusted our financial
statements to reflect revenues earned at Medicare rates for such patients
during the period from August 1993 through April 1995. This resulted in a
reduction in revenues for the period August 1993 through April 1995 of
approximately $3.1 million as these revenues had been previously recognized at
the generally higher private rates.
In June 1995, a federal court issued a preliminary injunction against HCFA
prohibiting HCFA from retroactively applying its reinterpretation of the OBRA
93 provisions to periods prior to its April 1995 instructions of clarification.
After the issuance of this preliminary injunction, we determined that a
permanent injunction would likely be issued, and we adjusted our financial
statements to reflect revenues earned during the period from August 1993
through April 1995 at the generally higher private rates. We made no adjustment
to revenues recognized going forward from April 1995 because the injunction did
not prohibit the prospective effect of HCFA's reinterpretation.
In January 1998, a federal court issued a permanent injunction preventing
HCFA from applying its reinterpretation of the OBRA 93 provisions because that
application would be unlawful retroactive rulemaking. We did not adjust our
revenues in January 1998 in response to the permanent injunction because
revenues had already been recognized at the generally higher private rates
after the issuance of the preliminary injunction in June 1995.
Medicare reimbursement
Under the Medicare reimbursement system, the reimbursement rates are fixed in
advance and have been adjusted from time to time by Congress. Although this
form of reimbursement limits the allowable charge per treatment, it provides us
with predictable and recurring per treatment revenues and permits us to retain
any profit earned.
Medicare has established a composite rate set by HCFA that determines the
Medicare reimbursement available for a designated group of dialysis services,
including the dialysis treatment, supplies used for that treatment, certain
laboratory tests and certain medications. The Medicare composite rate is
subject to regional differences based upon certain factors, including regional
differences in wage earnings. Certain other services and items are eligible for
separate reimbursement under Medicare and are not part of the composite rate,
including certain drugs like EPO, Calcijex and iron supplements, blood for
amounts in excess of three units per patient per year, and certain physician-
ordered tests provided to dialysis patients.
Claims for Medicare reimbursement must generally be presented within 15 to 27
months of treatment depending on the month in which the service was rendered.
Claims for Medicaid secondary reimbursement must be presented within 60 to 90
days after payment of the Medicare claim. We generally submit claims monthly
and are usually paid by Medicare within 15 days of submission.
We receive reimbursement for outpatient dialysis services provided to
Medicare-eligible patients at rates that are currently between $117 and $139
per treatment. This rate is subject to change by legislation. The
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Medicare ESRD reimbursement rate did not change from commencement of the
program in 1972 until 1983. From 1983 through December 1990 numerous
Congressional actions resulted in a net reduction of the average reimbursement
rate from a fixed fee of $138 per treatment in 1983 to approximately $125 per
treatment in 1990.
Congress increased the ESRD reimbursement rate, effective January 1, 1991, by
$1.00 per treatment resulting in the current average ESRD reimbursement rate of
$126 per treatment. In 1990, Congress required that the Department of Health
and Human Services, or HHS, and the Medical Payment Assessment Commission, or
MEDPAC, study dialysis costs and reimbursement procedures and make findings as
to the appropriateness of ESRD reimbursement rates. In March 1999, MEDPAC
recommended a 2.4% to 2.9% increase to the reimbursement rate. However,
Congress has not yet acted on this recommendation, is not required to implement
this recommendation and could either raise or lower the reimbursement rate.
During the last congressional session, there were various proposals for the
reform of numerous aspects of Medicare. We are unable to predict what, if any,
changes may occur in the Medicare composite reimbursement rate. Any reductions
in the Medicare composite reimbursement rate could have a material adverse
effect on our results of operations, financial condition and business.
Demonstration project
In January 1996, HCFA announced a three-year demonstration project involving
the enrollment of ESRD patients in managed care organizations. The
demonstration project is evaluating the appropriateness of capitation for
dialysis services. The project is adjusting capitation rates based upon
treatment status, age groups, and the cause of renal failure. There were
initially four demonstration project sites selected. Two sites are now actually
implementing the pilot program and we are participating in the project with
both HMOs.
The ESRD demonstration project and the analysis of the results of the project
are expected to continue over the next three to four years. Using the
experience of this project, HCFA will seek to evaluate the feasibility of
allowing managed care plans to participate in the Medicare ESRD program on a
capitated basis. The pilot program, if successful, could result in HCFA
allowing ESRD patients to enroll in managed care organizations. The likelihood
and timing of this decision is impossible to predict.
EPO reimbursement
On June 1, 1989, the FDA approved the production and sale of EPO, and HCFA
approved Medicare reimbursement for EPO's use by dialysis patients. EPO
stimulates the production of red blood cells and is beneficial in the treatment
of anemia, with the effect of reducing or eliminating the need for blood
transfusions for dialysis patients. Physicians began prescribing EPO for their
patients in our dialysis facilities in August 1989. Most of our dialysis
patients receive EPO.
Approximately 23% of our net operating revenues in fiscal 1998 was generated
from the administration of EPO, the majority of which was reimbursed through
the Medicare and Medicaid programs. Therefore, EPO reimbursement significantly
impacts our net income. The Office of the Inspector General of HHS has
recommended that Medicare reimbursement for EPO be reduced from the current
amount of $10 to $9 per 1,000 units. HHS has concurred with this
recommendation; however, HHS has not determined whether it will pursue this
change through the rulemaking process. In addition, President Clinton's
proposed budget for fiscal year 2000 includes a reduction in the Medicare
reimbursement for EPO of the same amount. Congress has yet to act on this
budget proposal. EPO reimbursement programs have been, and in the future may
be, subject to these and other legislative or administrative proposals. We
cannot predict whether future rate or reimbursement method changes will be
made. If such changes are made, they could have a material adverse effect on
our business, results of operations or financial condition. Furthermore, EPO is
produced by a single manufacturer, Amgen Corporation, and any interruption of
supply or product cost increases could adversely affect our operations. For
more information, see the subheading "Dependence on Medicare, Medicaid and
other sources of reimbursement" under the heading "Risk factors."
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In April 1996, HCFA notified providers that reimbursement of EPO
administration for a patient with a measurement of red blood cell
concentration, known as a hematocrit measurement, exceeding 36% would be
available only if the 90-day rolling hematocrit measurement for such patient
was 36.5% or less. If the 90-day rolling average hematocrit measure exceeded
36.5%, reimbursement for EPO administration would be denied, except in very
limited instances. In connection with this notification, HCFA instructed its
fiscal intermediaries to review the rolling three month hematocrit averages and
to ascertain compliance therewith. The single fiscal intermediaries for Total
Renal Care, Inc., or TRC, and RTC enacted such instructions in December and
September, 1997, respectively. Subsequently, HCFA notified its fiscal
intermediaries that it was changing the foregoing reimbursement policy.
Effective for monthly billing periods beginning on or after March 10, 1998,
reimbursement will be available when the 90-day rolling average hematocrit
measure exceeds 36.5%, with payment based on the lower of the actual dosage
billed for the current month or 80% of the prior month's allowable EPO dosage.
In addition, in this notice, HCFA reestablished the authorization to make
payment for EPO for a month when the patient's hematocrit exceeds 36%, when
accompanied by documentation establishing medical necessity. More specifically,
Medicare guidelines now enable dialysis providers to be: (a) fully reimbursed
for increased EPO dosage levels when the patient's hematocrit exceeds 36% and
there is a medical justification for such dosage; and (b) partially reimbursed
for increased EPO dosage levels when the patient's hematocrit exceeds 36% and
there is no such medical justification. This change has resulted in additional
revenues for dialysis providers.
Other drugs and services delivered at centers
At our facilities we provide most of our patients with intravenous drugs,
other ancillary services and testing, representing approximately 8% of our net
operating revenues in 1998. The intravenous drugs we administer include
Calcijex, iron supplements, various antibiotics and other medications. The
ancillary services and testing include studies that examine the degree of bone
deterioration, nerve conduction studies that examine the degree of
deterioration of nerves, doppler flow testing of the effectiveness of patients'
vascular access for dialysis and blood transfusions, and electrocardiograms.
Medicare currently reimburses us separately for the intravenous drugs at a
rate of 95% of the average wholesale price of each drug. The Clinton
administration has proposed a reduction in the reimbursement rate for
outpatient prescription drugs to 83% of the actual wholesale price. We cannot
predict whether Congress will approve this rate change, but if such a change is
implemented, it could have a material adverse effect on our business, results
of operations or financial condition.
With appropriate medical justification, Medicare separately reimburses us for
the provision of ancillary services and testing to ESRD patients in accordance
with a prescribed fee schedule.
Medicaid reimbursement
Medicaid programs are state administered programs partially funded by the
federal government. These programs are intended to provide coverage for
patients whose income and assets fall below state defined levels and who are
otherwise uninsured. The programs also serve as supplemental insurance programs
for the Medicare co-insurance portion and provide certain coverages, like oral
medications, that are not covered by Medicare. State regulations generally
follow Medicare reimbursement levels and coverages without any co-insurance
amounts. Certain states, however, require beneficiaries to pay a monthly share
of the cost based upon levels of income or assets. We are a licensed ESRD
Medicaid provider in the states in which we conduct our business.
Hospital inpatient dialysis services
We provide inpatient dialysis services, excluding physician professional
services, to patients in hospitals pursuant to written agreements with the
hospitals. We provide these services for a per-treatment fee which is
individually negotiated with each hospital. Some of these agreements provide
that we are the exclusive provider
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of dialysis services to the hospital, but many of them are non-exclusive. Some
of these agreements also allow either party to terminate the agreement without
cause. Competition for the provision of dialysis services at hospitals with
which we have a non-exclusive agreement and the termination of inpatient
dialysis services agreements could have an adverse effect on us.
Government regulation
General
Our dialysis operations are subject to extensive federal, state and local
governmental regulations. These regulations require us to meet various
standards relating to, among other things:
. Premises;
. Management of facilities;
. Personnel;
. The maintenance of proper records;
. Equipment; and
. Quality assurance programs/patient care.
Our dialysis facilities are subject to periodic inspection by state agencies
and other governmental authorities to determine if we satisfy applicable
standards and requirements. All of our dialysis facilities are certified by
HCFA, as is required for receipt of Medicare reimbursement payments.
Our business would be adversely impacted by:
. Any loss or suspension of (a) federal certifications; (b) authorization
to participate in the Medicare or Medicaid programs; or (c) licenses
under the laws of any state or governmental authority in which we
generate substantial revenues; or
. Reduction of dialysis reimbursement or reduction of or elimination of
coverage for dialysis services.
To date, we have not had any difficulty in maintaining our licenses or our
Medicare and Medicaid authorizations. However, our industry will continue to be
subject to government regulation, the scope and effect of which are difficult
to predict. This regulation could adversely impact us in a material way. In
addition, we periodically may be reviewed or challenged by various governmental
authorities which could have an adverse effect on our financial position.
Fraud and abuse under federal law
The "antikickback" statute contained in the Social Security Act imposes
criminal and civil sanctions on persons who receive or make payments in return
for:
. The referral of a patient for treatment; or
. The ordering or purchasing of items or services that are paid for in
whole or in part by Medicare, Medicaid or similar state programs.
Federal penalties for violation of these laws include imprisonment, fines and
exclusion of the provider from future participation in the Medicare and
Medicaid programs. Civil penalties for violation of these laws include
assessments of $2,000 per improper claim for payment plus twice the amount of
the claim and suspension from future participation in Medicare and Medicaid.
Some state antikickback statutes also include criminal penalties. The federal
statute expressly prohibits traditionally criminal transactions, such as
kickbacks, rebates or bribes for patient referrals. Court decisions have also
said that, under certain circumstances, the statute is also violated when a
purpose of a payment is to induce referrals.
In July 1991 and in November 1992, the Secretary of HHS published regulations
that create exceptions or "safe harbors" for certain business transactions.
Transactions structured within these safe harbors do not violate the
antikickback statute. A business arrangement must satisfy each and every
element of a safe harbor to be protected by that safe harbor. Transactions that
do not satisfy all elements of a relevant safe harbor do not
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necessarily violate the antikickback statute but may be subject to greater
scrutiny by enforcement agencies. We believe our arrangements with referring
physicians are in material compliance with these laws. We seek to structure our
various business arrangements to satisfy as many safe harbor elements as is
practical. Certain of our arrangements with referring physicians do not satisfy
all elements of a relevant safe harbor. Although we have never been challenged
under these statutes and believe we materially comply with these and other
applicable laws and regulations, we could in the future be required to change
our practices or experience a material adverse effect as a result of a
challenge.
The conditions of participation in the Medicare ESRD program require that
treatment at a dialysis facility be "under the general supervision of a
director who is a physician." Generally, the medical director must be board
eligible or board certified in internal medicine or pediatrics and have had at
least 12 months of experience or training in the care of patients at ESRD
facilities. We have by written agreement engaged qualified physicians or groups
of qualified physicians to serve as medical directors for our facilities. At
some facilities we also contract with physicians to serve as assistant or
associate medical directors, or to direct specific programs such as home
dialysis training, or, in a few instances, to provide medical director services
for acute dialysis services provided to hospitals. The compensation of the
medical directors and other physicians under contract is separately negotiated
for each facility and generally depends upon competitive factors in the local
market, the physician's professional qualifications, the specific duties and
responsibilities of the physician and the size and utilization of the facility
or relevant program. Written agreements with the medical directors and other
contracted physicians fix their compensation for periods of one year or more.
Because our medical directors and other contract physicians refer patients to
our facilities, the federal antikickback statute may apply. We believe our
arrangements with these physicians materially comply with the antikickback
statute. Among the available safe harbors is one relevant to our arrangements
with our medical directors and the other physicians under contract. The safe
harbor sets forth six requirements. Certain of our agreements with our medical
directors or other physicians under contract do not satisfy all six of these
requirements. We believe that, except in cases where a facility is in
transition from one medical director to another or where the term of an
agreement with a physician has expired and a new agreement is in negotiation,
our agreements with our medical directors and other contract physicians satisfy
at least five of the six requirements for this safe harbor.
At some of our dialysis facilities, physicians who refer patients to the
dialysis facilities hold interests in partnerships or limited liability
companies owning the facilities. The antikickback statute may apply in these
situations. We believe these business arrangements are in material compliance
with the antikickback statute. While none of these arrangements satisfies all
elements of a relevant small entity investment interests safe harbor, we
believe that each of the partnerships and limited liability companies satisfies
a majority of the safe harbor's elements.
We lease some of our dialysis facilities from entities in which interests are
held by physicians who refer patients to those facilities, and we sublease
space to referring physicians at some of our dialysis facilities. In addition,
a medical facility at which we provide ESRD ancillary services is leased from
physicians who refer patients for the ancillary services. The antikickback
statute may apply in these situations. We believe, however, that these leases
are in material compliance with the antikickback statute and that the leases
satisfy in all material respects each of the elements of the space rental safe
harbor applicable to these arrangements.
On July 21, 1994, the Secretary of HHS proposed a rule that it said "would
modify the original set of safe harbor provisions to give greater clarity to
the rulemaking's original intent." The proposed rule would, among other things,
make changes to the safe harbors discussed in the preceding few paragraphs. We
do not believe that our conclusions with respect to the application of these
safe harbors to our current arrangements would change if the proposed rule were
adopted in the form proposed. It is difficult to predict, however, the outcome
of the rulemaking process or whether changes in the safe harbor rules will
affect us.
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Fraud and abuse under state law
In several states (including California, Florida, Georgia, Kansas,
Louisiana, Maryland, New York, Utah and Virginia) in which we operate dialysis
facilities jointly owned with referring physicians, statutes prohibit
physicians from holding financial interests in various types of medical
facilities to which they refer patients. We believe our joint ownership
relationships with these physicians are within the exceptions stated in these
various state laws, as further described below.
. California. A California statute makes it unlawful for a physician (or an
immediate family member) who has a financial interest in an entity to
refer a person to that entity for various services, including laboratory
services. Under the California statute, "financial interest" includes any
type of ownership interest, lease, compensation or other form of payment
(whether in money or otherwise) between a physician and the entity to
which the physician makes a referral. The statute also prohibits the
entity to which the referral was made from presenting a claim for payment
to any payor for a service furnished pursuant to a prohibited referral
and prohibits a payor from paying for such a service. Violation of the
prohibition on submitting a claim is a misdemeanor that subjects the
offender to a fine of up to $15,000 for each violation and possible
action against licensure.
Some of our facilities perform laboratory services incidental to dialysis
services pursuant to the orders of referring physicians. Although we do
not believe that the California statute is intended to apply to laboratory
services that are provided incident to dialysis services, it is possible
that the California statute could be interpreted to apply to these
services. While the California statute includes certain exemptions, it
includes no explicit exemption for medical director services or other
services for which we contract with and compensate referring physicians in
California or for partnership interests of the type held by the referring
physicians in eight of our facilities in California. Thus, if the
California statute is interpreted to apply to referring physicians with
whom we contract for medical director and similar services or to referring
physicians who hold partnership interests, we would be required to
restructure some or all of our relationships with these referring
physicians. We cannot predict the consequences of this type of
restructuring.
. Florida. A Florida statute prohibits healthcare providers, defined to
include physicians, from referring a patient for the provision of
designated health services to an entity in which the healthcare provider
has an investment interest. The term "designated health services"
includes clinical laboratory services. Further, a healthcare provider may
not refer a patient for the provision of any healthcare item or service
that is not a "designated health service" to an entity in which the
healthcare provider is an investor unless:
(1) The entity is a corporation with shares publicly traded on a
national exchange or on the over-the-counter market with total assets
over $50 million or certain disclosure requirements are met;
(2) No more than 50% of the value of the investment interests are
held by investors in a position to make referrals to the entity;
(3) The terms under which an investment interest is offered to an
investor who is in a position to make referrals to the entity are no
different from the terms offered to investors who are not in a
position to make referrals;
(4) The terms offered to an investor in a position to make
referrals are not related to the previous or expected volume of
referrals from that investor to the entity; and
(5) There is no requirement that an investor make referrals or be in
a position to make referrals to the entity as a condition for becoming
or remaining an investor.
The disclosure requirements compel a healthcare provider who makes a
permitted referral to provide the patient with a written disclosure form
informing the patient of the existence of the investment interest, the
names and addresses of at least two alternative sources of such services
and the name and address of
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each applicable entity in which the referring provider is an investor. The
Florida statute carries with it penalties of up to $15,000 for each
service for any person who presents or causes to be presented a bill or
claim for services that the person knows or should know is prohibited.
Furthermore, any healthcare provider or other entity that enters into an
arrangement or scheme which the physician or entity knows or should know
has a principal purpose of assuring referrals by the physician to a
particular entity may be subject to a civil penalty of up to $100,000 for
each arrangement. A violation of the disclosure requirements constitutes a
misdemeanor and may be grounds for disciplinary action. We believe that we
and our referring physicians are exempt from the Florida statute.
. Georgia. A Georgia statute prohibits a healthcare provider, defined to
include physicians, from referring a patient for the provision of
designated health services to an entity in which the healthcare provider
has an investment interest, unless the provider satisfies certain
disclosure requirements. An "investment interest" is defined as an equity
or debt security issued by an entity, including units or other interests
in a partnership, but excludes certain investments in publicly-held
corporations. A "designated health service" is defined to include
clinical laboratory services, pharmaceutical services and outpatient
surgical services. To comply with the Georgia statute, the healthcare
provider must furnish the patient with a written disclosure form approved
by the provider's board of licensure, informing the patient of:
(1) The existence of the investment interest;
(2) The name and address of each entity in which the referring
provider is an investor; and
(3) The patient's right to obtain the items or services at the
location or from the healthcare provider or supplier of the patient's
choice.
In addition, the provider must post a copy of the disclosure form in a
conspicuous public place in the provider's office. Neither a healthcare
provider nor any entity may present a claim for payment to any
individual, third-party payor or other entity for services provided
pursuant to a prohibited referral. If the healthcare provider or entity
improperly collects any amount, the provider or entity must refund the
amount to the payor. Any provider or other entity that enters into an
arrangement or scheme which the provider or entity knows or should know
has a principal purpose of assuring referrals by the provider to a
particular entity is subject to a civil penalty of up to $50,000 for each
arrangement or scheme. Furthermore, any person who presents or causes to
be presented a bill for a claim for services that the person knows or
should know is for a service for which payment may not be made under the
Georgia statute is subject to a civil penalty of up to $15,000 for each
service. We believe that all physicians with an investment interest who
also refer patients to our dialysis facilities are in compliance with the
disclosure requirements of the Georgia statute and are thus exempt from
this statute.
. Kansas. A Kansas statute provides that a licensee's license may be
revoked, suspended or limited in the event the licensee has committed an
act of unprofessional conduct. Under the Kansas statute, unprofessional
conduct includes referring a patient to a healthcare entity for services
if the licensee, defined to include a physician, has a significant
investment interest in the healthcare entity, unless the licensee informs
the patient in writing of the investment interest and the ability of the
patient to obtain services elsewhere. The Kansas statute defines
"healthcare entity" to mean any corporation, firm, partnership or other
business entity which provides services for diagnosis or treatment of
human health conditions and which is owned separately from a referring
licensee's principal practice. The Kansas statute also defines
"significant investment interest" to mean ownership of at least 10% of
the shares of stock of the corporation which owns or leases the
healthcare entity. We believe that physicians with a "significant
investment interest" who also refer patients to our dialysis facilities
are in compliance with the disclosure requirements of the Kansas statute.
. Louisiana. A Louisiana statute prohibits healthcare providers, defined to
include physicians, from making referrals outside the same group practice
as that of the referring healthcare provider to any other healthcare
provider, licensed healthcare facility or provider of healthcare goods
and services, including
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providers of clinical laboratory services, when the referring provider has
a financial interest served by such referral. An exclusion from the
prohibition will apply if, in advance of any referral, the referring
provider discloses to the patient, in writing, the existence of such
financial interest. The Louisiana statute defines "financial interest" to
mean a significant ownership or investment interest established through
debt, equity or other means and held by a healthcare provider or a member
of a provider's immediate family, as well as any form of direct or
indirect compensation for referral. Any referring healthcare provider with
a financial interest who does not comply with the Louisiana statute
disclosure requirement must refund all sums the provider received in
payment for the goods and services furnished or rendered without
disclosure of the financial interest. We believe that all physicians who
have a "financial interest" and who also refer patients to our dialysis
facilities are in compliance with the Louisiana statute.
. Maryland. A Maryland statute prohibits healthcare practitioners from
referring patients to a healthcare entity in which the practitioner or
the practitioner's immediate family owns a beneficial interest or has a
compensation arrangement. The term "compensation arrangement" does not
include an arrangement between a healthcare entity and a healthcare
practitioner, or immediate family member of a practitioner, as an
independent contractor, if the arrangement is for identifiable services,
the amount of the compensation under the arrangement is consistent with
the fair market value of the service and is not determined in a manner
that takes into account the volume or value of any referrals by the
practitioner and the compensation is provided in accordance with an
agreement that would be commercially reasonable even if no referrals were
made. We believe that we will be exempt from the Maryland statute.
. New York. Several New York statutes relate to self-referrals. A
practitioner, defined to include physicians, authorized to order clinical
laboratory services or certain other referred services generally may not
make a referral for such services to an authorized healthcare provider
where such practitioner or an immediate family member has a financial
relationship with the healthcare provider receiving the referral. The New
York statutes provide that a healthcare provider or a referring
practitioner may not present or cause to be presented to any individual
or third-party payor or other entity a claim or other demand for payment
for clinical laboratory services that is prohibited. Under the New York
statutes, a "financial relationship" is defined to mean an ownership
interest, investment interest or compensation arrangement.
Generally, the New York statutes exempt from the New York referral
prohibition a practitioner's referral to a healthcare provider in which
the practitioner or an immediate family member has a financial interest
for clinical laboratory services if:
(1) It is related to practitioner services personally provided by
the referring practitioner or provided by a practitioner in the same
group as the referring practitioner;
(2) It is related to in-office ancillary services;
(3) It is related to a health maintenance organization or other type
of managed care program;
(4) It is related to inpatient hospital services;
(5) It is related to referrals by a hospital of patients for
clinical laboratory services to be provided by the hospital;
(6) The financial relationship with the hospital does not relate
directly to the services for which the referral was made; or
(7) It is determined not to pose a substantial risk of payor or
patient abuse.
The New York statutes also make an exception to the New York referral
prohibition in the event of an ownership interest or investment interest
of the practitioner or immediate family member in a healthcare provider,
upon proper disclosure being made, if (a) the services provided and the
practitioner or the
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patient are located in a rural area; or (b) the ownership interest or
investment interest is based on the ownership in a general hospital
itself, and not merely a subdivision thereof.
In addition to providing the exceptions discussed above, the New York
statutes exclude certain types of relationships from the New York referral
prohibition. The New York statutes provide that an ownership interest or
an investment interest generally does not exist based solely on the
ownership of investment securities of a publicly-traded company with total
assets of over $100 million. Further, the New York statutes generally
exclude the following from their definition of "compensation arrangement":
(1) Payments for the rental or lease of space;
(2) Administrative services arrangements between a general hospital
and a practitioner or immediate family member;
(3) Medical director or medical advisory board services arrangements
between a healthcare provider, other than a general hospital, and a
practitioner;
(4) Recruitment arrangements;
(5) Isolated financial transactions;
(6) Compensation arrangements between a group practice and salaried
practitioner of the group practice; and
(7) Other arrangements that are determined not to pose a substantial
risk of payor or patient abuse.
A practitioner must disclose to the patient, in the case of referrals not
subject to the New York referral prohibition, the financial relationship
prior to making the referral if the financial relationship is either
(a) an ownership or investment interest in the healthcare provider to
which the referral is being made; or (b) a compensation arrangement with
such healthcare provider that is in excess of fair market value or that is
based upon the volume and value of the providers' services.
Because dialysis itself is not a clinical laboratory service or other
service covered by the New York referral prohibition, we believe that only
the New York disclosure requirement should need to be satisfied for those
joint ownership relationships we maintain with referring physicians. We
believe that, to the extent only the New York disclosure requirement is
applicable, all physicians who have a financial interest and who also
refer patients to the dialysis facilities with which we have consultant
contracts are in compliance with the New York statutes. The facilities in
New York with which we have consultant contracts may, however, perform
laboratory services incidental to dialysis services pursuant to the orders
of the referring physicians. Although we do not believe that the New York
referral prohibition is intended to apply to laboratory services provided
incident to dialysis services, it is possible that the New York referral
prohibition could be interpreted to apply to these services. There is no
explicit exception to the New York referral prohibition for medical
director services or other services for which we contract with and
compensate referring physicians in New York. Thus, if the New York
Statutes are interpreted to apply to referring physicians with whom we
contract, we could be required to restructure these relationships. It is
difficult to predict the consequences of this restructuring.
. Utah. A Utah statute prohibits physicians from referring patients,
clients, or customers to any clinical laboratory, ambulatory or surgical
care facilities, or other treatment or rehabilitation services
facilities, in which the physician or a member of the physician's
immediate family has any financial relationship, unless the physician at
the time of making the referral discloses that relationship, in writing,
to the patient, client, or customer and such written disclosure states
that the patient may choose any facility or service center for purposes
of having the laboratory work or treatment service performed. The Utah
statute defines "financial relationship" to generally mean any ownership
or investment interest in an entity or any compensation arrangement with
an entity. We believe that all physicians who have a "financial
relationship" and who also refer patients to our dialysis facilities are
in compliance with the Utah statute.
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. Virginia. A Virginia statute generally prohibits a physician from
referring a patient for health services to an entity outside the
physician's office if the physician or any of the physician's immediate
family members is an investor in that entity unless (a) the physician
directly provides health services within the entity and will be
personally involved with the provision of care to the referred patient or
(b) has been granted an exception by the Virginia Board of Health
Professions, or the VBHP. Violation of the Virginia statute by the
physician subjects the entity to a monetary penalty of up to $20,000 per
referral or claim if the entity knows or has reason to know that the
referral is prohibited by the Virginia statute. Investment interests
acquired prior to February 1, 1993, including the minority interests
which physicians hold in our Virginia facilities, were required to be in
compliance with the Virginia statute by July 1, 1996.
We believe that physicians who refer patients to dialysis facilities
directly provide healthcare within such facilities and are "personally
involved with the provision of care" to such referred patients within the
meaning of the Virginia statute. We also believe that, as a public policy
matter, it would be reasonable to argue that the VBHP should grant an
exception to a physician who is an investor in a dialysis facility to
which the physician refers his or her patients for care. We are unaware,
however, of any official interpretation of the Virginia statute or the
grant of any exception by the VBHP indicating acceptance of these views.
We believe that the ownership of our Virginia facilities could be
restructured to conform to the requirements of the Virginia statute if
necessary due to future official interpretations differing from our
interpretations.
Stark I / Stark II
The Omnibus Budget Reconciliation Act of 1989 includes certain provisions,
known as Stark I, that restrict physician referrals for clinical laboratory
services to entities with which a physician or an immediate family member has a
"financial relationship." Stark I may be interpreted by HCFA to apply to our
operations. Regulations interpreting Stark I, however, have created an
exception to its applicability regarding services furnished in a dialysis
facility if payment for those services is included in the ESRD composite rate.
We believe that our compensation arrangements with Medical Directors and other
physicians under contract are in material compliance with Stark I.
OBRA 93 contains certain provisions, known as Stark II, that restrict
physician referrals for certain "designated health services" to entities with
which a physician or immediate family member has a "financial relationship."
The entity is prohibited under Stark II, as is the case for entities restricted
by Stark I from claiming payment for such services under the Medicare or
Medicaid programs, is liable for the refund of amounts received pursuant to
prohibited claims, is subject to civil penalties of up to $15,000 per service
and can be excluded from future participation in the Medicare and Medicaid
programs. Comparable provisions applicable to clinical laboratory services
became effective in 1992. Stark II provisions which may be relevant to us
became effective on January 1, 1995.
A "financial relationship" under Stark II is defined as the physician's
ownership or investment interest in, or a compensation arrangement with, the
entity. We have entered into compensation agreements with our medical directors
and other referring physicians. Some of our medical directors own equity
interests in entities which operate our dialysis facilities. Some of our
dialysis facilities are leased from entities in which referring physicians hold
interests, and we sublease space to referring physicians at some of our
dialysis facilities. In addition, some of the medical directors and other
physicians from whom we have acquired dialysis facilities own our common stock
or options to acquire our common stock. We believe that the ownership of the
stock and stock options and the other ownership interests and lease
arrangements for such facilities are in material compliance with Stark II.
Proposed Stark II regulations could require us to restructure the stock and
stock option ownership.
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Stark II includes certain exceptions. A personal services compensation
arrangement is excepted from Stark II prohibitions if:
. The arrangement is set out in writing, signed by the parties, and
specifies the services covered by the arrangement;
. The arrangement covers all of the services to be provided by the
physician, or immediate family member of the physician, to the entity;
. The aggregate services contracted for do not exceed those that are
reasonable and necessary for the legitimate business purposes of the
arrangement;
. The term of the arrangement is for at least one year;
. The compensation to be paid over the term of the arrangement is set in
advance, does not exceed fair market value and is not determined in a
manner that takes into account the volume or value of any referrals or
other business generated between the parties;
. The services to be performed do not involve a business arrangement or
other activity that violates any state or federal law; and
. The arrangement meets other requirements that may be imposed pursuant to
regulations promulgated by HCFA.
We believe that our compensation arrangements with medical directors and
other contract physicians materially satisfy these exceptions to the Stark II
prohibitions.
Payments made by a lessor to a lessee for the use of premises are excepted
from Stark II prohibitions if:
. The lease is set out in writing, signed by the parties, and specifies the
premises covered by the lease;
. The space rented or leased does not exceed that which is reasonable and
necessary for the legitimate business purposes of the lease or rental and
is used exclusively by the lessee when being used by the lessee, subject
to certain permitted common areas payments;
. The lease provides for a term of rental or lease of at least one year;
. The rental charges over the term of the lease are set in advance, are
consistent with fair market value and are not determined in a manner that
takes into account the volume or value of any referrals or other business
generated between the parties;
. The lease would be commercially reasonable even if no referrals were made
between the parties; and
. The lease meets other requirements that may be imposed pursuant to
regulations promulgated by HCFA.
We believe that our leases with referring physicians materially satisfy these
exceptions to the Stark II prohibitions.
The Stark II exception provisions applicable to physician ownership interests
in entities to which they make referrals do not encompass the kinds of
ownership arrangements that referring physicians hold in certain of our
subsidiaries that operate dialysis facilities.
For purposes of Stark II, "designated health services" include clinical
laboratory services, equipment and supplies, home health services, outpatient
prescription drugs and inpatient and outpatient hospital services. We believe
that the language and legislative history of Stark II and related regulations
indicate that Congress did not intend to include dialysis services and the
services and items provided incident to dialysis services. Our provision of, or
arrangement and assumption of financial responsibility for, outpatient
prescription drugs, including EPO and IDPN, clinical laboratory services,
facility dialysis services and supplies, home dialysis supplies and equipment
and services to hospital inpatients and outpatients under our dialysis services
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agreements with hospitals, include services and items which could, however, be
construed as designated health services within the meaning of Stark II.
Although we do not bill Medicare or Medicaid for hospital inpatient and
outpatient services, our Medical Directors may request or establish a plan of
care that includes dialysis services for hospital inpatients and outpatients
that may be considered a referral within the meaning of Stark II.
HCFA may interpret Stark II to apply to our operations. Consequently, Stark
II may require us to restructure existing compensation agreements with our
medical directors and to repurchase or to request the sale of ownership
interests in subsidiaries and partnerships held by referring physicians or, in
the alternative, to refuse to accept referrals for designated health services
from these physicians. We believe, but cannot assure, that if Stark II is
interpreted to apply to our operations, we will be able to bring our financial
relationships with referring physicians into material compliance with Stark II.
We would be materially impacted if HCFA interprets Stark II to apply to us and
we could not achieve that compliance. A broad interpretation of Stark II to
include items provided incident to dialysis services would apply to our
competitors, as well.
Medicare
Because the Medicare program represents a substantial portion of the federal
budget, Congress takes action in almost every legislative session to modify the
Medicare program for the purpose of, or with the result of, reducing the
amounts payable from the program to healthcare providers. Legislation or
regulations may be enacted in the future that may significantly modify the ESRD
program or substantially reduce the amount paid for our services. Further,
Statutes or regulations may be adopted which impose additional requirements for
eligibility to participate in the federal and state payment programs. Any
legislation or regulations of this type could adversely affect our business
operations in a material way.
International regulation
Our operations are subject to extensive government regulation by virtually
every country in which we operate. Although such regulations differ from
country to country, in general, non-U.S. regulations are designed to accomplish
the same objectives as U.S. regulations regarding the operation of dialysis
centers: 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. In
addition, each country has its own payment and reimbursement rules and
procedures, and some countries prohibit ownership of healthcare providers by
foreign interests or establish other regulatory barriers to direct ownership by
foreign companies. In those countries, we work within the framework of local
laws to establish alternative contractual arrangements for the management of
facilities.
Given the difficulties inherent with any operator entering a market for the
first time, there can be no assurance that we will be able to replicate our
successful history of completing, and integrating, domestic acquisitions. 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.
Florida laboratory payment dispute
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
formal overpayment determinations in the amount of $5.6 million for the review
period from January 1995 to April 1996 and $14.2 million for the review period
from May 1996 to March 1998. The carrier has also suspended all payments of
claims related to this laboratory, regardless of when the laboratory performed
the tests. The carrier had withheld approximately $11 million as of December
31, 1998. In addition the carrier has informed the local offices of the
Department of Justice, or DOJ, and HHS of this matter, and we are cooperating
with DOJ and HHS.
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We have consulted with outside counsel, reviewed our records, are disputing
the overpayment determinations 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 determinations. The first step in this formal review process is a
hearing before a hearing officer at the carrier. The hearing regarding the
initial review period from January 1995 to April 1996 was held on July 27 and
July 28, 1999. We expect the hearing officer to render a decision by mid-
November 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 believed it was necessary
to bring a prompt resolution to this payment dispute. In July 1999, the court
dismissed our complaint because we did not exhaust all administrative remedies.
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;
. Whether additional periods may be reviewed by the carrier; or
. Any other outcome of this investigation.
Any determination adverse to us could have an adverse impact on our business,
results of operations or financial condition.
The Health Insurance Portability and Accountability Act of 1996
The Health Insurance Portability and Accountability Act of 1996, or HIPAA,
among other things, allows individuals who lose or change jobs to transfer
their insurance, limits exclusions for preexisting conditions, and establishes
a pilot program for medical savings accounts. In addition, HIPAA also expands
federal attempts to combat healthcare fraud and abuse by making amendments to
the Social Security Act and the federal criminal code. Among other things,
HIPAA creates a new "Health Care Fraud and Abuse Control Account," under which
"advisory opinions" are issued by the Office of the Inspector General, or OIG,
regarding the application of the antikickback statute, certain criminal
penalties for Medicare and Medicaid fraud are extended to other federal
healthcare programs, the exclusion authority of the OIG is expanded, Medicare
and Medicaid civil monetary penalty provisions are extended to other federal
healthcare programs, the amounts of civil monetary penalties are increased, and
a criminal health care fraud statute is established.
The False Claims Act
The federal False Claims Act, or FCA, is another means of policing false
bills or requests for payment in the healthcare delivery system. In part, the
FCA imposes a civil penalty on any person who:
. Knowingly presents, or causes to be presented, to the federal government
a false or fraudulent claim for payment or approval;
. Knowingly makes, uses, or causes to be made or used, a false record or
statement to get a false or fraudulent claim paid or approved by the
federal government;
. Conspires to defraud the federal government by getting a false or
fraudulent claim allowed or paid; or
. Knowingly makes, uses or causes to be made or used, a false record or
statement to conceal, avoid, or decrease an obligation to pay or transmit
money or property to the federal government.
The penalty for a violation of the FCA ranges from $5,000 to $10,000 for each
fraudulent claim plus three times the amount of damages caused by each such
claim. The FCA has been used widely by the federal
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government to prosecute Medicare fraud in areas such as coding errors, billing
for services not rendered, the submission of false cost reports, billing
services at a higher reimbursement rate than is appropriate, billing services
under a comprehensive code as well as under one or more component codes, and
billing for care which is not medically necessary. Although subject to some
dispute, at least two federal district courts have also determined that alleged
violations of the federal antikickback statute or Stark I and Stark II are
sufficient to state a claim for relief under the FCA. In addition to the civil
provisions of the FCA, the federal government can use several criminal statutes
to prosecute persons who submit false or fraudulent claims for payment to the
federal government.
Other regulations
Our operations are subject to various state hazardous waste and non-hazardous
medical waste disposal laws. Those laws do not classify as hazardous most of
the waste produced from dialysis services. Occupational Safety and Health
Administration regulations require employers to provide workers who are
occupationally subject to blood or other potentially infectious materials with
certain prescribed protections. These regulatory requirements apply to all
healthcare facilities, including dialysis facilities, and require employers to
make a determination as to which employees may be exposed to blood or other
potentially infectious materials and to have in effect a written exposure
control plan. In addition, employers are required to provide or employ
hepatitis B vaccinations, personal protective equipment, infection control
training, post-exposure evaluation and follow-up, waste disposal techniques and
procedures and engineering and work practice controls. Employers are also
required to comply with various record-keeping requirements. We believe we are
in material compliance with these laws and regulations.
Some states have established certificate of need programs regulating the
establishment or expansion of healthcare facilities, including dialysis
facilities. We believe we are in material compliance with all applicable state
certificate of need laws.
Although we believe we comply materially with current applicable laws and
regulations, our industry will continue to be subject to substantial
regulation, the scope and effect of which are difficult to predict. We make no
assurance as to whether our activities will be reviewed or challenged by
regulatory authorities in the future.
Competition
A significant portion of the dialysis industry consists of many small,
independent facilities. The dialysis industry is highly competitive,
particularly in terms of acquiring existing dialysis facilities and developing
relationships with referring physicians. Competition for qualified physicians
to act as medical directors is also vigorous. We have also, from time to time,
experienced competition from former medical directors or referring physicians
who have opened their own dialysis facilities. A portion of our business
consists of monitoring and providing supplies for ESRD treatments in patients'
homes. Certain physicians also provide similar services, and if the number of
such physicians were to increase, our business, results of operations or
financial condition could be adversely affected.
As the chart below indicates, the market share of the five largest multi-
facility providers has increased significantly over the last five years.
However, the absolute number of dialysis facilities owned by hospitals and
independent physicians has remained fairly constant.
<TABLE>
<CAPTION>
January 1, 1993 January 1, 1998
Facilities/Percentage Facilities/Percentage
--------------------- ---------------------
<S> <C> <C>
Multi-facility providers......... 667/30% 1,720/53%
Independent physicians........... 822/37% 779/24%
Hospital-based facilities........ 733/33% 747/23%
---------- ----------
Total.......................... 2,222/100% 3,246/100%
========== ==========
</TABLE>
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Large multi-facility dialysis providers that we compete with domestically for
acquisitions include Fresenius Medical Care, Gambro Healthcare, Inc., Renal
Care Group, Inc. and Everest Healthcare Services Corp. In addition, we estimate
that the major international multi-facility providers served only approximately
5% of all non-U.S. dialysis patients in 1998. Certain of our competitors have
substantially greater financial resources than us and may compete with us for
acquisitions and developments of facilities in markets targeted by us. There
are also a number of large healthcare providers that have entered or may decide
to enter the dialysis business. We cannot assure that our facilities will
continue to compete successfully with the facilities of these other companies.
Insurance
We carry property and general liability insurance, professional liability
insurance and other insurance coverage in amounts deemed adequate by our
management. However, we cannot assure that any future claims will not exceed
applicable insurance coverage. Furthermore, we cannot assure that malpractice
and other liability insurance will be available at a reasonable cost or that we
will be able to maintain adequate levels of malpractice insurance and other
liability insurance in the future. Physicians practicing at our facilities are
required to maintain their own malpractice insurance, and our medical directors
maintain coverage for their individual private medical practices. We do,
however, provide insurance coverage for our medical directors with respect to
the performance of their duties as medical directors of our facilities.
Employees
As of March 15, 1999, we had more than 12,300 employees, including a
professional staff of approximately 8,500 employees, a corporate and regional
staff of approximately 1,200 employees and a facilities support and maintenance
staff of approximately 2,600 employees. Approximately 8,600 of our employees
are employed on a full-time basis. A small number of our employees are party to
collective bargaining agreements. We have experienced limited union organizing
activity. However, in general, we believe that our labor relations are good.
Risk factors
In addition to the other information set forth in this Form 10-K, you should
note the following risks related to our business.
If we fail to build adequate internal systems and controls then our revenue
and net income may be adversely affected.
We have experienced rapid growth in the last five years, and especially in
1998, as a result of our business strategy to acquire, develop and manage a
large number of dialysis centers. We also intend to continue to acquire,
develop and manage additional dialysis centers, both in the U.S. and
internationally. This historical growth and business strategy subjects us to
the following risks:
. Our billing and collection structures, systems and personnel may prove
inadequate to collect all amounts owed to us for services we have
rendered, resulting in a lack of sufficient cash flow;
. We may require additional management, administrative and clinical
personnel to manage and support our expanded operations, and we may not
be able to attract and retain sufficient personnel;
. Our assessment of the requirements of our growth on our information
systems may prove inaccurate, and we may have to spend substantial
amounts to enhance or replace our information systems;
. Our expanded operations may require cash expenditures in excess of the
cash available to us after paying our debt service obligations;
. We may inaccurately assess the historical and projected results of
operations of acquisition candidates, which may cause us to overpay for
acquisitions;
28
<PAGE>
. We may inaccurately assess the historical and projected results of
operations of existing and recently acquired facilities, which may cause
us not to achieve the results of operations expected for these
facilities; and
. We may not be able to integrate acquired facilities as quickly or
smoothly as we expect, which may cause us not to achieve the results of
operations expected for these acquired facilities.
These risks are enhanced when we acquire entire regional networks or other
national dialysis providers, such as RTC, or enter into multi-facility
management agreements.
Future declines, or the lack of an increase, in Medicare reimbursement rates
could substantially decrease our net income.
We are reimbursed for dialysis services primarily at fixed rates established
in advance under the Medicare ESRD program. Unlike many other Medicare
programs, which receive periodic cost of living increases, these rates have not
increased since 1991. Increases in operating costs that are subject to
inflation, such as labor and supply costs, have occurred and continue to occur
without a compensating increase in reimbursement rates. In addition, if
Medicare should begin to include in its composite reimbursement rate any
ancillary services that it currently reimburses separately, our revenue would
decrease to the extent there was not a corresponding increase in that composite
rate. We cannot predict whether future rate changes will be made. Approximately
51% of our net operating revenues in 1998 was generated from patients who had
Medicare as the primary payor.
HHS has recommended, and the Clinton administration has included in its
fiscal year 2000 budget proposal to the Congress, a 10% reduction in Medicare
reimbursement for EPO. We cannot predict whether this proposal or other future
rate or reimbursement method changes will be made. Approximately 13% of our net
operating revenues in 1998 was generated from EPO reimbursement through
Medicare and Medicaid programs. Consequently, any reduction in the rate of EPO
reimbursement through Medicare and Medicaid programs could materially reduce
our revenues and net income.
Medicare separately reimburses us for other outpatient prescription drugs
that we administer to dialysis patients at the rate of 95% of the average
wholesale price of each drug. The Clinton administration has also included in
its fiscal year 2000 budget proposal to the Congress a reduction in the
reimbursement rate for outpatient prescription drugs to 83% of 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 revenues and net income.
Many Medicaid programs base their reimbursement rates for the services we
provide on the Medicare reimbursement rates. Any reductions in the Medicare
rates could also result in reductions in the Medicaid reimbursement rates.
Approximately 4% of our net operating revenues in 1998 was generated from
patients who had Medicaid or comparable state programs as the primary payer.
If Medicare changes its ESRD program to a capitated reimbursement system, our
revenues and profits could be materially reduced.
HCFA has initiated a pilot demonstration project, expected to end in 2001, 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 or
managed care plans would receive a fixed periodic payment for servicing all of
our Medicare-eligible ESRD patients regardless of certain fluctuations in the
number of services provided in that period or the number of patients treated.
Under the current demonstration project, Medicare is paying managed care plans
a capitated rate equal to 95% of Medicare's current average cost of treating
dialysis patients. If HCFA considers this pilot program successful, HCFA or
Congress could lower the average Medicare reimbursement for dialysis.
29
<PAGE>
If we charge private payors at rates less than our current rates, then our
revenues and net income could be substantially reduced.
Approximately 36% of our net operating revenues in 1998 was generated from
patients who had domestic private payors as the primary payor. Domestic private
payors, particularly managed care payors, have become more aggressive in
demanding contract rates approaching or at Medicare reimbursement rates. We
believe that the financial pressures on private payors to decrease the rates at
which they reimburse us will continue to increase and could have a material
impact on our revenues and net income.
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.
Our balance sheet has an amount designated as "goodwill" that represents 49%
of our assets and 197% of our stockholders' equity at December 31, 1998.
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 average useful
life is 34 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.
We continuously review the appropriateness of the amortization periods we are
using and change them as necessary to reflect current expectations. This
information is also reviewed with our independent accountants. If the factors
we considered, and which give rise to a material portion of our goodwill,
result in an actual beneficial period shorter than our determined useful life,
earnings reported in periods immediately following some 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.
Interruption in the supply of, or cost increases in, EPO could materially
reduce our net income and affect our ability to care for our patients.
A single manufacturer, Amgen Corporation, produces EPO. 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.
If we fail to identify, assess and respond successfully to the unique
attributes of each of our foreign operations, our net income could be adversely
affected.
We only recently commenced operations outside the U.S., and expect to enter
additional foreign markets in the next few years. Our failure to identify,
understand and respond to the unique attributes of any of the foreign markets
that we enter could cause us to:
. Overpay for acquisitions of foreign dialysis centers;
. Fail to integrate foreign acquisitions into our operations successfully;
and
. Assess the performance of our foreign operations incorrectly.
30
<PAGE>
The unique attributes of our foreign operations include:
. Differences in payment and reimbursement rules and procedures, including
unanticipated slowdowns in payments from large payors in Argentina;
. Differences in accepted clinical standards and practices;
. Differences in management styles and practices;
. The unfamiliarity of foreign companies with U.S. financial reporting
standards; and
. Local laws that restrict or limit employee discharges and disciplinary
actions.
If we fail to adhere to all of the complex government regulations that apply
to our business, we could incur substantial fines or be excluded from
participating in government reimbursement programs.
Our dialysis operations are subject to extensive federal, state and local
government regulations in the U.S. and to extensive government regulation in
every foreign country in which we operate. Any of the following could adversely
impact our revenues:
. Loss of required government certifications;
. Loss of authorizations to participate in or exclusion from government
reimbursement programs, such as the Medicare ESRD Program and Medicaid
programs;
. Suspension of payments from government programs;
. Loss of licenses required to operate health care facilities in some of
the states in which we operate; and
. Any challenge to the relationships we have structured in some foreign
countries to comply with barriers to direct foreign ownership of
healthcare businesses.
The regulatory scrutiny of healthcare providers has increased significantly
in recent years. For example, the Office of Inspector General of HHS reported
that it recovered $1.2 billion in fiscal 1997 from health care fraud
investigations, an amount five times greater than that recovered in the
previous fiscal year.
. We may never collect the revenues from the payments suspended as a result
of an investigation of our laboratory subsidiary
Our Florida-based laboratory subsidiary is the subject of a third-party
carrier review relating to claims the laboratory submitted for Medicare
reimbursement. In May 1998, the carrier suspended all further Medicare payments
to the laboratory. Medicare revenues from the laboratory represent
approximately 2% of our net revenues. For the review period the carrier
initially identified, January 1995 to April 1996, the carrier has alleged that
the prescribing physician's medical justification did not properly support
99.3% of the tests the laboratory performed. The carrier also determined that
it overpaid the laboratory $5.6 million for this period. The carrier
subsequently requested billing records with respect to the additional period
from May 1996 to March 1998. The suspension of payments relates to all payments
due after the suspension started, regardless of when the laboratory performed
the tests. The carrier has withheld approximately $11 million as of
December 31, 1998, which has adversely affected our cash flow. We may never
recover the amounts withheld.
. Our failure to comply with federal and state 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 some of our dialysis
facilities meet all of the requirements of published safe harbors to the anti-
kickback provisions of the Social Security Act and similar state laws. These
laws impose civil and criminal sanctions on anyone who receives or makes
payments for referring a patient for any service reimbursed by Medicare,
Medicaid or similar federal and state programs. Arrangements within published
safe
31
<PAGE>
harbors are deemed not to violate these provisions. Enforcement agencies may
subject arrangements that do not fall within a safe harbor to greater scrutiny.
If we are challenged under these statutes, we may have to change our
relationships with our medical directors and with referring physicians holding
minority ownership interests.
The laws of several states in which we do business prohibit a physician from
making referrals for laboratory services to entities with which the physician,
or an immediate family member, has a financial interest. We currently operate a
large number of facilities in these states, which account for a significant
percentage of our business. These state statutes could apply to laboratory
services incidental to dialysis services. If so, we may have to change our
relationships with referring physicians who serve as medical directors of our
facilities or hold minority interests in any of our facilities.
We may not have sufficient cash flow from our business to service our debt.
The amount of our outstanding debt is large compared to the net book value of
our assets, and we have substantial repayment obligations under our outstanding
debt. As of December 31, 1998 we had:
. Total consolidated debt of approximately $1.25 billion;
. Stockholders' equity of approximately $481.8 million; and
. A ratio of earnings to fixed charges of 1.59.
The following chart shows our aggregate interest and principal payments due
on all of our outstanding debt for each of the next five fiscal years, as of
December 31, 1998. Under interest swap agreements covering $800 million of
debt, the interest rate under our credit facilities varies based on the amount
of debt we incur relative to our assets and equity. Accordingly, the amount of
these interest payments could fluctuate in the future.
<TABLE>
<CAPTION>
Interest Payments Principal Payments
----------------- ------------------
<S> <C> <C>
For the year ending December 31:
1999 $96,200,000 $21,847,000
2000 95,100,000 10,893,000
2001 88,400,000 94,579,000
2002 77,700,000 153,567,000
2003 68,800,000 241,559,000
</TABLE>
Due to the large amount of these principal and interest payments, we may not
have enough cash to pay the interest on our debt as it becomes due.
The large amount and terms of our outstanding debt may prevent us from taking
actions we would otherwise consider in our best interest.
Our credit facilities contain numerous financial and operating covenants that
limit our ability, and the ability of most of our subsidiaries, to engage in
activities such as incurring additional senior debt and disposing of our
assets. These covenants require that we meet interest coverage, net worth and
leverage tests.
Our level of debt and the limitations our credit facilities impose on us
could have other important consequences to you, including:
. We will have to use a portion of our cash flow from operations,
approximately $118.0 million in 1999 and $106.0 million in 2000, 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;
. We could be less able to take advantage of significant business
opportunities, including acquisitions, and react to changes in market or
industry conditions.
32
<PAGE>
If a change of control occurs, we may not have sufficient funds to repurchase
our outstanding 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 noteholders 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 our credit facilities generally prohibit
us from purchasing any notes until we have repaid all debt outstanding under
these credit facilities. 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 our outstanding notes or refinance the
borrowings that prohibit us from repurchasing our outstanding notes. If we do
not obtain a consent or repay the borrowings, we could not repurchase these
notes.
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 four, to define the
applicable year of business transactions. Due to the overall complexity of the
Y2K issues and the uncertainty surrounding third party responses to Y2K issues,
we cannot assure you 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 internal and external computer
networks, software applications and dialysis equipment; 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. We may experience the extended failure of external and internal computer
networks and equipment that control
. Medicare, Medicaid and other third party payors' ability to reimburse us;
. Regional infrastructures, such as power, water and telecommunications
systems;
.Equipment and machines that are essential for the delivery of patient
care; and
. Computer software necessary to support our billing process.
If any one of these events occurs, our cash flow could be materially reduced.
Even in the absence of a failure of these networks and equipment, we will
likely continue to incur costs related to remediation efforts, the 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.
33
<PAGE>
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.
Forward-looking statements
This Form 10-K 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-K. 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.
Item 2. Properties.
Thirteen of our dialysis facilities are operated on properties that we own.
We also own a 50% interest in a limited liability company that owns an
additional property on which we operate a dialysis facility. The remaining 523
dialysis facilities that we operate are located on premises leased by us or our
general partnerships, limited liability companies or subsidiary corporations or
by entities that we manage. We lease at fair market value certain facilities
from entities in which referring physicians hold an interest. Our leases
generally cover periods from five to ten years and typically contain renewal
options of five to ten years at the fair rental value at the time of renewal or
at rates subject to consumer price index increases since the inception of the
lease. Our facilities range in size from approximately 500 to 15,900 square
feet, with an approximate average size of 4,900 square feet. We operate our
corporate headquarters in approximately 35,800 square feet of office space in
Torrance, California which we currently lease for a term expiring in 2008. Our
general accounting office in Tacoma, Washington, is leased for a term expiring
in 2000. We have entered into an additional ten year lease in Tacoma,
Washington for an 80,000 square foot facility beginning in April 1999. We
maintain a 43,000 square foot facility in Berwyn, Pennsylvania for additional
billing and collections purposes and limited corporate and regional staff. The
Berwyn lease expires in 2001. Our Florida-based laboratory is located in a
30,000 square foot facility owned by us, with a ground lease, and our
Minnesota-based laboratory is located in a 9,500 square foot facility leased by
us.
34
<PAGE>
Certain of our facilities are operating at or near capacity. However, we
believe that we have adequate capacity within most of our existing facilities
to accommodate significantly greater patient volume through increased hours
and/or days of operation, or through the addition of dialysis stations at a
given facility upon obtaining appropriate governmental approvals. In addition,
we have the ability to build de novo facilities if existing facilities reach
capacity. With respect to relocating facilities or building de novo facilities,
we believe that we can generally lease space at economically reasonable rates
in the area planned for each of these facilities. Expansion or relocation of
our facilities would be subject to review for compliance with conditions
relating to participation in the Medicare ESRD program. In states that require
a certificate of need, approval of our application generally would be necessary
for expansion or relocation.
Item 3. Legal Proceedings.
Following the announcement on February 18, 1999 of our preliminary results
for the 4th quarter of 1998 and the full year then ended, 13 class action
lawsuits were filed against us and certain of our officers in the United States
District Court for the Central District of California. The lawsuits are:
1. Joseph Lipsky v. Total Renal Care Holdings, Inc., Victor M.G.
Chaltiel, Leonard Frie and John E. King, Central District of California,
Western Division, Case No. CV-99-1745CBM (RCx);
2. Andrew W. Davitt v. Total Renal Care Holdings, Inc., Victor M.G.
Chaltiel and John E. King, Central District of California, Western
Division, Case No. CV-99-01750DT (RCx);
3. Tozour Energy Systems Retirement Plan v. Total Renal Care Holdings,
Inc., Victor M.G. Chaltiel and John E. King, Central District of
California, Western Division, Case No. CV-99-01799DDP (RNBx);
4. Trust Advisors Equity Plus LLC v. Total Renal Care Holdings, Inc.,
Victor M.G. Chaltiel, John E. King and Barbara A. Bednar, Central District
of California, Western Division, Case No. CV-99-01800SVW (AJWx);
5. Alex Goldsleger v. Total Renal Care Holdings, Inc., Victor M.G.
Chaltiel, John E. King and Barbara A. Bednar, Central District of
California, Western Division, Case No. CV-99-01883ER (Ex);
6. Timothy Carlson and Kathleen O. Stack v. Total Renal Care Holdings,
Inc., Victor M.G. Chaltiel and John E. King, Central District of
California, Western Division, Case No. CV-99-01920ER (RZx);
7. Kurt W. Steidle v. Total Renal Care Holdings, Inc., Victor M.G.
Chaltiel and John E. King, Central District of California, Western
Division, Case No. CV-99-02016ABC (RZx);
8. Daniel Petroski v. Total Renal Care Holdings, Inc., Victor M.G.
Chaltiel and John E. King, Central District of California, Western
Division, Case No. CV-99-02022CM (Mcx);
9. Dan Whalen v. Total Renal Care Holdings, Inc., Victor M.G. Chaltiel
and John E. King, Central District of California, Western Division, Case
No. CV-99-02146CM (CWx);
10. Daniel K. Bloomfield v. Total Renal Care Holdings, Inc., Victor M.G.
Chaltiel, John E. King and Barbara A. Bednar, Central District of
California, Western Division, Case No. CV-99-02150DT (AIJx);
11. Mary Ann King v. Total Renal Care Holdings, Inc., Victor M.G.
Chaltiel and John E. King, Central District of California, Western
Division, Case No. CV-99-02252ABC (Mcx);
12. Albert Parker and Lawrence G. Maglione v. Total Renal Care Holdings,
Inc., Victor M.G. Chaltiel and John E. King, Central District of
California, Western Division, Case No. CV-99-02337LGB (Shx); and
13. State of Louisiana School Employees' Retirement System v. Total Renal
Care Holdings, Inc., Victor M.G. Chaltiel and John E. King, Central
District of California, Western Division, Case No. CV-99-03100CAS (Mcx).
35
<PAGE>
The complaints in the lawsuits are similar and allege violations of federal
securities law arising from allegedly false and misleading statements primarily
regarding our accounting for the integration of RTC into TRCH and request
unspecified monetary damages. The lawsuits have been consolidated under the
caption, In Re Total Renal Care Securities Litigation, Master File No. CV-99-
1745-CBM (RCx). A Consolidated Amended Complaint was filed on October 6, 1999.
This complaint alleges violations of the federal securities laws arising from
allegedly false and misleading statements during a class period of March 11,
1997 to July 18, 1999 and seeks unspecified monetary damages. The primary
allegations of this complaint are that we booked revenues at inflated amounts,
failed to disclose that a material portion of our accounts receivable were
uncollectible, reported excessive non-Medicare revenues, billed for treatments
that were never provided, failed to disclose accurately the basis for
suspension of payments to our Florida-based laboratory subsidiary on Medicare
claims, accounted for goodwill to overstate income, and manipulated the value
of intangible assets. We have not yet responded to this complaint, but 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 this consolidated litigation 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.
On February 19, 1999, our Florida-based laboratory subsidiary, Total Renal
Laboratories, Inc., d/b/a Dialysis Laboratories, filed a complaint against the
Secretary of Health and Human Services and Blue Cross and Blue Shield of
Florida, Inc., the third-party carrier that processes the laboratory's Medicare
claims, in the United States District Court for the Northern District of
Georgia. The carrier has suspended all payments for claims submitted by the
laboratory for Medicare reimbursement pending a review of these claims. The
complaint seeks a court order lifting the payment suspension. On July 29, 1999,
the court dismissed our complaint because we did not exhaust all administrative
remedies. See the subheading "Florida laboratory payment dispute" under the
heading "Government regulation."
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
financial condition.
Item 4. Submission of Matters to a Vote of Security Holders.
Not applicable.
36
<PAGE>
PART II
Item 5. Market for the Registrant's Common Equity and Related Stockholder
Matters.
Our common stock is traded on the New York Stock Exchange under the symbol
"TRL." The following table sets forth, for the periods indicated, the high and
low closing prices for our common stock as reported by the New York Stock
Exchange.
<TABLE>
<CAPTION>
High Low
------ ------
<S> <C> <C>
Fiscal year ended December 31, 1997
1st quarter............................................... $21.98 $18.23
2nd quarter............................................... 24.11 16.88
3rd quarter............................................... 30.08 21.83
4th quarter............................................... 33.44 25.06
Fiscal year ended December 31, 1998
1st quarter............................................... $35.69 $22.88
2nd quarter............................................... 36.13 30.31
3rd quarter............................................... 35.00 19.00
4th quarter............................................... 30.19 19.50
</TABLE>
The closing price of our common stock on March 15, 1999 was $9.25 per share.
As of March 15, 1999 there were approximately 1,937 holders of our common stock
named as holders of record by The Bank of New York, our registrar and transfer
agent. Since our recapitalization in 1994, we have not declared or paid cash
dividends to holders of our common stock. We do not anticipate paying any cash
dividends in the foreseeable future. We are subject to certain restrictions on
our ability to pay dividends on our common stock. For more details, see the
heading "Liquidity and capital resources" under "Item 7. Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
the notes to our consolidated financial statements.
37
<PAGE>
Item 6. Selected Financial Data.
The following table presents our selected consolidated financial and
operating data for the periods indicated. The consolidated financial data as of
May 31, 1994 and 1995 and as of December 31, 1995, 1996, 1997 and 1998 and for
the years ended May 31, 1994 and 1995, the seven month period ended December
31, 1995, and the years ended December 31, 1996, 1997 and 1998 have been
derived from our audited consolidated financial statements. The consolidated
financial data for the seven months ended December 31, 1994 and the year ended
December 31, 1995 are unaudited and include all adjustments consisting solely
of normal recurring adjustments necessary to present fairly our results of
operations for the period indicated. The results of operations for the seven
month periods ended December 31, 1994 and 1995 are not necessarily indicative
of the results which may occur for the full fiscal year. The following
financial and operating data should be read in conjunction with "Item 7.
Management's Discussion and Analysis of Financial Condition and Results of
Operations" and our consolidated financial statements filed as part of this
report.
<TABLE>
<CAPTION>
Seven months
Years ended ended
May 31,(1) December 31, Year ended December 31,
----------------- ----------------- -------------------------------------
1994 1995 1994 1995 1995 1996 1997 1998
(in thousands, except per share)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Income Statement Data:(2)(8)
Net operating revenues..... $153,513 $214,425 $122,065 $176,463 $299,411 $498,024 $760,997 $1,204,894
Total operating expenses(3)
.......................... 133,211 182,251 104,053 143,196 247,925 427,520 636,217 1,063,076
-------- -------- -------- -------- -------- -------- -------- ----------
Operating income .......... 20,302 32,174 18,012 33,267 51,486 70,504 124,780 141,818
Interest expense, net(3) .. 1,549 7,851 3,838 6,831 11,801 9,559 25,039 77,733
-------- -------- -------- -------- -------- -------- -------- ----------
Income before income taxes,
minority interests,
extraordinary item and
cumulative effect of
change in accounting
principle................. 18,753 24,323 14,174 26,436 39,685 60,945 99,741 64,085
Income taxes .............. 6,208 7,827 4,759 9,931 13,841 22,960 40,212 41,580
-------- -------- -------- -------- -------- -------- -------- ----------
Income before minority
interests, extraordinary
item and cumulative effect
of change in accounting
principle................. 12,545 16,496 9,415 16,505 25,844 37,985 59,529 22,505
Minority interests in
income of
consolidated subsidiaries.. 1,046 1,593 878 1,784 2,544 3,578 4,502 7,163
-------- -------- -------- -------- -------- -------- -------- ----------
Income before extraordinary
item and cumulative effect
of change in accounting
principle ................ $ 11,499 $ 14,903 $ 8,537 $ 14,721 $ 23,300 $ 34,407 $ 55,027 $ 15,342
======== ======== ======== ======== ======== ======== ======== ==========
Net income (loss)(4)....... $ 11,499 $ 14,903 $ 8,537 $ 12,166 $ 20,745 $ 26,707 $ 55,027 $ (4,298)
======== ======== ======== ======== ======== ======== ======== ==========
Earning per common
share(5):
Net income before
extraordinary item and
cumulative effect of
change in accounting
principle............... $ 0.33 $ 0.20 $ 0.26 $ 0.43 $ 0.46 $ 0.71 $ 0.19
======== ======== ======== ======== ======== ======== ==========
Net income (loss)(4)..... $ 0.33 $ 0.20 $ 0.22 $ 0.38 $ 0.36 $ 0.71 $ (0.05)
======== ======== ======== ======== ======== ======== ==========
Earning per common share--
assuming dilution(5):
Net income before
extraordinary item and
cumulative effect of
change in accounting
principle............... $ 0.31 $ 0.19 $ 0.25 $ 0.40 $ 0.45 $ 0.69 $ 0.19
======== ======== ======== ======== ======== ======== ==========
Net income (loss)(4)..... $ 0.31 $ 0.19 $ 0.20 $ 0.36 $ 0.35 $ 0.69 $ (0.05)
======== ======== ======== ======== ======== ======== ==========
<CAPTION>
Seven months
Year ended ended
May 31, December 31, Year ended December 31,
----------------- ----------------- -------------------------------------
1994 1995 1994 1995 1995 1996 1997 1998
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Ratio of earnings to fixed
charges(10)................ 6.06 2.97 3.17 3.48 3.22 3.96 3.47 1.59
</TABLE>
<TABLE>
<CAPTION>
May 31, December 31,
----------------- ---------------------------------------
1994 1995 1995 1996 1997 1998
(in thousands)
<S> <C> <C> <C> <C> <C> <C>
Balance Sheet
Data:(2)(9)
Working capital........ $ 33,773 $ 42,918 $ 98,071 $184,975 $ 199,754 $ 385,078
Total assets........... 103,628 218,081 338,866 665,221 1,278,235 1,915,581
Long-term debt ........ 17,531 115,522 96,979 233,126 723,782 1,225,781
Mandatorily redeemable
common stock(6)....... 3,990
Stockholders' equity... 65,391 61,749(7) 193,162 359,099 428,830 481,812
</TABLE>
(See notes on following page)
38
<PAGE>
- --------
(1) In 1995, we changed our fiscal year end to December 31 from May 31.
(2) Our recapitalization in 1994 and subsequent acquisitions have had a
significant impact on our capitalization and equity securities and on our
results of operations. Consequently, the balance sheet data as of May 31,
1995 and as of December 31, 1995, 1996, 1997 and 1998 and the income
statement data for the fiscal year ended May 31, 1995, for the seven
months ended December 31, 1995, and the years ended December 31, 1996,
1997 and 1998 are not directly comparable to corresponding information as
of prior dates and for prior periods, respectively.
(3) General and administrative expenses for the fiscal year ended May 31, 1994
include overhead allocations by our former parent of $1,458,000 for the
period June 1993 through February 1994. No overhead allocation was made
for the period from March 1994 through our recapitalization in 1994 at
which time we began to record general and administrative expenses as
incurred on a stand-alone basis. General and administrative expenses for
the fiscal year ended May 31, 1994 also reflect $458,000 in expenses
relating to a terminated equity offering. During the first quarter of 1998
we recorded an expense of $79,435,000 for merger and related costs
associated with the RTC merger and during the second quarter we recorded a
charge in interest expense of $9,823,000 to terminate interest rate swap
agreements on debt that were refinanced.
(4) In December 1995, we recorded an extraordinary loss of $2,555,000, or
$0.09 per share, net of tax, on the early extinguishment of debt. In July
and September 1996, we recorded a combined extraordinary loss of
$7,700,000 or $0.10 per share net of tax, on the early extinguishment of
debt. At the time of our merger with RTC we paid off their existing
revolving credit agreement and the remaining unamortized deferred
financing costs, net of tax, of $2,812,000 or approximately $0.04 per
share, was included as an extraordinary loss in 1998. In April 1998 we
replaced our existing $1.05 billion credit facilities with a combined
total of $1.35 billion in two senior credit facilities. As a result of
this refinancing, the remaining net deferred financing costs, net of tax,
of $9,932,000 or approximately $0.12 per share, was included as an
extraordinary loss in 1998. See Note 8 of our consolidated financial
statements.
In the first quarter of 1998 we adopted Statement of Position No. 98-5,
Reporting on the Costs for Start-up Activities, or SOP 98-5, which
requires that pre-opening and organization costs previously treated as
deferred costs should be expensed as incurred. As a result all existing
remaining unamortized deferred pre-opening and organizational costs was
taken as a charge, net of tax, of $6,896,000 or approximately $0.08 per
share, as a cumulative effect of a change in accounting principle. See our
consolidated financial statements and related notes.
(5) See additional income per share information in our consolidated statements
of income.
(6) Mandatorily redeemable common stock represents shares of common stock
issued in certain acquisitions subject to put options that terminated upon
the completion of our initial public offering.
(7) In connection with our recapitalization in 1994, we paid a special
dividend to Tenet Healthcare Corporation, or Tenet, of $81.7 million,
including $75.5 million in cash.
(8) The consolidated income statement data combine our results of operations
for the years ended May 31, 1994 and 1995, the seven months ended December
31, 1994 and 1995 and the years ended December 31, 1995, 1996 and 1997
with RTC's results of operations for the years ended December 31, 1993 and
1994, the six months ended December 31, 1994 and 1995 and the years ended
December 31, 1995, 1996 and 1997, respectively.
(9) The consolidated balance sheet data combines our balance sheet as of May
31, 1994 and 1995 and December 31, 1995, 1996 and 1997 with RTC's balance
sheet as of December 31, 1993, 1994, 1995, 1996 and 1997, respectively.
(10) The ratio of earnings to fixed charges is computed by dividing fixed
charges into earnings. Earnings is defined as pretax income from
continuing operations adjusted by adding fixed charges and excluding
interest capitalized during the period. Fixed charges means the total of
interest expense and amortization of financing costs and the estimated
interest component of rental expense on operating leases.
39
<PAGE>
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
The following should be read in conjunction with our consolidated financial
statements and the related notes contained elsewhere in this Form 10-K.
Background
Our wholly-owned subsidiary TRC, formerly Medical Ambulatory Care, Inc., was
organized in 1979 by Tenet, formerly National Medical Enterprises, Inc., to own
and operate Tenet's hospital-based dialysis services as freestanding dialysis
facilities and to acquire and develop additional dialysis facilities in Tenet's
markets. TRCH was organized to facilitate the 1994 sale by Tenet of
approximately 75% of its ownership interest to DLJ Merchant Banking Partners,
L.P., or DLJMB, and certain of its affiliates, our management and certain
holders of our debt securities.
In connection with our recapitalization in 1994, we paid a special dividend
to Tenet out of the net proceeds from (a) the issuance of units consisting of
$100 million in principal amount at maturity of 12% senior subordinated
discount notes due 2004, which were issued at approximately 70% of par, and
1,000,000 shares of common stock and (b) borrowing under TRC's revolving credit
facility. We raised additional capital to fund the continuation of our growth
strategy through an initial public offering, or IPO, in October 1995 in which
we raised gross proceeds of $107 million. Concurrent with the IPO, we listed
our common stock on the New York Stock Exchange under the symbol "TRL."
Subsequent to the IPO, we changed our fiscal year end from May 31 to December
31.
We raised additional capital to further our growth strategy with two
secondary stock offerings in April and October of 1996 which raised gross
proceeds to us of approximately $135 million. In October of 1996 we increased
our credit facility from $130 million to $400 million. With the proceeds from
the IPO, the April 1996 secondary offering and the credit facility, we were
able to complete the early retirement of the discount notes. In October 1997
and April 1998, we increased our credit facility to an aggregate of $1.05
billion and $1.35 billion respectively in two bank facilities. In November
1998, we sold $345 million of our 7% convertible subordinated notes.
Following our recapitalization in 1994, we implemented a focused strategy to
increase net operating revenues per treatment and improve operating income
margins. We have significantly increased per-treatment revenues through
improved pricing, the addition of in-house clinical laboratory services,
increased utilization of ancillary services and the addition of in-house
pharmacy services and other ancillary programs. To improve operating income, we
began a systematic review of our vendor relations leading to the renegotiation
of a number of supply contracts and insurance arrangements that reduced
operating expenses. In addition, we have focused on improving facility
operating efficiencies and leveraging corporate and regional management. These
improvements have been offset in part by increased amortization of goodwill and
other intangible assets relating to our acquisitions (all of which have been
accounted for as purchase transactions, except the merger with RTC) and start-
up expenses related to de novo developments.
On February 27, 1998, we acquired RTC in a stock for stock transaction valued
at approximately $1.3 billion. The transaction was accounted for as a pooling
of interests. Accordingly, our consolidated financial statements have been
restated to include RTC for all periods presented.
Net operating revenues
Net operating revenues are derived primarily from five sources: (a)
outpatient facility hemodialysis services; (b) ancillary services, including
the administration of EPO and other intravenous pharmaceuticals, clinical
laboratory services, oral pharmaceutical products and other ancillary services;
(c) home dialysis services and related products; (d) inpatient hemodialysis
services provided to hospitalized patients pursuant to arrangements with
hospitals; and (e) international operations. Additional revenues are derived
from the provision of dialysis facility management services to certain
subsidiaries and affiliated and unaffiliated dialysis
40
<PAGE>
centers. Our dialysis and ancillary services are reimbursed primarily under the
Medicare ESRD program in accordance with rates established by HCFA. Payments
are also provided by other third party payors, generally at rates higher than
those reimbursed by Medicare for up to the first 33 months of treatment as
mandated by law. Rates paid for services provided to hospitalized patients are
negotiated with individual hospitals. For the years ended December 31, 1996,
1997 and 1998, approximately 60%, 56% and 51%, respectively, and 4%, 5% and 4%,
respectively of our net patient revenues were derived from reimbursement under
Medicare and Medicaid, respectively.
We maintain a usual and customary fee schedule for our dialysis treatment and
other patient services. We often do not realize our usual and customary rates,
however, because of limitations on the amounts we can bill to or collect from
the payors for our services. We generally bill the Medicare and Medicaid
programs at net realizable rates determined by applicable fee schedules for
these programs, which are established by statute or regulation. We bill most
non-governmental payors, including managed care payors with which we have
contracted, at our usual and customary rates. Since we bill most non-
governmental payors at our usual and customary rates, but often expect to
receive payments at the lower contracted rates, we also record a contractual
allowance in order to record expected net realizable revenue for services
provided. This process involves estimates and we record revisions to these
estimates in subsequent periods as they are determined to be necessary.
For more information, see the subheading "Sources of revenue reimbursement"
under "Item 1. Business."
41
<PAGE>
Quarterly results of operations
The following table sets forth selected unaudited quarterly financial data
and operating information for 1997 and 1998. The unaudited financial data for
the quarters ended March 31, 1998, June 30, 1998 and September 30, 1998 have
been restated to reflect adjustments we have made to our accrual for merger and
related costs in connection with our merger with RTC. For more information
regarding the adjustments we made and their effects, see Notes 1 and 16 to our
consolidated financial statements.
<TABLE>
<CAPTION>
Quarters ended
-----------------------------------------------------------------------------------------
March 31, June 30, September 30, December 31, March 31, June 30, September 30,
1997 1997 1997 1997 1998 1998 1998
--------- -------- ------------- ------------ --------- -------- -------------
(dollars in thousands, except per share and per treatment data)
<S> <C> <C> <C> <C> <C> <C> <C>
Net operating revenues.. $157,937 $179,715 $197,749 $ 225,596 $ 258,749 $ 288,350 $ 318,585
Facility operating
expenses............... 107,728 121,373 131,670 150,219 166,995 183,324 200,925
General and
administrative
expenses............... 9,916 12,120 13,208 14,855 16,910 17,605 18,274
Operating income
(loss)(1).............. 24,596 28,694 33,287 38,203 (30,948) 56,837 66,184
Income before
extraordinary item and
cumulative effect of
change in accounting
principle.............. 11,788 13,470 14,632 15,137 (46,088) 17,839 27,381
Income per share before
extraordinary item and
cumulative effect of
change in accounting
principle(3)........... $ 0.15 $ 0.17 $ 0.18 $ 0.19 $ (0.59) $ 0.22 $ 0.33
Outpatient facilities... 267 316 337 380 391 423 477
Treatments.............. 691,406 803,035 894,067 1,003,163 1,099,627 1,186,597 1,283,734
Net operating revenues
per treatment.......... $ 228 $ 224 $ 221 $ 225 $ 235 $ 243 $ 248
Operating income
margin................. 15.6% 16.0% 16.8% 16.9% (12.0)%(2) 19.7% 20.8%
<CAPTION>
December 31,
1998
------------
<S> <C>
Net operating revenues.. $ 339,210
Facility operating
expenses............... 221,422
General and
administrative
expenses............... 23,040
Operating income
(loss)(1).............. 49,745
Income before
extraordinary item and
cumulative effect of
change in accounting
principle.............. 16,210
Income per share before
extraordinary item and
cumulative effect of
change in accounting
principle(3)........... $ 0.20
Outpatient facilities... 508
Treatments.............. 1,342,386
Net operating revenues
per treatment.......... $ 253
Operating income
margin................. 14.7%(2)
</TABLE>
- --------
(1)The reconciliation between the operating income before merger costs and
operating income (loss) included in the quarterly results of operations is
presented below:
<TABLE>
<CAPTION>
Quarters ended
-------------------------------------------------------------------------------------------
March 31, June 30, September 30, December 31, March 31, June 30, September 30, December 31,
1997 1997 1997 1997 1998 1998 1998 1998
--------- -------- ------------- ------------ --------- -------- ------------- ------------
(dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Operating income before
merger costs........... 24,596 28,694 33,287 38,203 48,487 56,837 66 ,184 48,498
Merger costs............ (79,435) 1,247
Operating income
(loss)................. 24,596 28,694 33,287 38,203 (30,948) 56,837 66,184 49,745
</TABLE>
(2) The operating income margin calculated prior to the merger and related
costs of $79,435,000 for the quarter ended March 31, 1998 is 18.7%. The
operating income margin calculated prior to the reduction of merger costs
of $1,247,000 for the quarter ended December 31, 1998 is 14.3%.
(3) See additional income per share information in Note 16 to our consolidated
financial statements.
42
<PAGE>
Utilization of our services generally is not subject to material seasonal
fluctuations. The quarterly variations shown above reflect the impact of
increasing labor costs and decreasing margins related to the corresponding
costs of providing services and amortization of intangibles from acquired
facilities.
Results of operations
The following table sets forth for the periods indicated selected information
expressed as a percentage of net operating revenues for such periods:
<TABLE>
<CAPTION>
Years ended
December 31,
-------------------
1996 1997 1998
<S> <C> <C> <C>
Net operating revenues................................ 100.0% 100.0% 100.0%
Facility operating expenses........................... 69.1 67.1 64.1
General and administrative expenses................... 6.5 6.6 6.3
Provision for doubtful accounts....................... 3.2 2.7 3.7
Depreciation and amortization......................... 6.5 7.2 7.6
Merger expenses....................................... 0.6 6.5
Operating income...................................... 14.2 16.4 11.8
Interest expense...................................... 2.7 3.7 6.0
Interest rate swap-early termination costs............ 0.8
Interest income....................................... 0.8 0.4 0.4
Income taxes.......................................... 4.6 5.3 3.5
Minority interests.................................... 0.7 0.6 0.6
Income before extraordinary item and cumulative effect
of change in accounting principle.................... 6.9 7.2 1.3
</TABLE>
Year ended December 31, 1998 compared to year ended December 31, 1997
Net operating revenues. Net operating revenues increased $443,897,000 to
$1,204,894,000 for the year ended December 31, 1998 from $760,997,000 for the
year ended December 31, 1997, representing a 58.3% increase. Of this increase,
$341,197,000 was due to increased treatments, of which $137,056,000 was from
acquisitions consummated during 1998, $188,702,000 was from existing facilities
as of December 31, 1997 and $15,439,000 was from de novo developments
commencing operations in 1998. The remaining increase of $102,700,000 resulted
from an increase in net operating revenues per treatment which increased from
$224.37 in 1997 to $245.28 in 1998. The increase in net operating revenues per
treatment was attributable to increased ancillary services utilization of
$44,581,000, primarily in the administration of EPO of $36,147,000, the overall
impact of a rate increase of $32,090,000, $21,912,000 resulting from an
increase in the number of services reimbursed by private payors, who pay at
higher rates, stemming from HCFA's extension of private payor primary
reimbursement obligations for an additional twelve-month period, and expanded
laboratory services extended to former RTC facilities of $4,117,000.
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 $261,676,000 to $772,666,000 in 1998 from
$510,990,000 in 1997 and as a percentage of net operating revenues, facility
operating expenses decreased 3.0% to 64.1% in 1998 from 67.1% in 1997. This
decrease primarily was attributable to a decrease in labor costs which, as a
percentage of revenue, declined by 2.7% from 28.2% in 1997 to 25.5% in 1998.
This decrease was due to the continued implementation of our Best Demonstrated
Practices Program at our facilities existing prior to the RTC merger and the
new implementation of this program at the former RTC facilities. Our Best
Demonstrated Practices Program includes measures designed to improve staffing
efficiencies and, as a result, decrease labor costs. The remaining decrease in
facility operating expenses of 0.3% was due to efficiencies achieved in the
cost of medical supplies and other facility expenses as a percentage of
operating revenues.
43
<PAGE>
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 $25,730,000 to $75,829,000 in 1998 from
$50,099,000 in 1997, and as a percentage of net operating revenues, general and
administrative expenses decreased to 6.3% for 1998 from 6.6% in 1997. The
decrease of 0.3% of net operating revenues, or approximately $3,493,000, is a
result of the elimination of duplicate corporate staff and efficiencies
achieved from the RTC merger of $4,100,000 and revenue growth and economies of
scale achieved by the leveraging of corporate staff across a higher revenue
base of $2,693,000, offset by bonus payments of $3,300,000 made in connection
with our merger with RTC.
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
$23,840,000 to $44,365,000 in 1998 from $20,525,000 in 1997. As a percentage of
net operating revenues, the provision for doubtful accounts increased to 3.7%
in 1998 from 2.7% in 1997. This increase was primarily due to an additional
allowance of $11,500,000, taken in the fourth quarter of 1998, as a result of
the most recent analysis of the remaining RTC accounts receivable that were on
the books as of December 31, 1997. The provision for doubtful accounts, as a
percentage of net operating revenues for 1998, before considering the
additional RTC allowance, was 2.7%. The additional allowance of $11.5 million
was the result of a detailed review, completed in the first quarter of 1999, of
RTC's account receivable balances. We previously conducted a detailed review of
all RTC accounts receivable balances for dates of service prior to 1998. This
previous review, completed in the second quarter of 1998, revealed errors in
RTC's determination of accounts receivable allowances, and resulted in
increases to RTC's provision for doubtful accounts in 1996 and 1997. These
increases are reflected in our financial statements for 1996 and 1997. We
undertook the second review of RTC's patient accounts receivable because our
collection experience following the initial review differed from our original
estimates of our ability to collect these accounts. The additional allowance of
$11.5 million represents a change in our estimate of our ability to collect
these receivables.
Depreciation and amortization. Depreciation and amortization increased
$37,425,000 to $92,028,000 in 1998 from $54,603,000 in 1997, and as a
percentage of net operating revenues, depreciation and amortization increased
to 7.6% in 1998 from 7.2% in 1997. This increase primarily was attributable to
accelerated depreciation associated with certain incompatible and duplicative
software as a result of the merger with RTC.
Merger and related expenses.
Merger and related costs recorded during 1998 include transaction costs
associated with certain integration activities, and costs of employee severance
and amounts due under employment agreements and other compensation programs.
44
<PAGE>
A summary of merger and related costs and accrual activity through December
31, 1998 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--1st
quarter 1998........... (7,771,000) (35,304,000) (9,474,000) (52,549,000)
----------- ------------ ----------- ------------
Accrual, March 31,
1998................... 13,809,000 6,656,000 6,421,000 26,886,000
Amounts utilized--2nd
quarter 1998........... (5,109,000) (1,096,000) (2,427,000) (8,632,000)
----------- ------------ ----------- ------------
Accrual, June 30, 1998.. 8,700,000 5,560,000 3,994,000 18,254,000
Amounts utilized--3rd
quarter 1998........... (837,000) (458,000) (1,048,000) (2,343,000)
----------- ------------ ----------- ------------
Accrual, September 30,
1998................... 7,863,000 5,102,000 2,946,000 15,911,000
Adjustment of
estimates.............. 1,305,000 (959,000) (1,593,000) (1,247,000)
Amounts utilized--4th
quarter 1998........... (9,168,000) (543,000) (188,000) (9,899,000)
----------- ------------ ----------- ------------
Accrual, December 31,
1998................... $ -- $ 3,600,000 $ 1,165,000 $ 4,765,000
=========== ============ =========== ============
</TABLE>
Direct transaction costs consist primarily of investment banking fees, legal
and accounting costs and other costs, including the costs of consultants,
printing and registration, which were incurred by both TRCH and RTC in
connection with the merger. During the fourth quarter we concluded negotiations
pertaining to the amount of certain of these fees and subsequently we paid
these amounts.
Severance and employment costs were incurred for the following:
. Severance pay. The RTC merger constituted a constructive termination of
employment under various preexisting employment contracts with RTC
officers. Terminated RTC officers were entitled to severance payments and
tax gross-up payments of approximately $6,500,000. In addition,
approximately 80 employees of RTC were informed that their positions
would be eliminated. Most of these employees were formerly located in
RTC's administrative office and a laboratory under development. The
terminations were structured over the integration period, which continued
through the end of 1998. The accrued severance payments to these
employees amounted to approximately $1,600,000. The remaining balance of
severance costs of $600,000 was paid in the first quarter of 1999 and tax
gross up payments of approximately $3,000,000 are expected to be paid in
1999.
. Option exercises. Pre-existing terms of RTC stock option grants permitted
the exercise of options by tender of RTC shares. Some of the RTC shares
tendered had been held for less than six months by the option holders
and, as required by Emerging Issues Task Force Issue 84-18, we recognized
a noncash expense of approximately $16,000,000 equal to the difference
between the exercise price of the options and the market value of the
stock on the date of exercise. We also incurred approximately $600,000 of
payroll tax related to the exercise of nonqualified stock options.
. Bonuses. RTC and TRCH each awarded special bonuses as a result of the
merger, paid in the first quarter in 1998, for which approximately
$16,300,000 was included in merger and related costs.
In connection with the RTC merger, we developed a plan which included
initiatives to integrate the operations of TRCH and RTC, eliminate duplicative
overhead, facilities and systems and improve service delivery. These
integration activities were commenced during the first quarter of 1998 and are
expected to be substantially completed by approximately July 1, 1999.
We eliminated the following RTC departments: human resources, managed care,
laboratory, and all finance functions, with the exception of patient
accounting. The finance functions eliminated included payroll, financial
reporting and analysis, budgeting, general ledger, accounts payable, and tax
functions. The RTC human resources and managed care departments were
discontinued in Berwyn, Pennsylvania and consolidated with our respective
departments in our Torrance, California headquarters as of September 30, 1998.
All finance functions, with the exception of patient accounting, were
consolidated into our Tacoma, Washington business
45
<PAGE>
office as of December 31, 1998. RTC's laboratory, located in Las Vegas, Nevada,
was closed prior to its commencement of operation. All laboratory functions
were consolidated into our laboratories in Minnesota and Florida in February
1998.
Costs to integrate operations included the following:
. Laboratory restructuring. As part of our merger integration plan, we
decided to restructure our laboratories. To optimize post-merger
operations, we terminated a long-term management services agreement with
a third party that provided full laboratory management on a contract
basis. The termination fee of approximately $3,800,000 was negotiated in
the first quarter of 1998. We also immediately halted development of
RTC's new laboratory, which was not required for post-merger operations.
The RTC laboratory, which was being developed in leased space, is now
vacant and a new sublessee is being sought. As a result of this decision,
previously capitalized leasehold improvements of $2,600,000 were
expensed. Additionally, merger and related costs include approximately
$1,000,000 of pre-opening start up costs incurred during the first
quarter of 1998 relating to the terminated RTC laboratory and $1,500,000
of remaining lease payments. The accrual for lease payments was not
offset by any anticipated sublease income. No such income has been
received to date and the remaining balance of this accrual at December
31, 1998 was approximately $1,165,000.
. Initial merger costs. Approximately $5,400,000 was expensed for
integration activities which occurred at the time of the merger. These
costs include a special training program held in March 1998 and attended
by many TRCH and RTC employees, merger related travel costs, consultant
costs and other costs attributed to the merger.
The expected savings to be achieved from the elimination of general and
administrative expenses will come in the form of reduced compensation in the
future as follows:
<TABLE>
<CAPTION>
1998 1999
---------- ----------
<S> <C> <C>
Executive management.................................. $2,305,000 $2,766,000
Finance and accounting................................ 631,000 1,285,000
Human resources, facility operations and other........ 107,000 490,000
Laboratory closing.................................... 1,069,000 1,283,000
---------- ----------
Total savings......................................... $4,112,000 $5,824,000
========== ==========
</TABLE>
No assurance can be given that we will achieve these savings.
There were approximately $64,900,000 of non-recurring cash expenditures,
incurred or to be incurred, necessary to conclude the merger transaction.This
includes approximately $61,600,000 in merger and related costs, specifically:
$22,900,000 of direct transaction costs, $24,400,000 of severance and
employment costs and $14,300,000 of costs to integrate operations. The
remaining non-recurring cash expenditure of approximately $3,300,000 was for
merger bonuses not included in the merger expenses described above. As a result
of these costs, we increased our borrowings under our credit facilities, which
increased our annualized interest expense by approximately $4,500,000 per year.
Operating income. Operating income increased $17,038,000 to $141,818,000 in
1998 from $124,780,000 in 1997. As a percentage of net operating revenues,
operating income decreased to 11.8% in 1998 from 16.4% in 1997. This decrease
was due to the costs associated with the RTC merger. Operating income before
the merger costs increased to 18.3%, as a percentage of net operating revenues,
in 1998. This increase primarily was due to increased revenues, and a general
decrease in operating costs partially offset by the additional provision for
doubtful accounts recorded in the fourth quarter.
Interest expense. Interest expense increased $44,590,000 to $72,804,000 in
1998 from $28,214,000 in 1997, and as a percentage of net operating revenues,
interest expense was 6.0% in 1998 and 3.7% in 1997. The increase in interest
expense primarily was due to an increase in borrowings made under our credit
facilities to fund acquisitions.
46
<PAGE>
Interest rate swap-early termination costs. In conjunction with the
refinancing of our credit facilities, two existing forward interest rate swap
agreements were canceled in April 1998. The early termination costs associated
with the cancellation of those swaps was $9,823,000.
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 increased $1,719,000 to $4,894,000
in 1998 from $3,175,000 in 1997. As a percentage of net operating revenues,
interest income remained at 0.4% for both years.
Provision for income taxes. Provision for income taxes increased $1,368,000
to $41,580,000 in 1998 from $40,212,000 in 1997. The effective income tax rate
after minority interests increased to 73.1% in 1998 from 42.2% in 1997. The
overall increase in the effective tax rate primarily reflects non-deductible
merger and related expenses consisting of certain compensation costs and stock
issuance costs of $36,000,000 as well as non-deductible goodwill associated
with other acquired businesses. Before the non-deductible merger charges, the
effective tax rate after minority interests declined to 39.8% in 1998 from
42.2% in 1997 primarily due to the restructuring of our business in Argentina
to increase our consolidated tax deductible income by increasing equity and
reducing debt in Argentina.
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 $2,661,000 to $7,163,000 in 1998
from $4,502,000 in 1997, and as a percentage of net operating revenues,
minority interest amounted to 0.6% for both years.
Extraordinary item. On February 27, 1998, in conjunction with our merger with
RTC, we terminated RTC's revolving credit agreement and recorded all of the
remaining unamortized deferred financing costs as an extraordinary loss of
$2,812,000, net of income tax effect. In April 1998, in conjunction with
replacing our senior credit facilities, we also recorded all of the remaining
related unamortized deferred financing costs as an extraordinary loss of
$9,932,000, net of income tax effect.
Cumulative effect of change in accounting principle. Effective January 1,
1998, we adopted SOP 98-5. SOP 98-5 requires that pre-opening and
organizational costs incurred in conjunction with pre-opening activities
associated with our de novo facilities, which previously had been treated as
deferred costs and amortized over five years, should be expensed as incurred.
In connection with this adoption, we recorded a charge of $6,896,000, net of
income tax effect, as a cumulative effect of change in accounting principle.
Year ended December 31, 1997 compared to year ended December 31, 1996
Net operating revenues. Net operating revenues increased $262,973,000 to
$760,997,000 for the year ended December 31, 1997 from $498,024,000 for the
year ended December 31, 1996 representing a 52.8% increase. Of this increase,
$257,113,000 was due to increased treatments, of which $159,837,000 was from
acquisitions consummated during 1997, $89,606,000 was from existing facilities
as of December 31, 1996 and $7,670,000 was from de novo developments commencing
operations in 1997. The remainder was due to an increase in net operating
revenues per treatment which were $224.37 in 1997 compared to $222.64 in 1996.
The increase in net operating revenues per treatment was due to increases in
ancillary services utilization and in affiliated and unaffiliated facility
management fees.
Facility operating expenses. Facility operating expenses increased
$166,810,000 to $510,990,000 in 1997 from $344,180,000 in 1996 and as a
percentage of net operating revenues, facility operating expenses decreased to
67.1% in 1997 from 69.1% in 1996. This decrease primarily was attributable to
decreases in medical supplies expense, which as a percentage of revenues
decreased by 2.1% to 24.9% in 1997 from 27.0% in 1996, and in labor costs,
which as a percentage of revenues decreased by 1.3% to 28.2% in 1997 from 29.5%
in 1996. These decreases were due to the implementation of our Best
Demonstrated Practices Program in December 1996, and were partially offset by
an increase in facility expenses from the expansion of our operations in
Argentina of 1.9% as a percentage of revenues. The remaining decrease in
facility operating expenses of 0.5% was due to the overall increase in net
revenue per treatment.
47
<PAGE>
General and administrative expenses. General and administrative expenses
increased $17,749,000 to $50,099,000 in 1997 from $32,350,000 in 1996, and as a
percentage of net operating revenues, general and administrative expenses
increased to 6.6% for 1997 from 6.5% in 1996. In 1997, we added additional
staff to implement our long-term strategy focused on the continued growth of
our business and improvement of the quality of care we deliver. These
additional resources are intended to support our long-term goals, rather than
provide an immediate financial benefit. Accordingly the revenue increase in
1997 was insufficient to offset these increases in general and administrative
expenses, resulting in the slight increase in these expenses as a percentage of
net operating revenues.
Provision for doubtful accounts. The provision for doubtful accounts
increased $4,788,000 to $20,525,000 in 1997 from $15,737,000 in 1996. As a
percentage of net operating revenues, the provision for doubtful accounts
decreased to 2.7% in 1997 from 3.2% in 1996, due to better management of the
collection process for patient secondary balances remaining after Medicare, as
the primary payor, had paid 80% of the claim.
Depreciation and amortization. Depreciation and amortization increased
$22,158,000 to $54,603,000 in 1997 from $32,445,000 in 1996, and as a
percentage of net operating revenues, depreciation and amortization increased
to 7.2% in 1997 from 6.5% in 1996. This increase was attributable to increased
amortization due to acquisition activity and increased depreciation from new
center leaseholds and routine capital expenditures.
Merger expenses. Merger expenses include investment banking, legal,
accounting and other fees and expenses associated with acquisitions accounted
for as poolings of interests. There were no merger expenses in 1997, as
compared to $2,808,000 in 1996. In 1996, merger expenses were incurred as a
result of the mergers accounted for under the pooling-of-interests method of
accounting that RTC completed during 1996.
Operating income. Operating income increased $54,276,000 to $124,780,000 in
1997 from $70,504,000 in 1996, and as a percentage of net operating revenues,
operating income increased to 16.4% in 1997 from 14.2% in 1996. This increase
in operating income as a percentage of net operating revenues reflected a
decrease in facility operating costs and the provision for doubtful accounts
offset by an increase in general and administrative expenses and depreciation
and amortization.
Interest expense. Interest expense increased $14,797,000 to $28,214,000 in
1997 from $13,417,000 in 1996, and as a percentage of net operating revenues,
interest expense was 3.7% in 1997 and 2.7% in 1996. The increase in interest
expense primarily was due to an increase in borrowings made under our credit
facilities to fund acquisitions that occurred during 1997 and were accounted
for under the purchase method of accounting.
Interest Income. Interest income decreased $683,000 to $3,175,000 in 1997
from $3,858,000 in 1996. This decrease was due to the timing of cash receipts
and additional borrowings and the use of those funds for acquisitions. As a
percentage of net operating revenues, interest income decreased to 0.4% from
0.8% in 1996.
Provision for income taxes. Provision for income taxes increased $17,252,000
to $40,212,000 in 1997 from $22,960,000 in 1996, and the effective income tax
rate after minority interests increased to 42.2% in 1997 from 40.0% in 1996.
The overall increase in the effective tax rate primarily reflected non-
deductible goodwill associated with stock acquired, and to foreign net
operating losses, for which no benefit was recognized during 1997, from
businesses in Argentina.
Minority interests. Minority interests increased $924,000 to $4,502,000 in
1997 from $3,578,000 in 1996, and as a percentage of net operating revenues,
minority interest decreased to 0.6% in 1997 from 0.7% in 1996. This decrease in
minority interest as a percentage of net operating revenues was a result of a
relative proportionate decrease in the formation of partnership affiliates and
subsidiaries as a percentage of total new acquisitions.
48
<PAGE>
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 $17.6 million for the year ended December
31, 1998 and net cash provided by operating activities was $26.7 million for
the year ended December 31, 1997. Net cash provided by operating activities
consists of our net income (loss), increased by non-cash expenses such as
depreciation, amortization, non-cash interest, the provision for doubtful
accounts, cumulative change in accounting principle, and extraordinary loss,
and adjusted by changes in components of working capital, primarily accounts
receivable, and accrued merger and related expenses in 1998. Accounts
receivable, before allowance for doubtful accounts, increased during 1998 by
$200.3 million, of which approximately $140.6 million was due to the increase
in our revenues; $23.7 million was due to a build up of accounts receivable
with governmental payors which occurs while these payors process a change of
ownership for facilities newly acquired by us, a process that typically can
take from three to twelve months; approximately $11.0 million was due to a
payment suspension imposed on our Florida-based laboratory by its Medicare
carrier; and approximately $9.2 million was due to the change in patient mix
toward commercial insurance from Medicare because of the changes in Medicare
secondary payor extension, resulting in a longer period for receiving
reimbursement because commercial insurance carriers generally process claims
less quickly than Medicare.The remaining $15.8 million was due to unresolved
collections on accounts primarily attributable to third party private payors.
Additionally, the allowance for doubtful accounts increased by $31.2 million,
including $11.5 million related to RTC receivables deemed uncollectible at year
end.
Net cash used in investing activities was $475.1 million in 1998 and $526.2
million in 1997. 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 $492.8 million for 1998 and $484.3 million
in 1997 primarily consisting of borrowings from our credit facilities and the
proceeds from our 7% convertible subordinated notes offering. As of December
31, 1998, we had working capital of $385.1 million, including cash of $41.5
million.
We believe that we will have sufficient liquidity to fund our debt service
obligations and our growth strategy over the next 12 months.
Expansion
Our strategy is to continue to expand our operations both through the
development of de novo facilities and through acquisitions. The development of
a typical facility generally requires $1.0 million to $1.2 million for initial
construction and equipment and $0.2 million to $0.3 million for working
capital. Based on our experience, a de novo facility typically achieves
operating profitability, before depreciation and amortization, by the 9th to
18th month of operation. However, the period of time for a de novo facility to
break even depends on many factors which can vary significantly from facility
to facility, and, therefore, our past experience may not be indicative of the
performance of future developed facilities. In 1998, we developed 27 new
facilities, three of which we manage, and we expect to develop approximately 40
additional new facilities in 1999. We anticipate that our aggregate capital
requirements for purchases of equipment and leasehold improvements for
facilities, including de novo facilities, will be approximately $75.0 to
$100.0 million for 1999.
During 1998, we paid cash of approximately $338.2 million for a pharmacy,
minority interests in certain of our partnerships and 76 facilities. The
operations of six of these facilities were not included in our consolidated
financial statements until January 1, 1999. Since December 31, 1998, we have
acquired 17 additional facilities for approximately $44.6 million.
Credit facilities
In April 1998, we replaced our $1.05 billion bank credit facilities with an
aggregate of $1.35 billion in two senior bank facilities. The credit facilities
consist of a seven-year $950.0 million revolving senior credit facility
49
<PAGE>
maturing on March 31, 2005 and a ten-year $400.0 million senior term facility
maturing on March 31, 2008. As of December 31, 1998 the outstanding principal
amount outstanding under the revolving facility was $353.6 million and under
the term facility was $396.0 million. The term facility requires annual
principal payments of $4.0 million, with the $360.0 million balance due on
maturity. Therefore, we had $596.4 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
December 31, 1998, we were 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 6.90%.
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 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.
50
<PAGE>
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.
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.
Our financial exposure from all sources of SAP and operating system Y2K
issues known to date is approximately $300,000, none of which has been
expended.
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 effect 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
51
<PAGE>
.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;
. 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.
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 7A. Quantitative and Qualitative Disclosures About Market Risk.
Interest rate sensitivity
The table below provides information about our derivative financial
instruments and other financial instruments that are sensitive to a change in
interest rates, consisting primarily of borrowings under our credit facilities.
The interest rates of our financial instruments that are sensitive to changes
in interest rates are hedged through interest rate swap agreements for fixed
rates.
For our debt obligations, the table presents principal repayments and
weighted average interest rates on these obligations. For our debt obligations
with variable interest rates, the rates presented are calculated based upon the
current LIBOR and our current leverage ratio.
52
<PAGE>
For our interest rate swap agreements, the table presents the repayment of
the notional amounts of these swaps at maturity, the fixed weighted average
interest rates we must pay the swap holders according to the swap agreements,
and the weighted average interest rates we will receive from the swap holders,
based upon the current LIBOR. Notional amounts are used to calculate the
contracted payments we will exchange with the swap holders under the swap
agreements. The interest rates we will receive from the swap holders are
variable, and are based on the LIBOR.
<TABLE>
<CAPTION>
Expected Maturity Date
----------------------------------------
There- Fair
1999 2000 2001 2002 2003 after Total Value
(in millions)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Liabilities
Long-term debt
Fixed rate ............ $ 470 $ 470 $469
Average interest rate.. 6.6% 6.6%
Variable rate.......... $ 22 $ 11 $ 95 $ 153 $ 242 $ 255 $ 778 $778
Average interest rate.. 6.88% 6.88% 6.88% 6.88% 6.88% 6.88% 6.88%
<CAPTION>
Expected Maturity Date
----------------------------------------
There- Fair
1999 2000 2001 2002 2003 after Total Value
(in millions)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Interest rate
derivatives
Interest rate swaps
Variable to fixed...... $ 100 $ 100 $ 600 $ 800 $(32)
Average pay rate....... 5.52% 5.51% 5.69% 5.64%
Average receive rate... 5.25% 5.25% 5.35% 5.32%
</TABLE>
Our swaps have a one-time call provision for our counterparty at varying
times based upon the maturity of the underlying swaps as follows:
<TABLE>
<CAPTION>
Notional
Swap Maturity Call Provision Amount
------------- -------------- -------------
(in millions)
<S> <C> <C>
Ten-year swaps: Seven-year $200
Five-year 200
Seven-year swaps: Four-year 100
Three-year 100
Five-year swaps: Two-year 100
Three-year swaps: One-year 100
----
$800
====
</TABLE>
The total outstanding amount of our debt obligations exceeds the aggregate
notional amount of our swap agreements.
Exchange rate sensitivity
We have foreign operations in Argentina, Germany, Italy and the United
Kingdom. Because the Argentine Peso trades evenly with the U.S. dollar and
because our operations in Germany, Italy and the United Kingdom are new and
relatively small, we have not experienced significant foreign exchange rate
risk. Through December 31, 1998, we have not utilized any derivative financial
instruments to manage foreign exchange rate risk.
Item 8. Financial Statements and Supplementary Data.
See the Index included at "Item 14. Exhibits, Financial Statement Schedules
and Reports on Form 8-K."
Item 9. Changes In and Disagreements with Accountants on Accounting and
Financial Disclosure.
None.
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<PAGE>
PART III
Item 10. Directors and Executive Officers of the Registrant.
Information concerning members of our board of directors
The following table sets forth certain information concerning members of our
board of directors as of December 31, 1998:
<TABLE>
<CAPTION>
Name Age Position
<C> <C> <S>
Chairman of the Board, Chief Executive Officer,
Victor M.G. Chaltiel 57 President and Director
Maris Andersons 62 Director
Peter T. Grauer 53 Director
Regina E. Herzlinger 55 Director
Shaul G. Massry 68 Director
</TABLE>
Victor M.G. Chaltiel has been our Chairman, CEO and President and one of our
directors since August 1994. Mr. Chaltiel served as President and CEO of Abbey
Healthcare Group, Inc., or Abbey, from November 1993 to February 1994 and prior
thereto as Chairman, CEO and President of Total Pharmaceutical Care, Inc., or
TPC, from March 1989 to November 1993, when Abbey completed its acquisition of
TPC. From May 1985 to October 1988, Mr. Chaltiel served as President, Chief
Operating Officer and a director of Salick Health Care, Inc., a publicly-held
company focusing on the development of outpatient cancer and dialysis treatment
centers. Mr. Chaltiel served in a consulting capacity with Salick Health Care,
Inc. from October 1988 until he joined TPC. Prior to May 1985, Mr. Chaltiel was
associated with Baxter International, Inc., or Baxter, for 18 years in numerous
corporate and divisional management positions, including Corporate Group Vice
President with responsibility for the International Group and five domestic
divisions with combined revenue in excess of $1 billion, President of Baxter's
Artificial Organs Division, Vice President of its International Division, Area
Managing Director for Europe and President of its French operations. While at
Baxter, Mr. Chaltiel was instrumental in the development and successful
worldwide commercialization of Continuous Ambulatory Peritoneal Dialysis,
currently the most common mode of home dialysis.
Maris Andersons has been one of our directors since August 1994. Mr.
Andersons was a Senior Vice President and Senior Advisor, Corporate Finance, of
Tenet Healthcare Corporation, or Tenet, until his retirement in 1997. Mr.
Andersons also has held various senior executive offices with Tenet since 1976.
Prior to joining Tenet, Mr. Andersons served as a Vice President of Bank of
America.
Peter T. Grauer has been one of our directors since August 1994. Mr. Grauer
has been a Managing Director of DLJ Merchant Banking, Inc., or DLJMB, since
September 1992. From April 1989 to September 1992, he was a Co-Chairman of
Grauer & Wheat, Inc., an investment firm specializing in leveraged buyouts.
Prior thereto Mr. Grauer was a Senior Vice President of Donaldson, Lufkin &
Jenrette Securities Corporation, or DLJ. Mr. Grauer is a director of Ameriserv
Food Distribution, Inc., DecisionOne Holdings Corporation, Doane Pet Care
Enterprises, Inc., Formica Corporation, Nebco Evans Holding Co., and Thermadyne
Holdings Corporation.
Regina E. Herzlinger has been one of our directors since July 1997. Ms.
Herzlinger, the Nancy R. McPherson Professor of Business Administration Chair
at the Harvard Business School, has been a member of the faculty at the Harvard
Business School since 1971. Ms. Herzlinger is a director of C.R. Bard, Inc.,
Cardinal Health, Inc., Deere & Company, and Schering-Plough Corporation.
Shaul G. Massry has been one of our directors since April 1997. Dr. Massry
has been a Professor of Medicine, Physiology and Biophysics and Chief, Division
of Nephrology, at the University of Southern California School of Medicine
since 1974. Dr. Massry served as the president of the National Kidney
Foundation from 1990 through 1992.
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<PAGE>
No arrangement or understanding exists between any director and any other
person or persons pursuant to which any director was or is to be selected as a
director other than pursuant to the shareholders agreement described in "Item
13. Certain Relationships and Related Transactions." None of the directors has
any family relationship among themselves or with any of our executive officers.
Each director is elected to hold office until the next annual meeting of
stockholders and until his or her respective successor is elected and
qualified.
Information concerning our executive officers
The following table sets forth certain information concerning our executive
officers as of December 31, 1998:
<TABLE>
<CAPTION>
Name Age Position
<C> <C> <S>
Victor M.G. Chaltiel............. 57 Chairman of the Board, Chief Executive
Officer, President and Director
Leonard W. Frie.................. 52 Executive Vice President and Chief
Operations Officer, West
Barry C. Cosgrove................ 41 Senior Vice President, General Counsel
and Secretary
John E. King..................... 38 Senior Vice President, Finance and
Chief Financial Officer
Stan M. Lindenfeld............... 51 Senior Vice President, Quality
Management and Chief Medical Officer
</TABLE>
Our executive officers are elected by and serve at the discretion of our
board of directors. Set forth below is a brief description of the business
experience of all executive officers other than Mr. Chaltiel, who is also a
director. See "Information concerning members of the board of directors."
Leonard W. Frie has been our Executive Vice President and Chief Operations
Officer, West since August 1994. Mr. Frie was our President from April 1994
through August 1994. Prior thereto, Mr. Frie served as President of Medical
Ambulatory Care, Inc. and its subsidiaries since 1984.
Barry C. Cosgrove was promoted to Senior Vice President in October 1998 from
Vice President, a position he held since August 1994. Mr. Cosgrove is also our
General Counsel and Secretary, positions he has held since August 1994. Prior
to joining us, from May 1991 to April 1994, Mr. Cosgrove served as Vice
President, General Counsel and Secretary of TPC. From February 1988 to 1991,
Mr. Cosgrove served as Vice President and General Counsel of McGaw
Laboratories, Inc. (a subsidiary of the Kendall Company). Prior to February of
1988, Mr. Cosgrove was with the Kendall Company for seven years in numerous
corporate, legal and management positions, including Assistant to the General
Counsel.
John E. King was promoted to Senior Vice President, Finance in October 1998
from Vice President, Finance, a position he held since August 1994. Mr. King is
also our Chief Financial Officer, a position he has held since April 1994.
Prior thereto, Mr. King served as Vice President, Finance and Chief Financial
Officer with Medical Ambulatory Care, Inc. since May 1993. From December 1990
to April 1993, he was the Chief Financial Officer for one of Tenet's general
acute hospitals.
Stan M. Lindenfeld, a nephrologist, was promoted to Senior Vice President,
Quality Management in October 1998 from Vice President, Quality Management and
Integrated Programs, a position he held since August 1994. Dr. Lindenfeld has
also served as our Chief Medical Officer since January 1995 and as one of our
medical directors since 1981. Since 1988 he has held the position of Clinical
Professor of Medicine at the University of California Medical Center in
San Francisco. Dr. Lindenfeld developed the Office of Clinical Resources
Management at the University of California Medical Center in San Francisco and
served as its director from July 1993 until July 1997.
None of the executive officers has any family relationship among themselves
or with any of our directors.
Section 16(a) beneficial ownership reporting compliance
Section 16(a) of the Exchange Act requires "insiders," including our
executive officers, directors and beneficial owners of more than 10% of our
common stock, to file reports of ownership and changes in
55
<PAGE>
ownership of our common stock with the Securities and Exchange Commission and
the New York Stock Exchange, and to furnish us with copies of all Section 16(a)
forms they file. We became subject to Section 16(a) in conjunction with the
registration of our common stock under the Exchange Act effective October 31,
1995. Based solely on our review of the copies of such forms received by us, or
written representations from certain reporting persons that no Form 5's were
required for those persons, we believe that our insiders complied with all
applicable Section 16(a) filing requirements during fiscal 1998.
Item 11. Executive Compensation.
The following table sets forth the compensation paid or accrued by us to our
chief executive officer and to each of our four most highly compensated
executive officers for each of the fiscal years in the three-year period ended
December 31, 1998:
Summary Compensation Table
<TABLE>
<CAPTION>
Long Term Compensation
--------------------------------
Annual Compensation Awards Payouts
------------------------------------ --------------------------------
All
Restricted Securities Other
Other Annual Stock Underlying LTIP Compen-
Name and Salary Bonus Compensation Award(s) Options* Payouts sation
Principal Position Year ($) ($) ($) ($) (#) ($) ($)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Victor M.G. Chaltiel 1998 $315,026 $8,250,000(1) $3,536(2) -- 1,000,000(3) -- $ 5,598(4)
Chairman of the Board, 1997 288,652 890,409(5) -- -- 333,334(3) -- 5,522(6)
Chief Executive Officer 1996 285,186 419,728 -- -- 166,667 -- 5,366(7)
President and Director
Leonard W. Frie 1998 200,410 321,254(8) -- -- 150,000 -- 13,197(9)
Executive Vice
President 1997 182,245 143,754 -- -- 111,916 -- 14,153(10)
and Chief Operations 1996 181,484 139,568 -- -- 159,140 -- 26,914(11)
Officer, West
Barry C. Cosgrove 1998 182,309 490,004(12) -- -- 200,000 -- 40,293(13)
Senior Vice President, 1997 149,817 115,004 -- -- 111,916 -- 11,582(14)
General Counsel and 1996 145,189 111,655 -- -- 116,083 -- 10,556(15)
Secretary
John E. King 1998 181,154 487,500(16) -- -- 200,000 -- 8,620(17)
Senior Vice President, 1997 130,504 112,500 -- -- 111,916 -- 14,089(18)
Finance and Chief 1996 99,533 93,750 -- -- 74,417 -- 15,509(19)
Financial Officer
Stan M. Lindenfeld 1998 273,883 382,211(20) -- -- 150,000 -- 425(21)
Senior Vice President, 1997 214,791 169,020 -- -- 58,333 -- --
Quality Management and 1996 121,647 85,302 -- -- 136,916 -- 192,520(22)
Chief Medical Officer
</TABLE>
- --------
* Includes options repriced in April 1997.
(1) Consists entirely of a special bonus received for services rendered in
connection with the merger with RTC.
(2) Paid as a gross-up adjustment to offset the personal income tax resulting
from Mr. Chaltiel's personal use of our leased corporate jet.
(3) In February 1999, Mr. Chaltiel voluntarily cancelled all 1,000,000 of the
options granted to him in 1998 and 166,667 of the options granted to him
in 1997 to increase the number of options available for grant under our
existing stock option plans.
(4) Includes (a) $520 paid by us for an umbrella insurance policy, and (b)
$5,078 representing imputed income from Mr. Chaltiel's personal use of our
leased corporate jet.
(5) Mr. Chaltiel's 1997 bonus of $451,776 was prepaid in December 1997.
(6) Includes (a) automobile allowance of $5,002, and (b) $520 paid by us for
an umbrella insurance policy.
(7) Includes (a) an automobile allowance of $4,846, and (b) $520 paid by us
for an umbrella insurance policy.
56
<PAGE>
(8) Includes the first installment, in the amount of $187,500, related to a
special bonus received for services rendered in connection with the merger
with RTC.
(9) Includes (a) an automobile allowance of $8,827, (b) $520 paid by us for an
umbrella insurance policy, and (c) $3,850 in deferred compensation.
(10) Includes (a) an automobile allowance of $8,500, (b) $520 paid by us for an
umbrella insurance policy, and (c) $5,133 in deferred compensation.
(11) Includes (a) an automobile allowance of $8,500, (b) $520 paid by us for an
umbrella insurance policy, (c) $4,894 in deferred compensation, and (d)
$13,000 in payment of cash value of accrued paid time off.
(12) Includes the first installment, in the amount of $375,000, related to a
special bonus received for services rendered in connection with the merger
with RTC.
(13) Includes (a) an automobile allowance of $8,100, (b) $520 paid by us for an
umbrella insurance policy, and (c) $31,673 in the payment of cash value of
accrued paid time off.
(14) Includes (a) an automobile allowance of $7,800, (b) $520 paid by us for an
umbrella insurance policy, and (c) $3,262 in deferred interest income.
(15) Includes (a) an automobile allowance of $7,800, (b) $520 paid by us for
an umbrella insurance policy, and (c) $2,236 in deferred interest income.
(16) Includes the first installment, in the amount of $375,000, related to a
special bonus received for services rendered in connection with the merger
with RTC.
(17) Includes (a) an automobile allowance of $8,100 and (b) $520 paid by us for
an umbrella insurance policy.
(18) Includes (a) an automobile allowance of $7,800, (b) $520 paid by us for
an umbrella insurance policy, and (c) $5,769 in payment of cash value of
accrued paid time off.
(19) Includes (a) an automobile allowance of $7,800, (b) $520 paid by us for
an umbrella insurance policy, (c) housing reimbursement of $3,624, and
(d) $3,565 in payment of cash value of accrued paid time off.
(20) Includes the first installment, in the amount of $187,500, related to a
special bonus received for services rendered in connection with the merger
with RTC.
(21) Consists entirely of a waiver of medical insurance premiums.
(22) Includes (a) $192,000 in medical director fees and (b) $520 paid by us for
an umbrella insurance policy.
The following table sets forth information concerning options granted to each
of the named executive officers during fiscal 1998:
Option/SAR Grants in Last Fiscal Year
<TABLE>
<CAPTION>
Individual Grants
- -----------------------------------------------------------------------
Number of % of Total
Securities Options/SARs Exercise
Underlying Granted to or Base Grant Date
Options/SARs Employees in Price Expiration Present Value
Name Granted(#)(1) Fiscal Year ($/Sh) Date ($)(2)
<S> <C> <C> <C> <C> <C> <C>
Victor M.G. Chaltiel.... 1,000,000 18.0% 32.1875 2/27/08 14,236,900
Leonard W. Frie......... 150,000 2.7 32.1875 2/27/08 2,135,535
Barry C. Cosgrove....... 200,000 3.6 32.1875 2/27/08 2,847,380
John E. King............ 200,000 3.6 32.1875 2/27/08 2,847,380
Stan M. Lindenfeld...... 150,000 2.7 32.1875 2/27/08 2,135,535
</TABLE>
- --------
(1) All options are nonqualified stock options and were granted under our 1997
Equity Compensation Plan. The options vest over four year periods at an
annual rate of 25% beginning on the first anniversary of the date of grant.
(2) The estimated grant date present value reflected in the above table was
determined using the Black-Scholes model. The material assumptions and
adjustments incorporated in the Black-Scholes model in estimating the value
of the options reflected in the above table include the following: (a) the
respective option exercise price for each individual grant, equal to the
fair market value of the underlying stock on the date of grant; (b) the
exercise of options within six years of the date that they become
exerciseable;
57
<PAGE>
(c) a risk-free interest rate of 5.632% per annum; (d) volatility of 34.2
calculated using the daily prices of our common stock; and (e) a dividend
yield of 0%. The ultimate values of the options will depend on the future
market price of our common stock, which cannot be forecasted with
reasonable accuracy. The actual value, if any, an optionee will realize
upon exercise of an option will depend on the excess of the market value of
our common stock over the exercise price on the date the option is
exercised. We cannot assure that the value realized by an optionee will be
at or near the value estimated by the Black-Scholes model or any other
model applied to value the options.
The following table sets forth information concerning the aggregate number
of options exercised by each of the named executive officers during fiscal
1998:
Aggregated Option Exercises in Last Fiscal Year and
Fiscal Year-End Option Values
<TABLE>
<CAPTION>
Number of Securities Value of
Underlying Unexercised
Unexercised In-the-Money
Options at FY-End Options at FY-End
Shares -------------------- -------------------
Acquired on Value Exercisable/ Exercisable/
Name Exercise(#) Realized($) Unexercisable(#) Unexercisable($)(1)
<S> <C> <C> <C> <C>
Victor M.G. Chaltiel.... -- -- 97,222/1,236,112(2) 929,685/2,257,820
Leonard W. Frie......... -- -- 137,999/ 229,472 3,203,770/ 759,950
Barry C. Cosgrove....... -- -- 94,944/ 279,472 2,023,525/ 759,950
John E. King............ -- -- 53,277/ 279,472 881,328/ 759,950
Stan M. Lindenfeld...... -- -- 81,055/ 285,027 1,146,955/1,291,194
</TABLE>
- --------
(1) Value is determined by subtracting the exercise price from the fair market
value of $28.3125 per share, the closing price for our common stock as
reported by the New York Stock Exchange as of December 31, 1998, and
multiplying the remainder by the number of underlying shares of common
stock.
(2) In February 1999, Mr. Chaltiel voluntarily cancelled 1,166,667 of these
options to increase the number of options available for grant under our
existing stock option plans.
Employment agreements
Mr. Chaltiel entered into an employment agreement with us on August 14,
1994, pursuant to which he was employed by us for an initial term of three
years, with one year automatic extensions at the end of each year. We may
terminate this agreement at any time, subject, among other things, to
severance payments as provided in the employment agreement. His base salary
paid during fiscal 1998 was $315,026 and is subject to annual review by our
board for possible increases, with a minimum increase tied to the California
consumer price index. Until May 31, 1999, Mr. Chaltiel will be entitled to a
yearly bonus of up to 150% of his base salary based upon our achieving certain
EBITDA performance targets. He also may be awarded an additional bonus at the
discretion of the Board if EBITDA targets are exceeded by more than 15%. After
May 31, 1999, Mr. Chaltiel will be awarded bonuses in a manner as determined
in the sole discretion of the Board, on a basis reasonably consistent with
past bonuses for similar performance.
On March 2, 1998 we amended Mr. Chaltiel's employment agreement to ensure
that any additional compensation payable to Mr. Chaltiel upon a change in
control would not be reduced by certain tax obligations possibly imposed by
sections 280G or 4999 of the Internal Revenue Code of 1986.
Mr. Chaltiel also was granted options pursuant to our 1994 Equity
Compensation Plan representing a total of approximately 1,477,778 shares of
common stock. The options had an exercise price of $0.90. By their terms, half
of the options were to vest over a four-year period and the other half were to
vest on the ninth anniversary of the date of grant, subject to accelerated
vesting in the event that we satisfied certain EBITDA performance targets. On
September 18, 1995, our board and our stockholders approved an agreement dated
as
58
<PAGE>
of the same date by and between Mr. Chaltiel and us pursuant to which the
vesting schedule for these options was accelerated so that all of Mr.
Chaltiel's outstanding options became vested and exercisable immediately. In
connection with this agreement, Mr. Chaltiel agreed to exercise all of his
options at that time to purchase 1,477,778 shares of common stock at an
exercise price of $0.90 per share. Mr. Chaltiel paid the exercise price
pursuant to a $1,330,000 four-year promissory note bearing interest at the
lesser of the prime rate or 8%. This note was subject to repayment, in part or
in full, to the extent of the receipt of any proceeds received by Mr. Chaltiel
upon disposition of such shares of common stock, and Mr. Chaltiel pledged these
shares as collateral for repayment of this note. Also, in accordance with the
agreement, we agreed to advance Mr. Chaltiel funds of up to $1,521,520
principal amount in the aggregate relating to Mr. Chaltiel's tax liability in
connection with additional taxes associated with the exercise of such options.
Such loans were evidenced by two additional promissory notes executed by Mr.
Chaltiel. The first note for $1,348,447 was executed concurrently with Mr.
Chaltiel's exercise of his options. The second note for $173,073 was executed
as of April 15, 1996. Simultaneously with the execution of the agreement, we
entered into a Release and Pledge Agreement with Mr. Chaltiel whereby we
released 1,855,555 shares of common stock owned by Mr. Chaltiel from a previous
pledge agreement and substituted the newly acquired 1,477,778 shares of common
stock. On March 31, 1998, Mr. Chaltiel repaid his outstanding loan balances
with us and we released those shares held as collateral under the Release and
Pledge Agreement.
On March 2, 1998 we entered into new employment agreements with each of our
executive officers, other than Mr. Chaltiel. These employment agreements
provide for an initial term through December 31, 1998 and will continue
thereafter with no further action by either party for successive one year
terms. Each executive officer's base salary will be subject to annual increases
consistent with the California consumer price index. Each executive officer
also will be entitled to receive a bonus of up to 75% of his base salary each
year. Fifty percent of this bonus will be based upon our achievement of certain
earnings per share targets and 50% will be granted at the discretion of the
compensation committee. In the event of a constructive discharge following a
change in control or a termination for any reason other than material cause,
each executive officer will be entitled to a lump sum payment equal to his
then-current base salary.
Each of Messrs. Frie, Cosgrove, King and Lindenfeld also have been granted
options pursuant to our equity compensation plans. These options vest at a rate
of 25% per year over four years. The exercise price of the options ranges from
$0.90 per share to $32.1875 per share. Upon voluntary termination of
employment, we may have the right to acquire all shares of our common stock
held by the terminated employee at fair market value per share, as defined in
the employment agreement.
On December 14, 1995, our board amended the stock option agreement of each
executive officer, other than Mr. Chaltiel, to provide for the immediate
vesting of all of such officers' stock options at any time following the sale
of 50% or more of our stock or assets, or upon a merger, consolidation or
reorganization in which we do not survive, if any of such officers' employment
is terminated for any reason.
Compensation of directors
Directors who are our employees or officers do not receive compensation for
service on the board or any committee of the board. Each of our directors who
is not one of our officers or employees is entitled to receive $20,000 per year
and certain additional compensation for attending more than four board meetings
per year. Our directors also are reimbursed for their reasonable out-of-pocket
expenses in connection with their travel to and attendance at the meetings of
the board. In addition, each director who is not one of our officers or
employees is entitled to receive 25,000 options to purchase shares of our
common stock each year they are elected to serve on our board. These options
have an exercise price equal to the fair market value of our common stock on
the date of grant and generally vest over four year periods at an annual rate
of 25% beginning on the first anniversary of the date of grant.
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<PAGE>
Compensation committee interlocks and insider participation
None of our executive officers or directors serves as a member of the board
of directors or compensation committee of any other entity which has one or
more executive officers serving as a member of our board. During fiscal 1998,
Messrs. Chaltiel and Andersons and Dr. Massry were our officers, employees or
consultants. Messrs. Andersons and Grauer and Ms. Herzlinger each served as a
member of the compensation committee of our board of directors during fiscal
1998.
Item 12. Security Ownership of Certain Beneficial Owners and Management.
The following table sets forth information regarding the ownership of our
common stock as of March 15, 1999 by (a) all those persons known by us to own
beneficially more than 5% of our common stock, (b) each of our directors and
each executive officers, and (c) all directors and executive officers as a
group. Except as otherwise noted under "Certain Relationships and Related
Transactions," we know of no agreements among our stockholders which relate to
voting or investment power over our common stock or any arrangement the
operation of which may at a subsequent date result in a change of control of
TRCH.
<TABLE>
<CAPTION>
Number of Shares Percentage of Shares
Name of Beneficial Owner Beneficially Owned Beneficially Owned
<S> <C> <C>
Massachusetts Financial Services(1)... 6,432,000 7.9%
500 Boylston Street
Boston, Massachusetts 02116
T. Rowe Price Associates, Inc.(2)..... 6,038,712 7.5%
100 East Pratt Street
Baltimore, MD 21202
Putnam Investments, Inc.(3)........... 4,935,801 6.1%
One Post Office Square
Boston, Massachusetts 02109
Victor M.G. Chaltiel(4)............... 1,145,302 1.4%
Leonard W. Frie(5).................... 287,488 *
Barry C. Cosgrove(6).................. 223,982 *
Stan M. Lindenfeld(7)................. 196,107 *
John E. King(8)....................... 153,051 *
Maris Andersons(9).................... 52,805 *
Shaul G. Massry(10)................... 45,487 *
Regina E. Herzlinger(11).............. 28,750 *
Peter T. Grauer(12)................... 23,125 *
All directors and executive officers
as a group (9 persons)(13)........... 2,156,097 2.6%
</TABLE>
- --------
* Amount represents less than 1% of our common stock.
(1) Based upon market survey information as of March 3, 1999. The survey was
conducted by the Corporate Investor Communication Surveillance Group and
has not been independently verified by us.
(2) Based upon information contained in a Schedule 13G filed with the SEC on
February 11, 1999.
(3) Represents 4,752,555 shares held by Putnam Investment Management, Inc., or
PIM, and 183,246 shares held by Putnam Advisory Company, Inc., or PAC. PIM
and PAC are each registered investment advisors that are wholly-owned by
Putnam Investments, Inc. The share amounts for PIM and PAC are based upon
information contained in an amendment to Schedule 13G filed with the SEC
on March 10, 1999.
(4) Includes 111,112 shares issuable upon the exercise of options which are
exercisable as of, or will become exercisable within 60 days of, March 15,
1999.
(5) Includes 207,943 shares issuable upon the exercise of options which are
exercisable as of, or will become exercisable within 60 days of, March 15,
1999.
(6) Includes 177,388 shares issuable upon the exercise of options which are
exercisable as of, or will become exercisable within 60 days of, March 15,
1999.
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<PAGE>
(7) Includes 178,777 shares issuable upon the exercise of options which are
exercisable as of, or will become exercisable within 60 days of, March 15,
1999.
(8) Includes 135,721 shares issuable upon the exercise of options which are
exercisable as of, or will become exercisable within 60 days of, March 15,
1999.
(9) Includes 46,917 shares issuable upon the exercise of options which are
exercisable as of, or will become exercisable within 60 days of, March 15,
1999.
(10) Includes 45,487 shares issuable upon the exercise of options which are
exercisable as of, or will become exercisable within 60 days of, March 15,
1999.
(11) Includes 28,750 shares issuable upon the exercise of options which are
exercisable as of, or will become exercisable within 60 days of, March 15,
1999.
(12) Includes 23,125 shares issuable upon the exercise of options which are
exercisable as of, or will become exercisable within 60 days of, March 15,
1999.
(13) Includes 955,220 shares issuable upon the exercise of options which are
exercisable as of, or will become exercisable within 60 days of, March 15,
1999.
Item 13. Certain Relationships and Related Transactions.
Victor M.G. Chaltiel is our Chairman of the Board, Chief Executive Officer,
President and one of our directors. Pursuant to Mr. Chaltiel's employment
agreement and the 1994 Equity Compensation Plan, Mr. Chaltiel purchased
1,855,557 shares of common stock at $0.90 per share during the year ended May
31, 1995. Mr. Chaltiel paid $835,000 of the purchase price in cash, with the
remainder being evidenced by a four-year promissory note bearing interest at
the lesser of the prime rate or 8% per annum, which note is secured by a pledge
of certain shares of our stock owned by Mr. Chaltiel. In July 1995, the board
approved a one-year deferral of all scheduled principal and accrued interest
payments under all outstanding promissory notes from our officers, including
this four-year promissory note. In September 1995, we entered into an agreement
with Mr. Chaltiel pursuant to which Mr. Chaltiel purchased 1,477,778 shares of
common stock upon exercise of options held by him. Mr. Chaltiel paid for such
shares with a four-year promissory note for $1,330,000 bearing interest at the
lesser of the prime rate or 8%. This note was subject to repayment, in part or
in full, to the extent of the receipt of proceeds received by Mr. Chaltiel upon
disposition of the shares of common stock, and Mr. Chaltiel pledged these
shares as collateral for repayment of this note. We also agreed to advance
Mr. Chaltiel funds of up to $1,521,520 principal amount in the aggregate
relating to Mr. Chaltiel's tax liability in connection with the shares. Such
loans were evidenced by two additional promissory notes executed by
Mr. Chaltiel. The first note for $1,348,447 was executed concurrently with Mr.
Chaltiel's exercise of his options in September 1995. The second note for
$173,073 was executed in April 1996. Simultaneously with the execution of the
agreement, we entered into a Release and Pledge Agreement with Mr. Chaltiel
whereby we released 1,855,557 shares of common stock owned by Mr. Chaltiel from
the previous pledge agreement and substituted the newly acquired 1,477,778
shares of common stock. On March 31, 1998, Mr. Chaltiel repaid his outstanding
loan balance with us and we released those shares held as collateral under the
related Release and Pledge Agreement.
Certain of our officers and employees have received loans from us in
connection with the purchase of shares of our common stock. All of the loans
have similar terms. The loans bear interest at the lower of 8% or the prime
rate, and are secured by all of the borrower's interests in our common stock,
including all vested stock options. When made, the loans had a four-year term
and one quarter of the original principal amount thereof plus all accrued
interest thereon had to be paid annually, subject to the limitation that the
borrower was not required to make any payment that exceeded 50% of the after-
tax proceeds of such borrower's bonus from us, based on maximum tax rates then
in effect. To date, our board has approved deferrals of all scheduled principal
and accrued interest payments under all such loans. No other terms of the loans
have been changed.
As of December 31, 1998, Leonard W. Frie, Barry C. Cosgrove and John E. King
had loans outstanding from us with principal amounts of $100,000, $70,000 and
$25,000, respectively. With respect to Mr. Cosgrove,
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<PAGE>
$50,000 was borrowed to purchase shares of common stock and $20,000 was
borrowed for relocation costs. Mr. Chaltiel had an outstanding loan of $835,000
prior to the addition in September 1995 of $2,678,447 pursuant to similar loans
in connection with Mr. Chaltiel's exercise of options for 1,477,778 shares of
common stock and related personal income tax obligations, as described above.
These loans were secured by a pledge of 1,444,445 shares of our common stock.
Mr. Chaltiel received a similar loan from us in April 1996, in the amount of
$173,073, in connection with additional taxes associated with the exercise of
those options. On March 31, 1998, Mr. Chaltiel repaid his outstanding loan
balances with us and we released those shares held as collateral.
Maris Andersons, one of our directors, serves as a consultant to us. He has
been granted options, vesting over four years, to purchase an aggregate of
76,792 shares of our common stock in consideration for these services. As of
December 31, 1998, Mr. Andersons had exercised 41,666 of said options leaving a
balance of 35,126 options to purchase shares of our common stock.
Shaul G. Massry, one of our directors, serves as a consultant to us. In
addition to certain compensation as a member of the board, Dr. Massry also
receives $120,000 per year and has been granted options, vesting over four
years, to purchase an aggregate of 44,722 shares of our common stock in
consideration for these services. As of December 31, 1998, Dr. Massry had
exercised 11,110 of such options leaving a balance of 33,612 options to
purchase shares of our common stock.
We entered into a shareholders' agreement with DLJ Merchant Banking Partners,
L.P., or DLJMBP, certain members of management and NME Properties Corporation,
a wholly-owned subsidiary of Tenet, in August 1994 pursuant to which, among
other provisions, DLJMBP had the right to nominate four of the five members of
our board. Although this right has terminated, an affiliate of DLJMBP, Peter T.
Grauer, continues to serve on our board. The shareholders' agreement further
provides for certain registration rights and for restrictions on transfers of
our common stock, certain rights of first refusal in favor of DLJMBP in the
event NME proposes to transfer shares of our common stock and certain rights
and obligations of NME to participate in transfers of shares by DLJMBP. DLJ and
certain of its affiliates from time to time perform various investment banking
and other services for us, for which we pay customary consideration.
We have entered into indemnity agreements with each of our directors and all
of our officers, which agreements require us, among other things, to indemnify
them against certain liabilities that may arise by reason of their status or
service as our directors, officers, employees or agents, other than liabilities
arising from conduct in bad faith or which is knowingly fraudulent or
deliberately dishonest, and, under certain circumstances, to advance their
expenses incurred as a result of proceedings brought against them.
62
<PAGE>
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.
(a)Documents filed as part of this Report:
(1) Index to Financial Statements:
<TABLE>
<CAPTION>
Page
<S> <C>
Report of Independent Accountants F-1
Consolidated Balance Sheets as of December 31, 1997 and December
31, 1998 F-2
Consolidated Statements of Income for the years ended December
31, 1996, December 31, 1997 and December 31, 1998 F-3
Consolidated Statements of Stockholders' Equity for the years
ended December 31, 1996, December 31, 1997 and December 31, 1998 F-4
Consolidated Statements of Cash Flows for the years ended
December 31, 1996, December 31, 1997 and December 31, 1998 F-5
Notes to Consolidated Financial Statements F-6
(2) Index to Financial Statement Schedules:
Report of Independent Accountants on Financial Statement
Schedule S-1
Schedule II--Valuation and Qualifying Accounts S-2
</TABLE>
(3)(a) Exhibits:
<TABLE>
<C> <S>
3.1 Amended and Restated Certificate of Incorporation of TRCH, dated December
4, 1995.(1)
3.2 Certificate of Amendment of Certificate of Incorporation of TRCH, dated
February 26, 1998.(2)
3.3 Bylaws of TRCH, dated October 6, 1995.(3)
4.1 Shareholders Agreement, dated August 11, 1994, between DLJMB, DLJIP,
DLJOP, DLJMBF, NME Properties, Continental Bank, as voting trustee, and
TRCH.(4)
4.2 Agreement and Amendment, dated as of June 30, 1995, between DLJMBP,
DLJIP, DLJOP, DLJMBF, DLJESC, Tenet, TRCH, Victor M.G. Chaltiel, the
Putnam Purchasers, the Crescent Purchasers and the Harvard Purchasers,
relating to the Shareholders Agreement dated as of August 11, 1994
between DLJMB, DLJIP, DLJOP, DLJMBF, NME Properties, Continental Bank,
as voting trustee, and TRCH.(4)
4.3 Indenture, dated June 12, 1996 by RTC to PNC Bank including form of RTC
Note.(12)
4.4 First Supplemental Indenture, dated as of February 27, 1998, among RTC,
TRCH and PNC Bank under the 1996 indenture.(2)
4.5 Second Supplemental Indenture, dated as of March 31, 1998, among RTC,
TRCH and PNC Bank under the 1996 indenture.(2)
4.6 Indenture, dated as of November 18, 1998, between TRCH and United States
Trust Company of New York, as trustee, and Form of Note.(5)
4.7 Registration Rights Agreement, dated as of November 18, 1998, between
TRCH and DLJ, BNY Capital Markets, Inc., Credit Suisse First Boston
Corporation and Warburg Dillon Read LLC, as the initial purchasers.(5)
4.8 Purchase Agreement, dated as of November 12, 1998, between TRCH and the
initial purchasers.(5)
Noncompetition Agreement, dated August 11, 1994, between TRCH and
10.1 Tenet.(4)
10.2 Employment Agreement, dated as of August 11, 1994, by and between TRCH
and Victor M.G. Chaltiel (with forms of Promissory Note and Pledge and
Stock Subscription Agreement attached as exhibits thereto).(4)*
</TABLE>
63
<PAGE>
<TABLE>
<C> <S>
10.3 Amendment to Mr. Chaltiel's employment agreement, dated as of August 11,
1994.(4)*
10.4 Second Amendment to Mr. Chaltiel's employment agreement, dated as of
March 2, 1998.*(13)
10.5 Employment Agreement, dated as of March 2, 1998, by and between TRCH and
Barry C. Cosgrove.(6)*
10.6 Employment Agreement, dated as of March 2, 1998, by and between TRCH and
Leonard W. Frie.(6)*
10.7 Employment Agreement, dated as of March 2, 1998, by and between TRCH and
John E. King.(6)*
10.8 Employment Agreement dated as of March 2, 1998, by and between TRCH and
Stan M. Lindenfeld.(6)*
10.9 Amendment to Dr. Lindenfeld's employment agreement, dated September 1,
1998.*(13)
10.10 First Amended and Restated 1994 Equity Compensation Plan of TRCH (with
form of Promissory Note and Pledge attached as an exhibit thereto),
dated August 5, 1994.(4)*
10.11 Form of Stock Subscription Agreement relating to the 1994 Equity
Compensation Plan.(4)*
10.12 Form of Purchased Shares Award Agreement relating to the 1994 Equity
Compensation Plan.(4)*
10.13 Form of Nonqualified Stock Option relating to the 1994 Equity
Compensation Plan.(4)*
10.14 1995 Equity Compensation Plan.(3)*
10.15 Employee Stock Purchase Plan.(3)*
10.16 Option Exercise and Bonus Agreement, dated as of September 18, 1995
between TRCH and Victor M.G. Chaltiel.(3)*
10.17 1997 Equity Compensation Plan.(7)
10.18 Amended and Restated Revolving Credit Agreement, dated as of April 30,
1998, by and among TRCH, the lenders party thereto, DLJ Capital
Funding, Inc., as Syndication Agent, First Union National Bank, as
Documentation Agent, and The Bank of New York, as Administrative
Agent.(8)
10.19 Amendment No. 1 and Consent No. 1, dated as of August 5, 1998, to the
Revolving Credit Agreement.(13)
10.20 Amendment No. 2, dated as of November 12, 1998, to the Revolving Credit
Agreement.(13)
10.21 Amended and Restated Term Loan Agreement, dated as of April 30, 1998, by
and among TRCH, the lenders party thereto, DLJ Capital Funding, Inc.,
as Syndication Agent, First Union National Bank, as Documentation
Agent, and The Bank of New York, as Administrative Agent.(8)
10.22 Subsidiary Guaranty dated as of October 24, 1997 by Total Renal Care,
Inc., TRC West, Inc. and Total Renal Care Acquisition Corp. in favor of
and for the benefit of The Bank of New York, as Collateral Agent, the
lenders to the Revolving Credit Agreement, the lenders to the Term Loan
Agreement, the Term Agent (as defined therein), the Acknowledging
Interest Rate Exchangers (as defined therein) and the Acknowledging
Currency Exchangers (as defined therein).(9)
10.23 Borrower Pledge Agreement dated as of October 24, 1997 and entered into
by and between the Company, and The Bank of New York, as Collateral
Agent, the lenders to the Revolving Credit Agreement, the lenders to
the Term Loan Agreement, the Term Agent (as defined therein), the
Acknowledging Interest Rate Exchangers (as defined therein) and the
Acknowledging Currency Exchangers (as defined therein).(9)
10.24 Amendment to Borrower Pledge Agreement, dated February 27, 1998,
executed by TRCH in favor of The Bank of New York, as Collateral
Agent.(13)
10.25 Form of Subsidiary Pledge Agreement dated as of October 24, 1997 by
Total Renal Care, Inc., TRC West, Inc. and Total Renal Care Acquisition
Corp., and The Bank of New York, as Collateral Agent, the lenders to
the Revolving Credit Agreement, the lenders to the Term Loan Agreement,
the Term Agent (as defined therein), the Acknowledging Interest Rate
Exchangers (as defined therein) and the Acknowledging Currency
Exchangers (as defined therein).(9)
10.26 Subsidiary Pledge Agreement, dated as of February 27, 1998, by RTC and
The Bank of New York, as Collateral Agent, the lenders to the Revolving
Credit Agreement, the lenders to the Term Loan Agreement, the Term
Agent (as defined therein), the Acknowledging Interest Rate Exchangers
(as defined therein) and the Acknowledging Currency Exchangers (as
defined therein).(13)
</TABLE>
64
<PAGE>
<TABLE>
<C> <S>
10.27 Form of First Amendment to Borrower/Subsidiary Pledge Agreement, dated
April 30, 1998, by and among TRCH, RTC, TRC and The Bank of New York,
as Collateral Agent.(8)
10.28 Form of Acknowledgement and Confirmation, dated April 30, 1998, by TRCH,
RTC, TRC West, Inc., Total Renal Care, Inc., Total Renal Care
Acquisition Corp., Renal Treatment Centers--Mid-Atlantic, Inc., Renal
Treatment Centers--Northeast, Inc., Renal Treatment Centers--
California, Inc., Renal Treatment Centers--West, Inc., and Renal
Treatment Centers--Southeast, Inc. for the benefit of The Bank of New
York, as Collateral Agent and the lenders party to the Term Loan
Agreement or the Revolving Credit Agreement.(8)
10.29 Agreement and Plan of Merger dated as of November 18, 1997 by and among
TRCH, Nevada Acquisition Corp., a Delaware corporation and wholly-owned
subsidiary of TRCH, and RTC.(10)
10.30 First Amendment to the Subsidiary Guaranty dated February 17, 1998.(2)
10.31 Special Purpose Option Plan.(11)
10.32 Guaranty, entered into as of March 31, 1998, by TRCH in favor of and for
the benefit of PNC Bank.(2)
10.33 First Amendment, dated as of August 5, 1998, to the Term Loan
Agreement.X
12.1 Statement re Computation of Ratios of Earnings to Fixed Charges.(13)
21.1 List of our subsidiaries.(13)
23.1 Consent of PricewaterhouseCoopers LLP.X
24.1 Powers of Attorney with respect to TRCH.(13)
27.1 Financial Data Schedule.(13)
</TABLE>
- --------
X Included in this filing.
* Management contract or executive compensation plan or arrangement.
(1) Filed on March 18, 1996 as an exhibit to our Transitional Report on Form
10-K for the transition period from June 1, 1995 to December 31, 1995.
(2) Filed on March 31, 1998 as an exhibit to our Form 10-K for the year ended
December 31, 1997.
(3) Filed on October 24, 1995 as an exhibit to Amendment No. 2 to our
Registration Statement on Form S-1 (Registration Statement No. 33-97618).
(4) Filed on August 29, 1995 as an exhibit to our Form 10-K for the year ended
May 31, 1995.
(5) Filed on December 18, 1998 as an exhibit to our Registration Statement on
Form S-3 (Registration Statement No. 333-69227).
(6) Filed as an exhibit to our Form 10-Q for the quarter ended September 30,
1998.
(7) Filed on August 29, 1997 as an exhibit to our Registration Statement on
Form S-8 (Registration Statement No. 333-34695).
(8) Filed on May 18, 1998 as an exhibit to Amendment No. 1 to our annual
report for the year ended December 31, 1997 on Form 10-K/A.
(9) Filed on December 19, 1997 as an exhibit to our Current Report on Form 8-
K.
(10) Filed on December 19, 1997 as Annex A to our Registration Statement on
Form S-4 (Registration Statement No. 333-42653).
(11) Filed on February 25, 1998 as an exhibit to our Registration Statement on
Form S-8 (Registration Statement No. 333-46887).
(12) Filed as an exhibit to RTC's Form 10-Q for the quarter ended June 30,
1996.
(13) Filed on March 31, 1999 as an exhibit to our Form 10-K for the year ended
December 31, 1998.
(b) Reports on Form 8-K:
Current Report on Form 8-K, dated November 3, 1998, reporting under Item
5 the issuance of our press releases in connection with the release of our
third quarter earnings and the offering of $345 million of our 7%
convertible subordinated notes pursuant to Rule 144A.
65
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders of
Total Renal Care Holdings, Inc.
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of income, of stockholders' equity, and of cash flows
present fairly, in all material respects, the financial position of Total Renal
Care Holdings, Inc. and its subsidiaries at December 31, 1997 and 1998, and the
results of their operations and their cash flows for each of the three years in
the period ended December 31, 1998 in conformity with generally accepted
accounting principles. These financial statements are the responsibility of the
Company's management; our responsibility is to express an opinion on these
financial statements based on our audits. We conducted our audits of these
statements in accordance with generally accepted auditing standards which
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for the opinion expressed above.
PricewaterhouseCoopers LLP
Seattle, Washington
March 29, 1999
F-1
<PAGE>
TOTAL RENAL CARE HOLDINGS, INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
December 31, December 31,
1997 1998
<S> <C> <C>
Assets
Cash and cash equivalents...................... $ 6,143,000 $ 41,487,000
Patient accounts receivable, less allowance for
doubtful accounts of $30,695,000 and
$61,848,000, respectively..................... 248,408,000 416,472,000
Receivable from Tenet.......................... 534,000 350,000
Inventories.................................... 15,766,000 23,470,000
Deferred income taxes.......................... 9,853,000 31,917,000
Prepaid expenses and other current assets...... 21,500,000 45,846,000
-------------- --------------
Total current assets....................... 302,204,000 559,542,000
Property and equipment, net.................... 172,838,000 233,337,000
Notes receivable............................... 14,104,000 29,257,000
Deferred taxes, noncurrent..................... 385,000
Other long-term assets......................... 14,438,000 9,050,000
Intangible assets, net......................... 774,266,000 1,084,395,000
-------------- --------------
$1,278,235,000 $1,915,581,000
============== ==============
Liabilities and Stockholders' Equity
Accounts payable............................... $ 33,283,000 $ 41,910,000
Employee compensation and benefits............. 25,430,000 34,778,000
Other accrued liabilities...................... 15,927,000 67,725,000
Current portion of long-term obligations....... 27,810,000 21,847,000
Income taxes payable........................... 8,204,000
-------------- --------------
Total current liabilities.................. 102,450,000 174,464,000
-------------- --------------
Long-term debt................................. 723,782,000 1,225,781,000
-------------- --------------
Deferred income taxes.......................... 2,500,000 8,212,000
-------------- --------------
Other long-term liabilities.................... 1,594,000 1,890,000
-------------- --------------
Minority interests............................. 19,079,000 23,422,000
-------------- --------------
Commitments and contingencies (Notes 8, 9 and
13)
Stockholders' equity
Preferred stock ($0.001 par value; 5,000,000
shares authorized; none outstanding)........
Common stock ($0.001 par value, 195,000,000
shares authorized; 77,991,595 and 81,029,560
shares issued and outstanding).............. 78,000 81,000
Additional paid-in capital................... 358,492,000 413,095,000
Notes receivable from stockholders........... (3,030,000) (356,000)
Retained earnings............................ 73,290,000 68,992,000
-------------- --------------
Total stockholders' equity................. 428,830,000 481,812,000
-------------- --------------
$1,278,235,000 $1,915,581,000
============== ==============
</TABLE>
See accompanying notes to consolidated financial statements.
F-2
<PAGE>
TOTAL RENAL CARE HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
Year Ended December 31,
------------------------------------------
1996 1997 1998
<S> <C> <C> <C>
Net operating revenues............. $498,024,000 $760,997,000 $1,204,894,000
------------ ------------ --------------
Operating expenses
Facilities........................ 344,180,000 510,990,000 772,666,000
General and administrative........ 32,350,000 50,099,000 75,829,000
Provision for doubtful accounts... 15,737,000 20,525,000 44,365,000
Depreciation and amortization..... 32,445,000 54,603,000 92,028,000
Merger and related costs.......... 2,808,000 78,188,000
------------ ------------ --------------
Total operating expenses........ 427,520,000 636,217,000 1,063,076,000
------------ ------------ --------------
Operating income................... 70,504,000 124,780,000 141,818,000
Interest expense, net of
capitalized interest.............. (13,417,000) (28,214,000) (72,804,000)
Interest rate swap-early
termination costs................. (9,823,000)
Interest income.................... 3,858,000 3,175,000 4,894,000
------------ ------------ --------------
Income before income taxes,
minority interests,
extraordinary item and
cumulative effect of change in
accounting principle............. 60,945,000 99,741,000 64,085,000
Income taxes....................... 22,960,000 40,212,000 41,580,000
------------ ------------ --------------
Income before minority interests,
extraordinary item and
cumulative effect of change in
accounting principle............. 37,985,000 59,529,000 22,505,000
Minority interests in income of
consolidated subsidiaries......... 3,578,000 4,502,000 7,163,000
------------ ------------ --------------
Income before extraordinary item
and cumulative effect of change
in accounting principle.......... 34,407,000 55,027,000 15,342,000
Extraordinary loss related to early
extinguishment of debt, net of tax
of $4,923,000 and $7,668,000,
respectively...................... 7,700,000 12,744,000
Cumulative effect of change in
accounting principle, net of tax
of $4,300,000..................... 6,896,000
------------ ------------ --------------
Net income (loss)................. $ 26,707,000 $ 55,027,000 $ (4,298,000)
============ ============ ==============
Earnings (loss) per common share:
Income before extraordinary item
and cumulative effect of change
in accounting principle.......... $ 0.46 $ 0.71 $ 0.19
Extraordinary loss, net of tax.... (0.10) (0.16)
Cumulative effect of change in
accounting principle, net of
tax.............................. (0.08)
------------ ------------ --------------
Net income (loss)................. $ 0.36 $ 0.71 $ (0.05)
============ ============ ==============
Weighted average number of common
shares outstanding................ 74,042,000 77,524,000 80,143,000
============ ============ ==============
Earnings (loss) per common share--
assuming dilution:
Income before extraordinary item
and cumulative effect of change
in accounting principle.......... $ 0.45 $ 0.69 $ 0.19
Extraordinary loss, net of tax.... (0.10) (0.16)
Cumulative effect of change in
accounting principle, net of
tax.............................. (0.08)
------------ ------------ --------------
Net income (loss)................. $ 0.35 $ 0.69 $ (0.05)
============ ============ ==============
Weighted average number of common
shares and equivalents
outstanding--assuming dilution.... 77,225,000 79,975,000 81,701,000
============ ============ ==============
</TABLE>
See accompanying notes to consolidated financial statements.
F-3
<PAGE>
TOTAL RENAL CARE HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
Notes
Common Stock Additional Receivable Retained
------------------ Paid-In from Earnings
Shares Amount Capital Stockholders (Deficit) Total
<S> <C> <C> <C> <C> <C> <C>
Balance at December 31,
1995................... 66,780,615 $67,000 $206,750,000 $(2,773,000) $(10,882,000) $193,162,000
Net proceeds from stock
offerings.............. 6,666,667 7,000 128,311,000 128,318,000
Shares issued in
acquisitions........... 161,095 2,810,000 2,810,000
Shares issued in
connection with
mergers................ 2,422,534 2,000 105,000 3,097,000 3,204,000
Shares issued to
employees and others... 1,883 15,000 15,000
Shares issued to repay
debt................... 190,109 1,474,000 1,474,000
Options exercised....... 463,461 1,000 3,183,000 3,184,000
Interest accrued on
notes receivable, net
of payments............ (54,000) (54,000)
Income tax benefit
related to stock
options exercised...... 938,000 938,000
Dividend distribution... (659,000) (659,000)
Net income.............. 26,707,000 26,707,000
---------- ------- ------------ ----------- ------------ ------------
Balance at December 31,
1996................... 76,686,364 77,000 343,586,000 (2,827,000) 18,263,000 359,099,000
Shares issued in
acquisitions........... 17,613 273,000 273,000
Shares issued to
employees and others... 174,775 1,773,000 1,773,000
Options exercised....... 447,456 2,019,000 2,019,000
Shares issued to repay
debt................... 664,580 1,000 5,147,000 5,148,000
Interest accrued on
notes receivable, net
of payments............ (203,000) (203,000)
Income tax benefit
related to stock
options exercised...... 5,453,000 5,453,000
Grant of stock options.. 235,000 235,000
Issuance of treasury
stock to repay debt.... 807 6,000 6,000
Net income.............. 55,027,000 55,027,000
---------- ------- ------------ ----------- ------------ ------------
Balance at December 31,
1997................... 77,991,595 78,000 358,492,000 (3,030,000) 73,290,000 428,830,000
Shares issued in
acquisitions........... 98,549 2,796,000 2,796,000
Shares issued to
employees and others... 49,060 1,085,000 1,085,000
Options exercised....... 2,890,356 3,000 36,395,000 36,398,000
Repayment of notes
receivable, net of
interest accrued....... 2,674,000 2,674,000
Income tax benefit
related to stock
options exercised...... 14,199,000 14,199,000
Grant of stock options.. 128,000 128,000
Net loss................ (4,298,000) (4,298,000)
---------- ------- ------------ ----------- ------------ ------------
Balance at December 31,
1998................... 81,029,560 $81,000 $413,095,000 $ (356,000) $ 68,992,000 $481,812,000
========== ======= ============ =========== ============ ============
</TABLE>
See accompanying notes to consolidated financial statements.
F-4
<PAGE>
TOTAL RENAL CARE HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Year Ended December 31,
---------------------------------------------
1996 1997 1998
<S> <C> <C> <C>
Cash flows from operating
activities
Net income (loss).............. $ 26,707,000 $ 55,027,000 $ (4,298,000)
Adjustments to reconcile net
income (loss) to net cash
provided by operating
activities:
Depreciation and
amortization................. 32,445,000 54,603,000 92,028,000
Extraordinary loss............ 12,623,000 20,412,000
Cumulative change in
accounting principle......... 11,196,000
Non-cash interest............. 4,396,000
Deferred income taxes......... (1,258,000) (5,131,000) (15,967,000)
Compensation expense from
stock option exercise........ 16,000,000
Income tax benefit related to
stock options exercised...... 938,000 5,453,000 14,199,000
Provision for doubtful
accounts..................... 15,737,000 20,525,000 44,365,000
Loss (gain) on disposition of
property and equipment....... (20,000) 76,000 192,000
Equity in losses (earnings)
from affiliate............... 16,000 (40,000) (157,000)
Minority interests in income
of consolidated
subsidiaries................. 3,578,000 4,502,000 7,163,000
Stock options issued to
consultants.................. 128,000
Changes in operating assets
and liabilities, net of
effect of acquisitions:
Accounts receivable........... (52,909,000) (109,811,000) (200,251,000)
Inventories................... (3,030,000) (1,843,000) (7,152,000)
Prepaid expenses and other
current assets............... (8,805,000) (143,000) (30,247,000)
Other long-term assets........ (9,166,000) 7,652,000
Accounts payable.............. 2,147,000 (992,000) (4,061,000)
Employee compensation and
benefits..................... 6,043,000 8,539,000 8,933,000
Other accrued liabilities..... (207,000) 2,791,000 34,873,000
Income taxes payable.......... (6,315,000) 2,329,000 12,525,000
Other long-term liabilities... (222,000) 13,000 (315,000)
------------- ------------- ---------------
Net cash provided by
operating activities........ 31,864,000 26,732,000 7,218,000
------------- ------------- ---------------
Cash flows from investing
activities
Purchases of property
and equipment................. (41,740,000) (62,033,000) (83,012,000)
Additions to intangible
assets........................ (10,775,000) (35,224,000) (37,891,000)
Cash paid for acquisitions, net
of cash acquired.............. (179,002,000) (455,090,000) (338,164,000)
Purchase of investments........ (55,311,000)
Sale of investments............ 14,109,000 41,202,000
Investment in affiliate, net... (46,000) (2,935,000) (1,187,000)
Issuance of long-term notes
receivable.................... (540,000) (12,502,000) (14,836,000)
Proceeds from disposition of
property and equipment........ 236,000 365,000
------------- ------------- ---------------
Net cash used in investing
activities.................. (273,069,000) (526,217,000) (475,090,000)
------------- ------------- ---------------
Cash flows from financing
activities
Proceeds from long-term
borrowings.................... 107,000 4,511,000 3,395,000
Principal payments on long-term
obligations................... (8,649,000) (26,269,000) (35,675,000)
Proceeds from convertible
notes......................... 121,250,000 345,000,000
Dividend distribution.......... (659,000)
Cash paid to retire bonds...... (68,499,000)
Proceeds from bank credit
facility...................... 239,835,000 505,000,000 1,567,225,000
Payment of bank credit
facility...................... (188,510,000) (1,407,650,000)
Net proceeds from issuance of
common stock.................. 131,517,000 3,792,000 21,483,000
Bank overdrafts................ 10,392,000
Cash received on notes
receivable from stockholders.. 170,000 35,000 2,674,000
Distributions to minority
interests..................... (2,442,000) (2,768,000) (3,628,000)
------------- ------------- ---------------
Net cash provided by
financing activities........ 224,120,000 484,301,000 503,216,000
------------- ------------- ---------------
Net (decrease) increase in
cash........................... (17,085,000) (15,184,000) 35,344,000
Cash and cash equivalents at
beginning of year.............. 38,412,000 21,327,000 6,143,000
------------- ------------- ---------------
Cash and cash equivalents at end
of year........................ $ 21,327,000 $ 6,143,000 $ 41,487,000
============= ============= ===============
</TABLE>
Supplemental cash flow information (Note 15)
See accompanying notes to consolidated financial statements
F-5
<PAGE>
TOTAL RENAL CARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Organization and summary of significant accounting policies
Organization
We operate kidney dialysis facilities and provide related medical services in
Medicare certified dialysis facilities in various geographic sectors of the
United States and also in Argentina, Puerto Rico, Europe and Guam.
On February 27, 1998 we acquired Renal Treatment Centers, Inc., or RTC, with
headquarters in Berwyn, Pennsylvania in a merger. In connection with the
merger, we issued 34,565,729 shares of our common stock in exchange for all of
the outstanding shares of RTC common stock. RTC stockholders received 1.335
shares of our common stock for each share of RTC common stock that they owned.
We also issued 2,156,424 options in substitution for previously outstanding RTC
stock options, including 1,662,354 of the vested options that were exercised on
the merger date or shortly thereafter. In addition, we guaranteed $125,000,000
of RTC's 5 5/8% subordinated convertible notes. In conjunction with this
transaction, our board of directors and our stockholders authorized an
additional 140,000,000 shares of common stock.
The RTC merger transaction was accounted for as a pooling of interests and as
such, these consolidated financial statements have been restated to include RTC
for all periods presented. There were no transactions between RTC and us prior
to the combination and no adjustments were necessary to conform RTC's
accounting policies to ours. Certain reclassifications also were made to the
RTC financial statements to conform to our presentations.
The results of operations for Total Renal Care Holdings, Inc., or TRCH, and
the combined amounts presented in the consolidated financial statements follow:
<TABLE>
<CAPTION>
Years Ended December 31,
-------------------------
1996 1997
<S> <C> <C>
Net operating revenues
TRCH.......................................... $272,947,000 $438,205,000
RTC........................................... 225,077,000 322,792,000
------------ ------------
$498,024,000 $760,997,000
============ ============
Net income before extraordinary item
TRCH.......................................... $ 23,725,000 $ 36,977,000
RTC........................................... 10,682,000 18,050,000
------------ ------------
$ 34,407,000 $ 55,027,000
============ ============
Net income after extraordinary item
TRCH.......................................... $ 16,025,000 $ 36,977,000
RTC........................................... 10,682,000 18,050,000
------------ ------------
$ 26,707,000 $ 55,027,000
============ ============
</TABLE>
As a result of the merger, RTC's revolving credit agreement was terminated
and the outstanding balance of approximately $297,228,000 was paid off through
additional borrowings under our credit facilities. The remaining net
unamortized deferred financing costs in the amount of $4,392,000, less tax of
$1,580,000, related to RTC's revolving credit agreement were recognized as an
extraordinary loss during 1998.
In connection with the merger, we developed a plan which included initiatives
to integrate our operations with those of RTC, eliminate duplicative overhead,
facilities and systems and improve service delivery. These integration
activities were commenced during the first quarter of 1998 and are expected to
be substantially completed by approximately July 1, 1999.
F-6
<PAGE>
TOTAL RENAL CARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Merger and related costs recorded during the first quarter of 1998 include
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. These amounts are more fully described below and
are based on our estimates of those costs.
A summary of merger and related costs and accrual activity through December
31, 1998 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--1st
quarter 1998........... (7,771,000) (35,304,000) (9,474,000) (52,549,000)
----------- ------------ ----------- ------------
Accrual, March 31, 1998
(unaudited)............ 13,809,000 6,656,000 6,421,000 26,886,000
Amounts utilized--2nd
quarter 1998........... (5,109,000) (1,096,000) (2,427,000) (8,632,000)
----------- ------------ ----------- ------------
Accrual, June 30, 1998
(unaudited)............ 8,700,000 5,560,000 3,994,000 18,254,000
Amounts utilized--3rd
quarter 1998........... (837,000) (458,000) (1,048,000) (2,343,000)
----------- ------------ ----------- ------------
Accrual, September 30,
1998 (unaudited)....... 7,863,000 5,102,000 2,946,000 15,911,000
Adjustment of
estimates.............. 1,305,000 (959,000) (1,593,000) (1,247,000)
Amounts utilized--4th
quarter 1998........... (9,168,000) (543,000) (188,000) (9,899,000)
----------- ------------ ----------- ------------
Accrual, December 31,
1998................... $ -- $ 3,600,000 $ 1,165,000 $ 4,765,000
=========== ============ =========== ============
</TABLE>
Direct transaction costs consist primarily of investment banking fees, legal
and accounting costs and other direct transaction costs, including the costs of
consultants, printing and registration, which were incurred by both TRCH and
RTC in connection with the merger. We concluded negotiations as to certain
amounts due in the fourth quarter of 1998 and subsequently we paid these
amounts.
Severance and employment costs were incurred for the following:
. Severance pay--The merger constituted a constructive termination of
employment under various preexisting employment contracts with RTC
officers. Terminated RTC officers were entitled to severance payments and
tax gross-up payments of approximately $6,500,000. In addition,
approximately 80 employees of RTC were informed that their positions
would be eliminated. Most of these employees were formerly located in
RTC's administrative office and a laboratory under development. The
terminations were structured over the integration period, which continued
through the end of 1998. The accrued severance payments to these
employees amounted to approximately $1,600,000. The remaining balance of
such severance costs of $600,000 was paid in the first quarter of 1999
and tax gross up payments of approximately $3,000,000 are expected to be
paid in 1999.
. Option exercises--Pre-existing terms of RTC stock option grants permitted
the exercise of options by tender of RTC shares. Some of the RTC shares
tendered had been held less than six months by the option holders and, as
required by Emerging Issues Task Force Issue 84-18, we recognized a
noncash expense of approximately $16,000,000 equal to the difference
between the exercise price of the options and the market value of the
stock on the date of exercise. We also incurred approximately $600,000 of
payroll tax related to the exercise of nonqualified stock options.
. Bonuses--RTC and TRCH each awarded special bonuses as a result of the
merger, paid in the first quarter of 1998, for which approximately
$16,300,000 was included in merger and related costs.
In connection with the RTC merger, we developed a plan which included
initiatives to integrate the operations of TRCH and RTC, eliminate duplicative
overhead, facilities and systems and improve service
F-7
<PAGE>
TOTAL RENAL CARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
delivery. These integration activities were commenced during the first quarter
of 1998 and are expected to be substantially completed by approximately July 1,
1999.
We eliminated the following RTC departments: human resources, managed care,
laboratory, and all finance functions, with the exception of patient
accounting. The finance functions eliminated included payroll, financial
reporting and analysis, budgeting, general ledger, accounts payable, and tax
functions. The RTC human resources and managed care departments were
discontinued in Berwyn, Pennsylvania and consolidated with our respective
departments in our Torrance, California headquarters as of September 30, 1998.
All finance functions, with the exception of patient accounting, were
consolidated into our Tacoma, Washington business office as of December 31,
1998. RTC's laboratory, located in Las Vegas, Nevada, was closed prior to its
commencement of operation. All laboratory functions were consolidated into our
laboratories in Minnesota and Florida in February 1998.
Costs to integrate operations include the following:
. Laboratory restructuring--As part of our merger integration plan, we
decided to restructure our laboratories. To optimize post-merger
operations, we terminated a long-term management services agreement with
a third party that provided full laboratory management on a contract
basis. The termination fee of approximately $3,800,000 was negotiated in
the first quarter of 1998. We also immediately halted development of
RTC's new laboratory, which was not required for post-merger operations.
The RTC laboratory, which was being developed in leased space, is now
vacant and a new sublessee is being sought. As a result of this decision,
previously capitalized leasehold improvements of $2,600,000 were
expensed. Additionally, merger and related costs include approximately
$1,000,000 of pre-opening start up costs incurred during the first
quarter of 1998 relating to the terminated RTC laboratory and $1,500,000
of remaining lease payments. The accrual for lease payments was not
offset by any anticipated sublease income. No such income has been
received to date and the remaining balance of this accrual at December
31, 1998 was approximately $1,165,000.
. Initial merger costs--Approximately $5,400,000 was expensed for
integration activities which occurred at the time of the merger. Such
costs include a special training program held in March 1998 and attended
by many of our employees, including former RTC employees, merger related
travel costs, consultant costs and other costs attributed to the merger.
During the fourth quarter of 1998 we reduced the remaining balance of the
accrual by $1,247,000 representing differences between initial estimates and
actual amounts of expenses incurred.
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 as set forth in the following table. The selected
quarterly financial data in Note 16 has also been restated to reflect the
following revisions:
<TABLE>
<CAPTION>
Three months ended
--------------------------------------------------- Year ended
March 31, June 30, September 30, December 31, December 31,
1998 1998 1998 1998 1998
<S> <C> <C> <C> <C> <C>
Operating Expenses
Facilities............ $ 1,700,000 $ 1,700,000
General and
administrative....... $1,100,000 $1,100,000 $ 1,100,000 3,300,000
Depreciation and
amortization......... 590,000 1,770,000 1,770,000 1,770,000 5,900,000
Merger and related
costs................ (13,400,000) (1,247,000) (14,647,000)
------------ ---------- ---------- ----------- ------------
(Decrease) Increase to
operating expenses..... $(11,110,000) $2,870,000 $2,870,000 $ 1,623,000 $ (3,747,000)
============ ========== ========== =========== ============
</TABLE>
F-8
<PAGE>
TOTAL RENAL CARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
A summary of the primary revisions is as follows:
.Reclassification of merger charges into operating expenses:
<TABLE>
<S> <C>
Reclassify inventory writeoff as facility expense............. $1,700,000
Amortize merger bonuses with deferred payout schedule in
1998......................................................... 3,300,000
Amortize remaining book value of incompatible and duplicative
software in 1998............................................. 5,900,000
.Reversal of accrued expenses within the merger charges:
Reverse accrual of estimated potential tax liability.......... $2,500,000
Reversal of differences between original estimates and actual
amounts of the merger expenses incurred...................... 1,247,000
----------
Total reduction in operating costs.......................... $3,747,000
==========
</TABLE>
Basis of presentation
Our consolidated financial statements include our accounts and those of our
wholly owned and majority-owned subsidiaries and partnerships. Minority-owned
investments are recorded under the equity method of accounting because TRCH
owns at least a 20% interest in, and has significant influence over, the
investments. The results of operations of our foreign-based entities are
included through November 30, 1998 to allow time for the accumulation of their
financial information for inclusion with the results of operations of our
domestic operations.
In February 1996, RTC acquired, through two separate transactions,
Intercontinental Medical Services, Inc., or IMS, and Midwest Dialysis Unit and
its affiliates, or MDU. In July 1996, RTC acquired Panama City Artificial
Kidney Center, Inc. and North Florida Artificial Kidney Center, Inc., or the
Kidney Center Group. Accordingly, the consolidated financial statements have
been prepared to give retroactive effect to these mergers. Each of the
transactions was separately accounted for as a pooling-of-interests. The
consolidated financial statements include the results of IMS, MDU and the
Kidney Center Group as of January 1, 1996.
Net operating revenues
Revenues are recognized when services and related products are provided to
patients in need of ongoing life sustaining kidney dialysis treatments.
Operating revenues consist primarily of dialysis and ancillary fees from
patient treatments. We maintain a usual and customary fee schedule for our
dialysis treatment and other patient services. We often do not realize our
usual and customary rates, however, because of limitations on the amounts we
can bill to or collect from the payors for our services. We generally bill the
Medicare and Medicaid programs at net realizable rates determined by applicable
fee schedules for these programs, which are established by statute or
regulation. We bill most non-governmental payors, including managed care payors
with which we have contracted, at our usual and customary rates. Since we bill
most non-governmental payors at our usual and customary rates, but often expect
to receive payments at the lower contracted rates, we also record a contractual
allowance in order to record expected net realizable revenue for services
provided. Appropriate allowances are established based upon credit risk of
specific third-party payors, historical trends and other factors and are
reflected in the provision for doubtful accounts as a component of operating
expenses in the consolidated statements of income. This process involves
estimates and we record revisions to these estimates in subsequent periods as
they are determined to be necessary.
During 1996, 1997 and 1998, we received approximately 64%, 61% and 56%
respectively, of our dialysis revenues from Medicare and Medicaid programs.
Accounts receivable from Medicare and Medicaid amounted to $205,564,000 and
$204,770,000 as of December 31, 1997 and 1998, respectively. Medicare
historically pays
F-9
<PAGE>
TOTAL RENAL CARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
approximately 80% of government established rates for services provided by us.
The remaining 20% typically is paid by state Medicaid programs, private
insurance companies or directly by the patients receiving the services.
Medicare and Medicaid programs funded by the U.S. government generally
reimburse us according to fee schedules at predetermined rates per treatment,
which vary from region to region and are generally below our established
private rates. Revenue under these programs is recognized at these
predetermined rates which are subject to periodic adjustments by federal and
state agencies. We bill non-governmental third-party payors at our established
private rates. We have also contracted for the provision of dialysis services
to members of managed care organizations at rates that are significantly less
than our established private rates.
In August 1993, the Omnibus Budget Reconciliation Act of 1993, or OBRA 93,
became effective. The Healthcare Financing Administration, or HCFA, originally
interpreted certain provisions of OBRA 93 to require employer group health
sponsored insurance plans, or private payors, to be the primary payor for
patients who became dually entitled to Medicare benefits because they developed
ESRD after they had earlier been entitled to Medicare due to age or disability.
In July 1994, HCFA instructed the Medicare fiscal intermediaries to apply the
provisions of OBRA 93 retroactively to August 10, 1993. Accordingly, we billed
the responsible private payors as the primary payors and recognized these
revenues, at the generally higher private rates, as services were rendered for
periods after August 10, 1993.
In April 1995, HCFA issued instructions of clarification to the fiscal
intermediaries which stated that it had misinterpreted the OBRA 93 provisions,
and that Medicare would continue as the primary payor despite a patient
obtaining dual eligibility status under the Medicare ESRD provisions.
Accordingly, we began recognizing revenues at Medicare rates for all such
patients going forward from April 1995. We also adjusted our financial
statements to reflect revenues earned at Medicare rates for such patients
during the period from August 1993 through April 1995. This resulted in a
reduction in revenues for the period August 1993 through April 1995 of
approximately $3.1 million as these revenues had been previously recognized at
the generally higher private rates.
In June 1995, a federal court issued a preliminary injunction against HCFA
prohibiting HCFA from retroactively applying its reinterpretation of the OBRA
93 provisions to periods prior to its April 1995 instructions of clarification.
After the issuance of this preliminary injunction, we determined that a
permanent injunction would likely be issued, and we adjusted our financial
statements to reflect revenues earned during the period from August 1993
through April 1995 at the generally higher private rates. We made no adjustment
to revenues recognized going forward from April 1995 because the injunction did
not prohibit the prospective effect of HCFA's reinterpretation.
In January 1998, a federal court issued a permanent injunction preventing
HCFA from applying its reinterpretation of the OBRA 93 provisions because that
application would be unlawful retroactive rulemaking. We did not adjust our
revenues in January 1998 in response to the permanent injunction because
revenues had already been recognized at the generally higher private rates
after the issuance of the preliminary injunction in June 1995.
As a Medicare and Medicaid provider, we are subject to extensive regulation
by both the federal government and the states in which we conduct our business.
Due to heightened awareness of federal and state budgets, scrutiny is being
placed on the health care industry, potentially subjecting us to regulatory
investigation and changes in billing procedures (see Note 13).
The provisions of the Kennedy-Kassebaum legislation issued January 1, 1997
may limit our ability to pay for policy premiums for patients even with proven
financial hardship. However, we believe that the bill did not intend to limit
our ability to pay premiums for insurance coverage to third-party or
governmental payors. In the
F-10
<PAGE>
TOTAL RENAL CARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
fall of 1997, the Office of Inspector General of the Department of Health and
Human Services, of HHS, issued an advisory opinion which would allow us to make
grants to a foundation that may provide for these premium payments on behalf of
eligible ESRD patients. Furthermore, a recent Congressional action will allow
dialysis providers to pay their patients' insurance premiums for secondary
insurance. These premiums are generally less than the 20% co-payment that a
private insurer would pay. Dialysis providers would be allowed to capture as
incremental profit the difference between the premiums paid to these secondary
insurers and the reimbursement amounts received from them. We plan to pay for a
patient's secondary insurance premium only if the patient does not qualify for
Medicaid and the patient demonstrates an inability to pay for this insurance.
Dialysis providers will be able to pay directly their patients' premiums for
secondary insurance beginning upon the enactment of regulations implementing
the Congressional action, which is expected in the third quarter of 1999.
We provide management services to dialysis facilities that we do not own
under long-term and short-term agreements. Our fees typically are determined as
a percentage of the facilities' patient revenues or operating results. The net
fee due us is included in our net operating revenues as earned. Any costs
incurred in performing these management services are recognized in facility
operating and general and administrative expenses.
Cash and cash equivalents
Cash equivalents are highly liquid investments with original maturities of
three months or less.
As part of our cash management strategy, we utilize a zero-balance
disbursement account that resulted in a cash overdraft of $10,392,000 as of
December 31, 1998. This overdraft has been reclassified and included in
accounts payable in these financial statements.
Inventories
Inventories are stated at the lower of cost (first-in, first-out) or market
and consist principally of drugs and dialysis related supplies.
Supplier rebates associated with medical supplies inventory are based on a
percentage of purchases during the contract period and generally are paid to us
on a quarterly or semi-annual basis. The percentage rate of rebate recognized
by us is based upon expected purchase thresholds to be achieved during the
contract period. We recognize supplier rebates in the same period that the
related inventory expense is recognized and they are included in facility
operating expenses in the consolidated statement of income. A corresponding
rebate receivable is included in other current assets in the consolidated
balance sheet.
Property and equipment
Property and equipment are stated at cost. Maintenance and repairs are
charged to expense as incurred. Depreciation and amortization expense are
computed using the straight-line method over the useful lives of the assets
estimated as follows: buildings, 20 to 40 years; leaseholds and improvements,
over the shorter of their estimated useful life or the lease term; and
equipment, 3 to 15 years.
Capitalized interest
We capitalize interest associated with the costs of significant facility
expansion and construction. Interest is capitalized by using an interest rate
which is equal to the weighted average borrowing rate on our long-term debt.
Approximately $685,000 and $804,000 in interest expense was capitalized during
1997 and 1998, respectively.
F-11
<PAGE>
TOTAL RENAL CARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Intangible assets
Business acquisition costs allocated to patient lists are amortized generally
over five to eight years using the straight-line method. Business acquisition
costs allocated to covenants not to compete are amortized over the terms of the
agreements, typically three to eleven years, using the straight-line method.
Deferred debt issuance costs are amortized over the term of the debt using the
effective interest method. Pre-opening and development costs are expensed as
incurred during 1998.
The excess of aggregate purchase price over the fair value of net assets of
businesses acquired is recorded as goodwill. Goodwill is amortized over 15 to
40 years using the straight-line method. Currently, the blended average life of
our goodwill is 34 years.
Impairment of Property and Equipment and Intangible Assets
The carrying value of property and equipment and intangible assets are
assessed for any permanent impairment by evaluating the operating performance
and future undiscounted cash flows from operations of the underlying
businesses. Adjustments are made if the sum of the expected future undiscounted
net cash flows is less than book value. Statement of Financial Accounting
Standards No. 121, Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to be Disposed of, or SFAS 121, requires that long-lived
assets be reviewed for impairment whenever events or changes in circumstances
indicate that the carrying amount of assets may not be recoverable.
Income taxes
We account for income taxes using an asset and liability approach, which
requires recognition of deferred income taxes for all temporary differences
between the tax and financial reporting bases of our assets and liabilities
based on enacted tax rates applicable to the periods in which the differences
are expected to be recovered or settled.
Minority interests
Minority interests represent the proportionate equity interest of other
partners and stockholders in our consolidated entities which are not wholly
owned. As of December 31, 1998, these included 24 active partnerships and
corporations.
Stock-based compensation
Statement of Financial Accounting Standards No. 123, Accounting for Stock-
Based Compensation, or SFAS 123, requires us to elect to account for stock-
based compensation on a fair value based model or an intrinsic value based
model. We currently use the intrinsic value based model which is the accounting
principle prescribed by Accounting Principles Board No. 25, Accounting for
Stock Issued to Employees, or APB 25. Under this model, compensation cost is
the excess of the quoted market price of the stock at the date of grant or
other measurement date over the amount an employee must pay to acquire the
stock. The fair value based model prescribed by SFAS 123 requires us to value
stock-based compensation using an accepted valuation model. Compensation cost
is measured at the grant date based on the value of the award and would be
recognized over the service period which is usually the vesting period. SFAS
123 requires us to either reflect the results of the valuation in the
consolidated financial statements or alternatively continue to apply the
provisions of APB 25 and make appropriate disclosure of the impact of such
valuation in the accompanying notes to consolidated financial statements.
We have elected to continue to apply the provisions of APB 25 to our employee
stock-based compensation plans and have included the required disclosure of the
pro forma impact on net income and earnings per share
F-12
<PAGE>
TOTAL RENAL CARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
of the difference between compensation expense using the intrinsic value method
and the fair value method (see Note 10).
Options granted to non-employees subsequent to December 15, 1998 are recorded
at the fair value based upon the fair value criteria of SFAS 123.
Earnings per share
In February 1997, the Financial Accounting Standards Board issued the
Statement of Financial Accounting Standards No. 128, Earnings Per Share, or
SFAS 128. SFAS 128 establishes standards for computing and presenting earnings
per share. Basic earnings per share is calculated by dividing net income before
extraordinary item and net income by the weighted average number of shares of
common stock outstanding. Earnings per common share assuming dilution includes
the dilutive effects of stock options and warrants, using the treasury stock
method, in determining the weighted average number of shares of common stock
outstanding. Not currently used in the calculation is the effect of our
convertible debt. For 1997 and 1998, the effect of our convertible debt is
antidilutive and as such, is not to be included in the diluted EPS calculation.
Earnings per share for all periods presented have been restated following the
provisions of SFAS 128.
Interest rate swap agreements
We have entered into interest rate swap agreements (see Note 8) as a means of
managing our interest rate exposure. We have not entered these agreements for
trading or speculative purposes. These agreements have the effect of converting
our line of credit obligation from a variable rate to a fixed rate. Net amounts
paid or received are reflected as adjustments to interest expense. The
counterparties to these agreements are large international financial
institutions. These interest rate swap agreements subject us to financial risk
that will vary during the life of the agreements in relation to the prevailing
market interest rates. We are also exposed to credit loss in the event of non-
performance by these counterparties. However, we do not anticipate non-
performance by the other parties, and no material loss would be expected from
non-performance by the counterparties.
Financial instruments
Our financial instruments consist primarily of cash, accounts receivable,
notes receivable, accounts payable, employee compensation and benefits, and
other accrued liabilities. These balances, as presented in the financial
statements at December 31, 1997 and 1998, approximate their fair value.
Borrowings under our credit facilities, of which $749,575,000 was outstanding
as of December 31, 1998, reflect fair value as they are subject to fees and
rates competitively determined in the marketplace. The fair value of the
interest rate swap agreements is based on the present value of expected future
cash flows from the agreement and was in a net payable position of $31,300,000
at December 31, 1998. The fair value of our 7% convertible subordinated notes
was equal to the carrying book value because of the proximity in the time
between the issue date of these notes and December 31, 1998; the fair value of
the RTC 5 5/8% convertible subordinated notes was approximately $124,000,000 at
December 31, 1998.
Foreign currency translation
Our principal operations outside of the United States are in Argentina and
are relatively self-contained and integrated within Argentina. The currency in
Argentina, which is considered the functional currency, floats with the U.S.
dollar, therefore, there are no significant foreign currency translation
adjustments. Our operations in Europe were nominal through December 31, 1998.
F-13
<PAGE>
TOTAL RENAL CARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Comprehensive income
In June 1997, the Financial Accounting Standards Board, or FASB, issued
Statement of Financial Accounting Standards No. 130, Reporting Comprehensive
Income, or SFAS 130, which was adopted by us in the first quarter of 1998. SFAS
130 establishes standards for reporting and displaying comprehensive income and
its components (revenues, expenses, gains and losses) in a full set of general-
purpose financial statements or as additional line items within the current set
of financial statements. Comprehensive income as defined includes certain
changes in stockholders' equity during a period from non-income sources. Such
items may include foreign currency translation adjustments, unrealized
gains/losses from investing and hedging activities, and other transactions.
SFAS 130 requires that all items that are required to be recognized under
accounting standards as components of comprehensive income be reported in a
financial statement that is displayed with the same prominence as other
financial statements. As we have no components of other comprehensive income
through December 1998, there were no disclosure requirements involved in our
adoption of SFAS 130. In the future, we are likely to have other comprehensive
income that SFAS 130 will require us to disclose.
Segment information
In June 1997, the FASB issued Statement of Financial Accounting Standards No.
131, Disclosures about Segments of an Enterprise and Related Information, which
requires that we report financial and descriptive information about our
reportable operating segments. We have determined that we do not have any
separately reportable segments.
Derivative instruments and hedging activities
In June 1998, the FASB issued Statement of Financial Accounting Standards No.
133, Accounting for Derivative Instruments and Hedging Activities, or SFAS 133.
SFAS 133 is effective for all fiscal quarters of all fiscal years beginning
after June 15, 1999. Accordingly, for us, SFAS 133 will become effective
January 1, 2000. SFAS 133 requires that all derivative instruments be recorded
on the balance sheet at their fair value. Changes in the fair value of
derivatives are recorded each period in current earnings or other comprehensive
income, depending on whether a derivative is designated as part of a hedge
transaction and, if it is, the type of hedge transaction. For fair-value hedge
transactions in which we are hedging changes in an asset's, liability's, or
firm commitment's fair value, changes in the fair value of the derivative
instrument will generally be offset in the income statement by changes in the
hedged item's fair value. For cash-flow hedge transactions, in which we are
hedging the variability of cash flows related to a variable-rate asset,
liability, or a forecasted transaction, changes in the fair value of the
derivative instrument will be reported in other comprehensive income. The gains
and losses on the derivative instrument that are reported in other
comprehensive income will be reclassified as earnings in the periods in which
earnings are impacted by the variability of the cash flows of the hedged item.
The ineffective portion of all hedges will be recognized in current-period
earnings.
We have not yet determined the impact that the adoption of SFAS 133 will have
on our earnings or statement of financial position.
Use of estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires us to make estimates and assumptions that affect
the reported amounts of assets and liabilities and disclosure of contingent
assets and liabilities at the date of the financial statements and the reported
amounts of revenues and expenses during the reporting period. Actual results
could differ from those estimates.
Reclassifications
Certain prior year balances have been reclassified to conform to the current
year presentation.
F-14
<PAGE>
TOTAL RENAL CARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
2. Property and equipment
Property and equipment comprise the following:
<TABLE>
<CAPTION>
December 31,
---------------------------
1997 1998
<S> <C> <C>
Land.......................................... $ 1,410,000 $ 1,410,000
Buildings..................................... 6,463,000 10,622,000
Leaseholds and improvements................... 78,956,000 113,409,000
Equipment..................................... 147,824,000 204,156,000
Construction in progress...................... 7,352,000 11,849,000
------------ -------------
242,005,000 341,446,000
Less accumulated depreciation and
amortization................................. (69,167,000) (108,109,000)
------------ -------------
Property and equipment, net................... $172,838,000 $ 233,337,000
============ =============
</TABLE>
Depreciation and amortization expense on property and equipment was
$13,903,000, $22,160,000 and $40,032,000 for 1996, 1997, and 1998,
respectively.
3. Intangible assets
A summary of intangible assets is as follows:
<TABLE>
<CAPTION>
December 31,
----------------------------
1997 1998
<S> <C> <C>
Goodwill....................................... $624,740,000 $ 951,330,000
Patient lists.................................. 122,463,000 132,048,000
Noncompetition agreements...................... 61,797,000 96,670,000
Deferred debt issuance costs................... 23,415,000 19,329,000
Other.......................................... 18,891,000
------------ --------------
851,306,000 1,199,377,000
Less accumulated amortization.................. (77,040,000) (114,982,000)
------------ --------------
$774,266,000 $1,084,395,000
============ ==============
</TABLE>
Amortization expense applicable to intangible assets was $18,542,000,
$32,443,000 and $51,996,000 for 1996, 1997 and 1998 respectively.
In April 1998, Statement of Position No. 98-5, Reporting on the Costs of
Start-up Activities, or SOP 98-5, was issued. We adopted SOP 98-5 effective
January 1, 1998. SOP 98-5 requires that pre-opening and organization costs,
incurred in conjunction with facility pre-opening activities, which previously
had been treated as deferred costs and amortized over five years, should be
expensed as incurred. As a result of the adoption of SOP 98-5, all remaining
unamortized pre-opening, development and organizational costs existing prior to
January 1, 1998 of $11,196,000 were recognized, net of tax of $4,300,000, as
the cumulative effect of a change in accounting principle in 1998.
F-15
<PAGE>
TOTAL RENAL CARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
4. Prepaid expenses and other current assets
Prepaid expenses and other current assets comprise the following:
<TABLE>
<CAPTION>
December 31,
-----------------------
1997 1998
<S> <C> <C>
Supplier rebates and other current non-trade
receivables...................................... $10,886,000 $37,917,000
Prepaid income taxes.............................. 5,501,000
Prepaid expenses.................................. 4,910,000 7,290,000
Deposits.......................................... 203,000 639,000
----------- -----------
$21,500,000 $45,846,000
=========== ===========
</TABLE>
5. Notes receivable
During 1997, we entered into various agreements to provide funding for
expansion to certain companies that provide renal dialysis or renal related
services. These notes receivables are secured by the assets and operations of
these companies. A summary of notes receivable is as follows:
<TABLE>
<CAPTION>
December 31,
-----------------------
1997 1998
<S> <C> <C>
Convertible note due June 2001 with interest at
prime plus 1.5%.................................... $ 7,701,000 $15,919,000
Convertible notes, due in quarterly installments
commencing in 2001, with interest at prime plus
1.5%............................................... 1,506,000 7,449,000
Note receivable due November 30, 2002 with interest
of 8.5%............................................ 3,077,000 3,689,000
Note from Victor M.G. Chaltiel, chief executive
officer, repaid in 1998............................ 1,820,000
Convertible note, from a related party, due May 2000
with interest at prime plus 1.5%................... 2,200,000
----------- -----------
$14,104,000 $29,257,000
=========== ===========
</TABLE>
6. Other accrued liabilities
Other accrued liabilities comprise the following:
<TABLE>
<CAPTION>
December 31,
-----------------------
1997 1998
<S> <C> <C>
Customer refunds.................................... $ 5,278,000 $22,483,000
Purchase price payable (see Note 8)................. 15,223,000
Accrued interest.................................... 5,395,000 10,986,000
Merger accrual...................................... 4,765,000
Other............................................... 5,254,000 14,268,000
----------- -----------
$15,927,000 $67,725,000
=========== ===========
</TABLE>
F-16
<PAGE>
TOTAL RENAL CARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
7. Income taxes
Our provision for income taxes consists of the following:
<TABLE>
<CAPTION>
Years ended December 31,
--------------------------------------
1996 1997 1998
<S> <C> <C> <C>
Current
Federal............................ $20,655,000 $35,128,000 $ 47,426,000
State.............................. 3,562,000 6,430,000 9,069,000
Foreign............................ 1,070,000 1,052,000
Deferred
Federal............................ (1,151,000) (1,963,000) (14,268,000)
State.............................. (106,000) (453,000) (1,699,000)
----------- ----------- ------------
$22,960,000 $40,212,000 $ 41,580,000
=========== =========== ============
</TABLE>
Temporary differences which give rise to deferred tax assets and liabilities
are as follows:
<TABLE>
<CAPTION>
December 31,
------------------------
1997 1998
<S> <C> <C>
Receivables, primarily allowance for doubtful
accounts....................................... $ 8,635,000 $22,613,000
Merger costs.................................... 6,159,000
Accrued benefits payable........................ 2,114,000 2,821,000
Deferred compensation........................... 67,000
Foreign NOL carryforward........................ 944,000 944,000
Foreign tax credit carryforward................. 200,000 200,000
Other........................................... 417,000 324,000
----------- -----------
Gross deferred tax assets....................... 12,377,000 33,061,000
Fixed assets.................................... (2,821,000) (4,115,000)
Intangible assets............................... (657,000) (4,097,000)
Other........................................... (17,000)
----------- -----------
Gross deferred tax liabilities................ (3,495,000) (8,212,000)
Valuation allowance........................... (1,144,000) (1,144,000)
----------- -----------
Net deferred tax assets....................... $ 7,738,000 $23,705,000
=========== ===========
</TABLE>
The valuation allowance relates to deferred tax assets established under SFAS
No. 109 for foreign net operating loss carryforwards of $2.86 million and
foreign tax credit carryforwards of $200,000. These unutilized loss and credit
carryforwards which expire in 2002, will be carried forward to future years for
possible utilization. No benefit of these carryforwards has been recognized on
the financial statements.
F-17
<PAGE>
TOTAL RENAL CARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The reconciliation between our effective tax rate and the U.S. federal income
tax rate on income is as follows:
<TABLE>
<CAPTION>
Years ended December 31,
----------------------------
1996 1997 1998
<S> <C> <C> <C>
Federal income tax rate...................... 35.0% 35.0% 35.0%
State taxes, net of federal benefit.......... 4.1 4.1 3.1
Foreign income taxes......................... 0.4
Nondeductible amortization of intangible
assets...................................... 1.1 0.8 1.7
Valuation allowance.......................... 1.2
Other........................................ (0.2) 0.7
-------- -------- --------
Effective tax rate........................... 40.0 42.2 39.8
Minority interests in partnerships........... (2.3) (1.9) (8.2)
Merger charges............................... 33.3
-------- -------- --------
Effective tax rate before minority interests
and merger charges.......................... 37.7% 40.3% 64.9%
======== ======== ========
</TABLE>
8. Long-term debt
Long-term debt comprises:
<TABLE>
<CAPTION>
December 31,
----------------------------
1997 1998
<S> <C> <C>
Credit facilities............................ $590,000,000 $ 749,575,000
Convertible subordinated notes, 7%, due
2009........................................ 345,000,000
Convertible subordinated notes, 5 5/8%, due
2006........................................ 125,000,000 125,000,000
Acquisition obligations and other notes
payable..................................... 31,412,000 24,160,000
Capital lease obligations (see Note 9)....... 5,180,000 3,893,000
------------ --------------
751,592,000 1,247,628,000
Less current portion......................... (27,810,000) (21,847,000)
------------ --------------
$723,782,000 $1,225,781,000
============ ==============
</TABLE>
Maturities of long-term debt are as follows:
<TABLE>
<S> <C>
1999........................................................ $ 21,847,000
2000........................................................ 10,893,000
2001........................................................ 94,579,000
2002........................................................ 153,567,000
2003........................................................ 241,559,000
Thereafter.................................................. 725,183,000
</TABLE>
12% senior subordinated discount notes
In July and September 1996, we retired the remaining 65% of our 12% senior
subordinated discount notes then outstanding for $68,499,000, including consent
payments of $1,100,000. An extraordinary loss on the early extinguishment of
debt of $12,623,000, net of income tax effect of $4,923,000, was recorded in
1996.
F-18
<PAGE>
TOTAL RENAL CARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Credit facilities
At December 31, 1998 and 1997, we had outstanding borrowings under our
revolving credit facility of $353,575,000 and $353,000,000, respectively, and
at December 31, 1998, $396,000,000 was outstanding under our fixed term loan.
On April 30, 1998, we replaced our existing $1,050,000,000 credit facilities
with an aggregate of $1,350,000,000 in two senior bank facilities. These credit
facilities consist of a seven-year $950,000,000 revolving senior credit
facility and a ten-year $400,000,000 senior term facility. Up to $75,000,000
may be utilized for foreign financing. In general, borrowings under the credit
facilities bear interest at one of two floating rates selected by us: (a) the
Alternate Base Rate (defined as the higher of The Bank of New York's prime rate
or the federal funds rate plus 0.5%); or (b) Adjusted LIBOR (defined as the 30-
, 60-, 90- or 180-day London Interbank Offered Rate, adjusted for statutory
reserves) plus a margin that ranges from 0.45% to 1.75% depending on our
leverage ratio. As a result of this financing, remaining net deferred financing
costs in the amount of approximately $16,019,000, less tax of $6,087,000, were
recognized as an extraordinary loss in 1998.
Maximum borrowings under the $950,000,000 revolving credit facility will be
reduced by $89,100,000 on September 30, 2001, $148,400,000 on September 30,
2002, and another $237,500,000 on September 30, 2003, and the revolving credit
facility terminates on March 31, 2005. Under the $400,000,000 term facility,
payments of $4,000,000 shall be made each consecutive year beginning on
September 30, 1998 and continuing through September 30, 2007. The remaining
balance of $360,000,000 is due on March 31, 2008 when the term facility
terminates. 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. We are in compliance with all such covenants.
Certain of our subsidiaries, including Total Renal Care, Inc., or TRC, TRC
West, Inc., Total Renal Care Acquisition Corp., RTC, Renal Treatment Centers-
Mid Atlantic, Inc., Renal Treatment Centers-Northeast, Inc., Renal Treatment
Centers-California, Inc., Renal Treatment Centers-West, Inc. and Renal
Treatment Centers-Southeast, Inc., have guaranteed our obligations under the
credit facilities on a senior basis.
RTC also had a credit agreement which provided for a $350,000,000 revolving
credit/term facility available to fund acquisitions and general working capital
requirements, of which $237,000,000 was outstanding as of December 31, 1997.
The RTC credit agreement was terminated and repaid with borrowings under our
credit facilities on February 27, 1998 in connection with the completion of our
merger with RTC. The remaining net amortized deferred financing costs in the
amount of $4,392,000 related to the RTC credit agreement were recognized as an
extraordinary loss, net of tax effect of $1,580,000, in 1998.
5 5/8% convertible subordinated notes
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.
F-19
<PAGE>
TOTAL RENAL CARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The following is summarized financial information of RTC:
<TABLE>
<CAPTION>
December 31,
-------------------------
1997 1998
<S> <C> <C>
Cash and cash equivalents........................ $ 743,000 $ 5,396,000
Accounts receivable, net......................... 95,927,000 130,129,000
Other current assets............................. 19,484,000 19,106,000
------------ ------------
Total current assets........................... 116,154,000 154,631,000
Property and equipment, net...................... 72,777,000 75,641,000
Intangible assets, net........................... 384,529,000 406,562,000
Other assets..................................... 12,034,000 9,249,000
------------ ------------
Total assets................................... $585,494,000 $646,083,000
============ ============
Current liabilities (includes $306,628,000
intercompany payable to TRC at December 31,
1998)........................................... $ 62,673,000 $352,753,000
Long-term debt................................... 367,219,000 125,199,000
Other long-term liabilities...................... 444,000
Stockholders' equity............................. 155,158,000 168,131,000
------------ ------------
Total liabilities and stockholders' equity..... $585,494,000 $646,083,000
============ ============
</TABLE>
<TABLE>
<CAPTION>
Year ended December 31,
--------------------------------------
1996 1997 1998
<S> <C> <C> <C>
Net operating revenues.............. $225,077,000 $322,792,000 $472,355,000
Total operating expenses............ 203,402,000 277,869,000 446,438,000
------------ ------------ ------------
Operating income.................... 21,675,000 44,923,000 25,917,000
Interest expense, net............... 4,384,000 11,802,000 8,993,000
------------ ------------ ------------
Income before income taxes.......... 17,291,000 33,121,000 16,924,000
Income taxes........................ 6,609,000 15,071,000 19,930,000
------------ ------------ ------------
Income before extraordinary item and
cumulative effect of change in
accounting principle............... 10,682,000 18,050,000 (3,006,000)
Extraordinary loss related to early
extinguishment of debt, net of
tax................................ 2,812,000
Cumulative effect of change in
accounting principle, net of tax... 3,993,000
------------ ------------ ------------
Net income (loss)................. $ 10,682,000 $ 18,050,000 $ (9,811,000)
============ ============ ============
</TABLE>
7% convertible subordinated notes
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 common stock at a
conversion price of $32.81 principal amount 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 ours and our subsidiaries.
We subsequently filed a registration statement covering the resale of the 7%
notes.
F-20
<PAGE>
TOTAL RENAL CARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Acquisition obligations
In 1994, pursuant to a business acquisition, RTC entered into an agreement to
pay $7,364,100 in annual installments commencing June 1995 through June 1998.
Interest on the unpaid principal amount of the note accrued at an annual rate
of 6.5%, payable in arrears each June 1 from 1995 from 1998. The note allowed
the seller to convert the principal amount of the note into that number of
shares of common stock of RTC based upon the average daily closing sale price
of RTC stock during December 1994. During 1997, the note payable was paid in
full through the issuance of common stock.
In 1996, pursuant to a business acquisition, RTC entered into an agreement to
pay a total of $8,050,000 to the seller in a single installment in January
1997. During 1997, pursuant to several business acquisitions, RTC entered into
several other agreements to pay the various sellers a total of $24,468,000 in
single installments in January 1998.
In conjunction with certain facility acquisitions, we have issued three
letters of credit. Two of these were released on April 1, 1997. The remaining
letter of credit of $3,000,000 is being released to the seller in three annual
principal installments of $1,000,000 commencing January 1997. We have also
agreed to pay the seller interest at 6.50% on the outstanding principal. As of
December 31, 1997 and December 31, 1998 the aggregate amount outstanding,
including accrued interest, was $2,183,000 and $1,106,000 respectively.
In December 1998, we purchased two facilities for a combined total of
$15,223,000 with a short term loan made to the sellers, which subsequently has
been repaid. Because of its short term maturity it has been included in other
accrued liabilities as of December 31, 1998.
Interest rate swap agreements
On November 25, 1996, we entered into a seven-year interest rate swap
agreement involving the exchange of fixed and floating interest payment
obligations without the exchange of the underlying principal amounts. At
December 31, 1997, the total notional principal amount of this interest rate
swap agreement was $100,000,000 and the effective interest rate thereon was
7.57%. On July 24, 1997, we entered into a ten-year interest rate swap
agreement. At December 31, 1997, the total notional principal amount of this
interest rate swap agreement was $200,000,000 and the effective interest rate
thereon was 7.77%. In April 1998, in conjunction with the refinancing of our
senior credit facilities, these two forward interest rate swap agreements were
cancelled. The loss associated with the early cancellation of those swaps was
approximately $9,823,000.
In May 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 December 31, 1998, the effective interest rate for
borrowings under the swap agreement is 6.90%.
9. Leases
We lease the majority of our facilities under noncancelable operating leases
expiring in various years through 2021. Most lease agreements cover periods
from five to ten years and contain renewal options of five to ten years at the
fair rental value at the time of renewal or at rates subject to consumer price
index increases since the inception of the lease. In the normal course of
business, operating leases are generally renewed or replaced by other similar
leases.
F-21
<PAGE>
TOTAL RENAL CARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Future minimum lease payments under noncancelable operating leases are as
follows:
<TABLE>
<S> <C>
1999....................................................... $ 41,794,000
2000....................................................... 32,317,000
2001....................................................... 28,388,000
2002....................................................... 25,784,000
2003....................................................... 23,545,000
Thereafter................................................. 84,908,000
------------
Total minimum lease payments............................... $236,736,000
============
</TABLE>
Rental expense under all operating leases for 1996, 1997 and 1998 amounted to
$15,901,000, $24,589,000 and $38,975,000 respectively.
We also lease certain equipment under capital lease agreements. Future
minimum lease payments under capital leases are as follows:
<TABLE>
<S> <C>
1999........ $ 2,675,000
2000........ 1,303,000
2001........ 712,000
2002........ 267,000
2003........ 91,000
Thereafter.. --
Less portion
representing
interest... (1,155,000)
-----------
Total
capital
lease
obligation,
including
current
portion.... $ 3,893,000
===========
</TABLE>
The net book value of fixed assets under capital lease was $5,649,000 and
$4,314,000 at December 31, 1997 and 1998, respectively. Capital lease
obligations are included in long-term debt (see Note 8).
10. Stockholders' equity
Public offerings of common stock
On April 3, 1996, and October 31, 1996 we completed equity offerings of
13,416,667 and 4,166,667 shares of our common stock, respectively; 5,833,333
and 833,334, respectively, of which were sold for our account and 7,583,333 and
3,333,333 respectively, of which were sold by certain of our stockholders. The
net proceeds received by us of $109,968,000 and $18,350,000, respectively, were
used to repay borrowings incurred under our credit facilities in connection
with acquisitions, to repurchase and subsequently retire our 12% senior
subordinated notes, to finance other acquisitions and de novo developments and
for working capital and other corporate purposes.
Change in shares, stock splits and dividends
Dividend distributions paid during 1996 were to the former shareholders of
entities acquired by RTC in transactions accounted for as poolings of interests
as described in Note 1.
On September 30, 1997 we announced a common stock dividend to all
stockholders of record as of October 7, 1997, to be paid on October 20, 1997.
Each stockholder received two additional shares of common stock for each three
shares held. Fractional shares calculated as a result of the stock dividend
were paid out in cash in the amount of approximately $14,000. As such, all
share and per share amounts presented in the financial statements and related
notes thereto have been retroactively restated to reflect this dividend which
was accounted for as a stock split.
F-22
<PAGE>
TOTAL RENAL CARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Earnings per share
The reconciliation of the numerators and denominators used to calculate
earnings per share is as follows:
<TABLE>
<CAPTION>
Year ended December 31,
-------------------------------------
1996 1997 1998
<S> <C> <C> <C>
Income before extraordinary item and
cumulative effect of change in
accounting principle:
As reported........................... $34,407,000 $55,027,000 $15,342,000
=========== =========== ===========
Income before extraordinary item and
cumulative effect of change in
accounting principle--assuming
dilution:
As reported........................... $34,407,000 $55,027,000 $15,342,000
Add back interest on RTC earnout note,
tax effected......................... 233,000 34,000
----------- ----------- -----------
$34,640,000 $55,061,000 $15,342,000
=========== =========== ===========
Applicable common shares:
Average outstanding during the year... 74,172,000 77,649,000 80,156,000
Reduction in shares in connection with
notes receivable from employees...... (130,000) (125,000) (13,000)
----------- ----------- -----------
Weighted average number of shares
outstanding for use in computing basic
earnings per share..................... 74,042,000 77,524,000 80,143,000
Outstanding stock options (based on
the treasury stock method)........... 2,411,000 2,288,000 1,558,000
Dilutive effect of RTC earnout note... 772,000 163,000
----------- ----------- -----------
Adjusted weighted average number of
common and common share equivalent
shares outstanding--assumming
dilution............................. 77,225,000 79,975,000 81,701,000
=========== =========== ===========
Earnings per common share--basic........ $ 0.46 $ 0.71 $ 0.19
Earnings per common share--assuming
dilution............................... $ 0.45 $ 0.69 $ 0.19
</TABLE>
Stock-based compensation plans
At December 31, 1998, we had four stock-based compensation plans, which are
described below.
1994 plan. In August 1994, we established the Total Renal Care Holdings, Inc.
1994 Equity Compensation Plan which provides for awards of nonqualified stock
options to purchase our common stock and other rights to purchase shares of our
common stock to certain of our employees, directors, consultants and facility
medical directors.
Under terms of the 1994 plan, we may grant awards for up to 8,474,078 shares
of our common stock. Original options granted generally vest on the ninth
anniversary of the date of grant, subject to accelerated vesting in the event
that we meet certain performance criteria. In April 1996, we changed the
vesting schedule for new options granted so that options vest over four years
from the date of grant. The exercise price of each option equals the market
price of our stock on the date of grant, and an option's maximum term is ten
years.
Purchase rights to acquire 1,314,450 common shares for $0.90-$3.60 per share
have been awarded to certain employees under the 1994 plan. All of these rights
were exercised and we received notes for the uncollected portion of the
purchase proceeds. These notes bear interest at the lesser of The Bank of
New York's prime rate or 8%, are full recourse to the employees, and are
secured by the employees' stock. The notes are repayable four years from the
date of issuance, subject to certain prepayment requirements. At December 31,
1997 and 1998 the outstanding notes plus accrued interest totaled $212,000 and
$215,000, respectively.
F-23
<PAGE>
TOTAL RENAL CARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
During fiscal 1995, 1,477,778 of the options issued to purchase our common
stock were issued to Victor M.G. Chaltiel. These options originally vested 50%
over four years and 50% in the same manner as other options granted under the
1994 plan. In September 1995, our board of directors and stockholders agreed to
accelerate Mr. Chaltiel's vesting period and all of the options became 100%
vested. Pursuant to this action, Mr. Chaltiel exercised all of the stock
options through the issuance of a full recourse note of $1,330,000 bearing
interest at the lesser of prime or 8%. Additionally, Mr. Chaltiel executed a
full recourse note for $1,349,000 bearing interest at the lesser of prime or 8%
per annum to meet his tax liability in connection with the stock option
exercise. In April 1996, this note was increased by an additional $173,000.
These notes were secured by other shares of company stock and matured in
September 1999 or upon disposition of the common stock by Mr. Chaltiel. During
1998, this note was repaid in full.
1995 plan. In November 1995, we established the Total Renal Care Holdings,
Inc. 1995 Equity Compensation Plan which provides awards of stock options and
the issuance of our common shares, subject to certain restrictions, to certain
employees, directors and other individuals providing services to us. There are
1,666,667 common shares reserved for issuance under the 1995 plan. Options
granted generally vest over four years from the date of grant and an option's
maximum term is ten years, subject to certain restrictions. We generally issue
awards with the exercise prices equal to the market price of our stock on the
date of grant.
1997 plan. In July 1997, we established the Total Renal Care Holdings, Inc.
1997 Equity Compensation Plan which provides awards of stock options and the
issuance of our common shares, subject to certain restrictions, to certain
employees, directors and other individuals providing services to us. In
February 1998, we increased the shares reserved for issuance under the 1997
plan to 7,166,667 common shares. Options granted generally vest over four years
from the date of grant and an option's maximum term is ten years. We generally
issue awards with the exercise prices equal to the market price of our stock on
the date of grant.
The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option-pricing model with the following assumptions used for
grants for 1996, 1997, and 1998, respectively: dividend yield of 0% for all
periods; weighted average expected volatility of 36.35%, 35.12% and 33.98%;
risk-free interest rates of 6.56%, 6.40% and 5.51% and expected lives of six
years for all periods.
A combined summary of the status of the 1994 plan, the 1995 plan, and the
1997 plan as of and for the years ended December 31, 1996, 1997 and 1998 is
presented below:
<TABLE>
<CAPTION>
Year ended Year ended Year ended
December 31, 1996 December 31, 1997 December 31, 1998
-------------------- -------------------- --------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Options Price Options Price Options Price
<S> <C> <C> <C> <C> <C> <C>
Outstanding at beginning
of period.............. 1,441,685 $ 1.91 3,118,394 $13.82 5,039,838 $16.01
Granted................. 1,818,913 22.28 3,931,080 19.74 5,570,567 31.10
Exercised............... (111,647) 0.92 (275,620) 3.96 (254,220) 9.48
Forfeited............... (30,557) 2.43 (1,734,016) 22.46 (308,401) 28.25
---------- ------ ---------- ------ ---------- ------
Outstanding at end of
year................... 3,118,394 $13.82 5,039,838 $16.01 10,047,784 24.15
========== ====== ========== ====== ========== ======
Options exercisable at
year end............... 663,007 797,474 1,959,913
========== ========== ==========
Weighted-average fair
value of options
granted during the
year................... $10.52 $ 9.15 $13.67
====== ====== ======
</TABLE>
Forfeitures and grants include the effects of modifications to the terms of
awards as if the original award was repurchased and exchanged for a new award
of greater value. On April 24, 1997, 1,649,735 shares were
F-24
<PAGE>
TOTAL RENAL CARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
cancelled and reissued at the market price as of that date. The new awards vest
annually over three years on the anniversary date of the new award.
The following table summarizes information about fixed stock options
outstanding at December 31, 1998:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
------------------------------------------ --------------------------
Range of Weighted Average Weighted Weighted
Exercise Remaining Average Average Exercise
Prices Options Contractual Life Exercise Price Options Price
<S> <C> <C> <C> <C> <C>
$ 0.01-$ 5.00 812,937 5.8 years $ 1.15 770,474 $ 1.10
$ 5.01-$10.00 16,545 5.8 years 5.40 12,204 5.40
$10.01-$15.00 13,890 6.8 years 11.82 10,705 11.82
$15.01-$20.00 3,650,919 7.9 years 18.68 1,023,984 18.56
$20.01-$25.00 260,891 9.1 years 21.84 36,454 21.76
$25.01-$30.00 435,043 8.9 years 26.31 82,836 26.50
$30.01-$35.00 4,854,559 9.5 years 32.15 23,256 30.79
$35.01-$40.00 3,000 9.2 years 35.58
---------- --------- ------ --------- ------
10,047,784 8.6 years $24.15 1,959,913 $12.12
========== ========= ====== ========= ======
</TABLE>
RTC plans. In September 1990, RTC established a stock plan, which provided
for awards of incentive and nonqualified stock options to certain directors,
officers, employees and other individuals. In 1995 and 1996, the stock plan was
amended to increase the number of RTC common shares available for grant to
3,253,395 and 4,321,395 respectively. In addition, in 1996, RTC established an
option plan for outside directors pursuant to which nonqualified stock options
to purchase up to 80,100 shares of RTC common stock were reserved for issuance.
Options granted under RTC's plans generally vest from three to five years and
an option's maximum term is ten years, subject to certain restrictions.
Incentive stock options were granted at an exercise price not less than the
fair market value of RTC's common stock on the date of grant. Nonqualified
stock options were permitted to be granted as low as 50% of market value,
subject to certain floor restrictions. Accordingly, compensation expense for
the difference between the fair market value and the exercise price for
nonqualified stock options is recorded over the vesting period of these
options.
In May 1995, RTC granted 559,557 incentive stock options to certain
directors, officers and employees of RTC. These options were granted at an
exercise price equal to the fair market value of RTC's common stock on the date
of the grant. These options vest over three years. Certain options totaling
407,175 vest upon the earlier of attainment of predetermined earnings per share
targets or nine years.
In March 1996, RTC granted 821,495 incentive stock options to certain
directors, officers and employees of RTC. These options were granted at an
exercise price equal to the fair market value of RTC's common stock on the date
of the grant and vest over four years. Certain options aggregating 231,398 vest
upon the earlier of attainment of predetermined earnings per share targets or
nine years.
In December 1996, RTC granted 133,500 incentive stock options to one of its
officers. These options were granted at an exercise price equal to the fair
market value of RTC's common stock on the date of the grant and were fully
vested on the grant date.
Also in December 1996, RTC granted 40,050 non-qualified stock options in
connection with the release of RTC from certain obligations. The options were
granted at an exercise price equal to the fair market value of RTC's common
stock on the date of grant and were fully vested as of December 31, 1997.
F-25
<PAGE>
TOTAL RENAL CARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
During 1997, RTC granted 1,182,543 incentive stock options to certain
directors, officers and employees. These options were granted at an exercise
price equal to the fair market value of RTC's common stock on the dates of the
grants and vest in two to five years.
In 1997 RTC granted 26,700 options to acquisition consultants for covenants
not to compete. These options were granted at a price equal to the fair market
values of RTC's common stock on the date of the grant and were valued at
$235,000.
Upon consummation of our merger with RTC, all outstanding options were
converted to Total Renal Care Holdings Inc. Special Purpose Option Plan
options. This plan provides for awards of incentive and nonqualified stock
options in exchange for outstanding RTC stock plan options. Options under this
plan have the same provisions and terms provided for in the RTC stock plan,
including acceleration provisions upon certain sale of assets, mergers and
consolidations. On the merger date, there was a conversion of 2,156,426 of
RTC's options. Further, options for 1,305,738 shares became fully vested due to
change in control accelerated vesting provisions which were contained in the
original grants. Options for 1,662,356 shares were exercised subsequent to the
merger date. Our Stock Plan Committee has the option of accelerating the
remaining options upon certain sales of assets, mergers and consolidations.
The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option-pricing model with the following assumptions used for
1996 and 1997, respectively: dividend yield of 0% for all periods; weighted
average expected volatility of 29.3% and 43%; risk free interest rates of 6.18%
and 6.55%; and expected lives of 5.63 and 4.29 years.
A summary of the status of the RTC plans as of and for the years ended
December 31, 1996, 1997 and 1998, is presented below:
<TABLE>
<CAPTION>
Year ended Year ended Year ended
December 31, 1996 December 31, 1997 December 31, 1998
------------------- ------------------- --------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Options Price Options Price Options Price
<S> <C> <C> <C> <C> <C> <C> <C>
Outstanding at beginning
of period ............. 1,658,601 $ 7.33 2,293,483 $11.09 3,285,192 $13.20
Granted................. 997,376 16.50 1,182,543 16.84
Exercised............... (351,814) 8.73 (171,830) 7.60 (2,901,218) 12.88
Forfeited............... (10,680) 9.09 (19,004) 13.09 (16,341) 15.45
--------- ------ --------- ------ ---------- ------
Outstanding at end of
year................... 2,293,483 $11.09 3,285,192 $13.33 367,633 15.66
========= ====== ========= ====== ========== ======
Options exercisable at
year end............... 966,903 1,785,169 248,958
========= ========= ==========
Weighted-average fair
value of options
granted during the
year................... $ 7.35 $ 9.70
====== ======
</TABLE>
The following table summarizes information about RTC fixed stock options
outstanding at December 31, 1998:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
--------------------------------------- ----------------------
Range of Weighted Average Weighted Weighted
Exercise Remaining Average Average
Prices Options Contractual Life Exercise Price Options Exercise Price
<S> <C> <C> <C> <C> <C>
5.01-15.00 30,972 6.0 $ 8.58 24,564 $ 8.57
15.01-20.00 336,661 8.0 16.31 224,394 16.45
------- --- ------ ------- ------
367,633 7.9 $15.66 248,958 $15.68
======= === ====== ======= ======
</TABLE>
F-26
<PAGE>
TOTAL RENAL CARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Stock Purchase Plan. In November 1995, we established the Total Renal Care
Holdings, Inc. Employees Stock Purchase Plan which entitles qualifying
employees to purchase up to $25,000 of common stock during each calendar year.
The amounts used to purchase stock are typically accumulated through payroll
withholdings and through an optional lump sum payment made in advance of the
first day of the plan. The plan allows employees to purchase stock for the
lesser of 100% of the fair market value on the first day of the purchase right
period or 85% of the fair market value on the last day of the purchase right
period. Each purchase right period begins on January 1 or July 1, as selected
by the employee and ends on December 31. Payroll withholdings related to the
plan, included in accrued employee compensation and benefits, were $1,120,000
and $1,892,000 at December 31, 1997, and 1998 respectively. Subsequent to
December 31, 1996, and December 31, 1997, 174,775 and 49,060 shares,
respectively were issued to satisfy our obligations under the plan.
For the November 1995 and July 1996 purchase right periods the fair value of
the employees' purchase rights were estimated on the beginning date of the
purchase right period using the Black-Scholes model with the following
assumptions for grants on November 3, 1995, July 1, 1996, January 1, 1997 and
July 1, 1997, respectively: dividend yield of 0% for all periods; expected
volatility of 36.6% in 1995 and 1996 and 34.23% in 1997; risk-free interest
rate of 5.5%, 6.6%, 6.8% and 6.8% and expected lives of 1.2, 0.5, 1.0, and 0.5
years. Using these assumptions, the weighted-average fair value of purchase
rights granted were $2.86, $7.37, $15.31, and $11.17, respectively.
The fair value of the January 1, 1998 and July 1, 1998 purchase right periods
were not estimated at December 31, 1998 because of the employees' ability to
withdraw from participation through December 31.
F-27
<PAGE>
TOTAL RENAL CARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Pro forma net income and earnings per share. We applied APB Opinion No. 25
and related interpretations in accounting for all of our plans. Accordingly, no
compensation cost has been recognized for our fixed stock option plans and our
stock purchase plan. Had compensation cost for our stock-based compensation
plans been determined consistent with SFAS 123, our net income and earnings per
share would have been reduced to the pro forma amounts indicated below:
<TABLE>
<CAPTION>
Year ended Year ended
December December Year ended
31, 31, December 31,
1996 1997 1998
<S> <C> <C> <C>
Income before extraordinary item and
cumulative effect of change in
accounting principle................... $28,830,000 $43,282,000 $ 9,154,000
Extraordinary loss.................... (7,700,000) (12,744,000)
Cumulative effect of change in
accounting principle................. (6,896,000)
----------- ----------- ------------
Net income (loss)..................... $21,130,000 $43,282,000 $(10,486,000)
=========== =========== ============
Earnings per common share
Income before extraordinary item...... $ 0.39 $ 0.56 $ 0.11
Extraordinary loss.................... (0.10) (0.16)
Cumulative effect of change in
accounting principle................. (0.08)
----------- ----------- ------------
Net income (loss)..................... $ 0.29 $ 0.56 $ (0.13)
=========== =========== ============
Weighted average number of common shares
and equivalents outstanding 74,042,000 77,524,000 80,143,000
=========== =========== ============
Earnings per common share--assuming
dilution:
Income before extraordinary item...... $ 0.35 $ 0.55 $ 0.11
Extraordinary loss.................... ( 0.09) (0.16)
Cumulative effect of change in
accounting principle................. (0.08)
----------- ----------- ------------
Net income (loss)..................... $ 0.26 $ 0.55 $ (0.13)
=========== =========== ============
Weighted average number of common shares
and equivalents outstanding--assuming
dilution............................... 83,477,000 78,982,000 81,701,000
=========== =========== ============
</TABLE>
11. Transactions with related parties
Tenet
Tenet Healthcare Corporation, or Tenet, owns less than 5% of our common stock
and we provide dialysis services to Tenet hospital patients under agreements
with terms of one to three years. The contract terms are comparable to
contracts with unrelated third parties. Included in the receivable from Tenet
are amounts related to these services of $534,000 and $350,000 at December 31,
1997 and 1998, respectively. Net operating revenues received from Tenet for
these services were $2,260,000, $2,640,000 and $2,424,000 for 1996, 1997 and
1998, respectively.
DLJ
A managing director of Donaldson, Lufkin & Jenrette, or DLJ, serves on our
board of directors and, prior to August 1997, an affiliate of DLJ held an
ownership interest in us. During 1996 DLJ was one of several underwriters for
two public stock offerings in which we issued 11,666,667 and 833,334 shares,
respectively. Fees for these transactions to DLJ or its affiliates were
$5,075,000, and $780,000, respectively. Effective with the August 1997 public
offering of common stock, DLJ and its affiliates no longer own an interest in
us. During 1998, DLJ advised us on our acquisition of RTC and assisted us in
the issuance of the 7% notes.
F-28
<PAGE>
TOTAL RENAL CARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
12. Employee benefit plan
We have a savings plan for substantially all employees, which has been
established pursuant to the provisions of Section 401(k) of the Internal
Revenue Code, or IRC. The plan provides for employees to contribute from 1% to
15% of their base annual salaries on a tax-deferred basis not to exceed IRC
limitations. We may make a contribution under the plan each fiscal year as
determined by our board of directors. We made matched contributions of $58,000,
in accordance with specific state requirements, in 1998.
RTC had a defined contribution savings plan covering substantially all of its
employees. RTC's contributions under the plan were approximately $548,000, and
$1,069,000 and $641,000 for years ended December 31, 1996, 1997 and 1998,
respectively. Effective July 1, 1998, the plan was terminated and merged into
our plan.
13. Contingencies
Our Florida-based laboratory subsidiary is presently the subject of a
Medicare carrier review. The carrier has requested certain medical and billing
records for certain patients and we have provided the requested records. The
carrier has suspended further payments to the laboratory subsidiary, amounting
to approximately $11 million at December 31, 1998, and made a formal
overpayment determination. We are appealing the overpayment determination and
have filed a suit to lift the payment suspension.
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.
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.
14. Mergers and acquisitions
Mergers
During the fiscal year 1996, RTC completed the following three mergers:
. The Kidney Center Group
On July 23, 1996, RTC acquired the Kidney Center Group. The two dialysis
facilities acquired are located in Florida and serviced a total of
approximately 185 patients as of the acquisition date. The transaction was
accounted for under the pooling-of-interests method of accounting. In the
transaction, RTC issued 482,377 shares of its common stock in exchange for all
of the outstanding stock of the Kidney Center Group.
. MDU
On February 29, 1996, RTC acquired MDU. The 11 dialysis facilities acquired
are located in Oklahoma and serviced a total of approximately 317 patients as
of the acquisition date. The transaction was accounted for
F-29
<PAGE>
TOTAL RENAL CARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
under the pooling-of-interests method of accounting. In the transaction, RTC
issued 767,168 shares of its common stock in exchange for all of the
outstanding stock of MDU.
. IMS
On February 20, 1996, RTC acquired IMS. The four dialysis facilities acquired
are located in Hawaii and serviced a total of approximately 444 patients as of
the acquisition date. The transaction was accounted for under the pooling-of-
interests method of accounting. In the transaction, RTC issued 1,047,464 shares
of its common stock in exchange for all of the outstanding stock of IMS.
The consolidated financial statements give retroactive effect to the mergers
with the Kidney Center Group, IMS and MDU and include the Kidney Center Group,
IMS and MDU for all periods presented. The following is a summary of the
separate and combined results of operations for 1996:
<TABLE>
<CAPTION>
Pooling
RTC Companies* RTC Combined
<S> <C> <C> <C>
Net patient revenue................ $217,529,000 $7,548,000 $225,077,000
Income from operations............. 20,495,000 1,180,000 21,675,000
Net income......................... 9,985,000 697,000 10,682,000
</TABLE>
- --------
* Includes pooling transactions only for period prior to acquisition. Activity
subsequent to acquisition dates is included in RTC.
Acquisitions
We have implemented an acquisition strategy which, through December 31, 1998,
has resulted in the acquisition of (a) 396 facilities providing services to
ESRD patients; (b) two laboratories; (c) a pharmacy; (d) a vascular access
management company; and (e) a clinical research company specializing in renal
and renal-related services. The following is a summary of acquisitions that
were accounted for as purchases for 1996, 1997 and 1998.
<TABLE>
<CAPTION>
Year ended December 31,
--------------------------------------
1996 1997 1998
<S> <C> <C> <C>
Number of facilities acquired.......... 67 119 76
Number of common shares issued......... 102,645 17,613 98,549
Estimated fair value of common shares
issued................................ $ 1,830,000 $ 273,000 $ 2,796,000
Acquisition obligations (Note 8)....... 15,886,000 15,233,000
Cash paid, net of cash acquired........ 179,002,000 455,090,000 338,164,000
------------ ------------ ------------
Aggregate purchase price............... $196,718,000 $455,363,000 $356,193,000
============ ============ ============
</TABLE>
In addition, during this period we developed 52 de novo facilities, three of
which we manage, entered into management contracts covering an additional 29
unaffiliated facilities, and purchased the minority interest at nine of our
existing facilities.
F-30
<PAGE>
TOTAL RENAL CARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The assets and liabilities of the acquired entities in the preceding table
were recorded at their estimated fair market values at the dates of
acquisition. The initial allocations of fair market value are preliminary and
subject to adjustment during the first year following the acquisition. The
results of operations of the facilities and laboratories have been included in
our financial statements from their respective acquisition dates. These initial
allocations were as follows:
<TABLE>
<CAPTION>
Years ended December 31,
----------------------------------------
1996 1997 1998
<S> <C> <C> <C>
Identified intangibles................ $ 34,682,000 $ 87,498,000 $ 39,992,000
Goodwill.............................. 135,456,000 366,121,000 315,655,000
Tangible assets....................... 44,265,000 47,053,000 30,650,000
Liabilities assumed................... (17,685,000) (45,309,000) (30,104,000)
------------ ------------ ------------
Total purchase price................ $196,718,000 $455,363,000 $356,193,000
============ ============ ============
</TABLE>
The following summary, prepared on a pro forma basis, combines the results of
operations as if the acquisitions had been consummated as of the beginning of
each of the periods presented, after including the impact of certain
adjustments such as amortization of intangibles, interest expense on
acquisition financing and income tax effects.
<TABLE>
<CAPTION>
Year ended Year ended Year ended
December 31, December 31, December 31,
1996 1997 1998
(unaudited) (unaudited) (unaudited)
<S> <C> <C> <C>
Net revenues......................... $794,235,000 $999,033,000 $1,345,376,000
Net income before extraordinary item
and cumulative effect of change in
accounting principle................ $ 50,253,000 $ 64,467,000 $ 19,530,000
Net income (loss).................... 42,553,000 64,467,000 (110,000)
Pro forma net income per share before
extraordinary item and cumulative
effect of change in accounting
principle........................... $ 0.68 $ 0.83 $ 0.24
Pro forma net income per share before
extraordinary item and cumulative
effect of change in accounting
principle--assuming dilution........ $ 0.65 $ 0.81 $ 0.24
Pro forma net income (loss) per
share............................... 0.57 0.83 0.00
Pro forma net income (loss) per
share--assuming dilution............ 0.55 0.81 0.00
</TABLE>
The unaudited pro forma results are not necessarily indicative of what
actually would have occurred if the acquisitions had been completed prior to
the beginning of the periods presented. In addition, they are not intended to
be a projection of future results and do not reflect any of the synergies,
additional revenue-generating services or direct facility operating expense
reduction that might be achieved from combined operations.
Since December 31, 1998, we have acquired 17 additional facilities in ten
separate transactions for an aggregate purchase price of approximately $44.6
million all of which will be accounted for as purchases.
F-31
<PAGE>
TOTAL RENAL CARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
15. Supplemental cash flow information
The table below provides supplemental cash flow information:
<TABLE>
<CAPTION>
Years ended December 31,
-----------------------------------
1996 1997 1998
<S> <C> <C> <C>
Cash paid for:
Income taxes............................. $30,069,000 $37,402,000 $13,676,000
Interest................................. 5,730,000 25,039,000 66,409,000
Noncash investing and financing activities:
Estimated value of stock and options
issued in acquisitions.................. 2,810,000 273,000 2,796,000
Fixed assets acquired under capital lease
obligations............................. 3,670,000 829,000 583,000
Contribution to partnerships............. 943,000 2,318,000 2,592,852
Issuance of common stock in connection
with earn out note...................... 1,474,000 5,148,000
Issuance of common stock in connection
with Kidney Center Group, IMS and MDU
mergers................................. 3,204,000
Grant of stock options in connection with
covenant not to compete................. 235,000
</TABLE>
F-32
<PAGE>
TOTAL RENAL CARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
16. Selected quarterly financial data (unaudited)
Summary unaudited quarterly financial data for 1997 and 1998 is as follows
(in thousands, except per share amounts). The unaudited quarterly financial
data for the quarters ended March 31, 1998, June 30, 1998 and September 30,
1998 have been restated in accordance with Note 1.
<TABLE>
<CAPTION>
March 31, June 30, September 30, December 31, March 31, June 30, September 30, December 31,
1997 1997 1997 1997 1998 1998 1998 1998
(restated) (restated) (restated)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Net operating revenues.. $157,937 $179,715 $197,749 $225,596 $258,749 $288,350 $318,585 $339,210
Operating income........ 24,596 28,694 33,287 38,203 (30,948) 56,837 66,184 49,745
Income (loss) before
extraordinary item and
cumulative effect of
change in accounting
principle.............. 11,788 13,470 14,632 15,137 (46,088) 17,839 27,381 16,210
Net income (loss)....... 11,788 13,470 14,632 15,137 (55,796) 7,907 27,381 16,210
Income (loss) per common
share:
Income before
extraordinary item and
cumulative effect of
change in accounting
principle............. 0.15 0.17 0.19 0.19 (0.59) 0.22 0.34 0.20
Extraordinary loss..... (0.03) (0.12)
Cumulative effect of
change in accounting
principle............. (0.09)
-------- -------- -------- -------- -------- -------- -------- --------
Net income (loss) per
share................. 0.15 0.17 0.19 0.19 (0.71) 0.10 0.34 0.20
======== ======== ======== ======== ======== ======== ======== ========
Income (loss) per common
share--assuming
dilution:
Income (loss) before
extraordinary item and
cumulative effect of
change in accounting
principle............. 0.15 0.17 0.18 0.19 (0.59) 0.22 0.33 0.20
Extraordinary loss..... (0.03) (0.12)
Cumulative effect of
change in accounting
principle............. (0.09)
-------- -------- -------- -------- -------- -------- -------- --------
Net income (loss) per
share................. 0.15 0.17 0.18 0.19 (0.71) 0.10 0.33 0.20
======== ======== ======== ======== ======== ======== ======== ========
</TABLE>
F-33
<PAGE>
TOTAL RENAL CARE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
A reconciliation of the amounts originally reported for the first three
quarters of 1998 to the amounts presented above is as follows:
<TABLE>
<CAPTION>
March 31, March 31, June 30, June 30, September 30,
1998 1998 1998 1998 1998 September 30,
Original Adjustment Adjusted Original Adjustment Adjusted Original Adjustment 1998 Adjusted
--------- ---------- --------- -------- ---------- -------- ------------- ---------- -------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Net operating
revenues........... $258,749 $258,749 $288,350 $288,350 $318,585 $318,585
Operating income.... (42,058) 11,110 (30,948) 59,707 (2,870) 56,837 69,054 (2,870) 66,184
Income before
extraordinary item
and cumulative
effect of change in
accounting
principle.......... (52,776) 6,688 (46,088) 19,567 (1,728) 17,839 29,109 (1,728) 27,381
Net income (loss)... (62,484) 6,688 (55,796) 9,635 (1,728) 7,907 29,109 (1,728) 27,381
Income (loss) per
common share:
Income before
extraordinary item
and cumulative
effect of change
in accounting
principle......... (0.67) 0.08 (0.59) 0.24 (0.02) 0.22 0.36 (0.02) 0.34
Extraordinary
loss.............. (0.03) (0.03) (0.12) (0.12)
Cumulative effect
of change in
accounting
principle......... (0.09) (0.09)
Net income (loss)
per share......... (0.79) 0.08 (0.71) 0.12 (0.02) 0.10 0.36 (0.02) 0.34
Income (loss) per
common share--
assuming dilution:
Income before
extraordinary item
and cumulative
effect of change
in accounting
principle......... (0.67) 0.08 (0.59) 0.24 (0.02) 0.22 0.35 (0.02) 0.33
Extraordinary
loss.............. (0.03) (0.03) (0.12) (0.12)
Cumulative effect
of change in
accounting
principle......... (0.09) (0.09)
Net income (loss)
per share......... (0.79) 0.08 (0.71) 0.12 (0.02) 0.10 0.35 (0.02) 0.33
</TABLE>
See Note 1 regarding revisions to 1998 quarterly results.
F-34
<PAGE>
SIGNATURES
Pursuant to the requirements Section 13 or 15(d) of the Securities Exchange
Act of 1934, we have duly caused this Report on Form 10-K/A to be signed on
our behalf by the undersigned, thereunto duly authorized, in the City of
Torrance, State of California, on October 8, 1999.
TOTAL RENAL CARE HOLDINGS, INC.
/s/ George DeHuff
By: ____________________________
George DeHuff
President and
Interim Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
Report on Form 10-K/A has been signed by the following persons in the
capacities and on the dates indicated.
<TABLE>
<CAPTION>
Signature Title Date
--------- ----- ----
<C> <S> <C>
/s/ George DeHuff President and Interim October 8, 1999
____________________________________ Chief Executive Officer
George DeHuff (Principal Executive
Officer)
/s/ Maris Andersons Director and Chairman, October 8, 1999
____________________________________ Finance Committee of
Maris Andersons the Board of Directors
(Principal Financial
Officer)
/s/ John J. McDonough Vice President and Chief October 8, 1999
____________________________________ Accounting Officer
John J. McDonough (Principal Accounting
Officer)
* Director October 8, 1999
____________________________________
Victor M.G. Chaltiel
* Director October 8, 1999
____________________________________
Peter T. Grauer
* Director October 8, 1999
____________________________________
Regina E. Herzlinger
* Director October 8, 1999
____________________________________
Shaul G. Massry
/s/ Barry C. Cosgrove
*By: _______________________________
Barry C. Cosgrove
Attorney-in-Fact
</TABLE>
II-1
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS ON
FINANCIAL STATEMENT SCHEDULE
To the Board of Directors
of Total Renal Care Holdings, Inc.
Our audit of the consolidated financial statements referred to in our report
dated March 29, 1999, appearing on page F-1 of this Annual Report on Form 10-
K/A also included audits of the information included in the Financial Statement
Schedule listed in Item 14(a)(2) of this Form 10-K/A for the years ended
December 31, 1996, 1997 and 1998. In our opinion, based upon our audit, the
Financial Statement Schedule presents fairly, in all material respects, the
information for the years ended December 31, 1996, 1997 and 1998 set forth
therein when read in conjunction with the related consolidated financial
statements.
PricewaterhouseCoopers LLP
Seattle, Washington
March 29, 1999
S-1
<PAGE>
TOTAL RENAL CARE HOLDINGS, INC.
SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS
<TABLE>
<CAPTION>
Additions Deductions
---------------------- -----------
Balances
Balance at Amounts of
Beginning Charged to Companies Amounts Balance at
Description of Year Income Acquired Written off End of Year
<S> <C> <C> <C> <C> <C>
Allowance for doubtful accounts:
Year ended December 31, 1996.. $ 9,172,000 $15,737,000 $1,896,000 $11,040,000 $15,765,000
Year ended December 31, 1997.. 15,765,000 20,525,000 2,962,000 8,557,000 30,695,000
Year ended December 31, 1998.. 30,695,000 44,365,000 1,172,000 14,384,000 61,848,000
</TABLE>
S-2
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibit Page
Number Description Number
<C> <S> <C>
3.1 Amended and Restated Certificate of Incorporation of TRCH,
dated December 4, 1995.(1)
3.2 Certificate of Amendment of Certificate of Incorporation of
TRCH, dated February 26, 1998.(2)
3.3 Bylaws of TRCH, dated October 6, 1995.(3)
4.1 Shareholders Agreement, dated August 11, 1994, between DLJMB,
DLJIP, DLJOP, DLJMBF, NME Properties, Continental Bank, as
voting trustee, and TRCH.(4)
4.2 Agreement and Amendment, dated as of June 30, 1995, between
DLJMBP, DLJIP, DLJOP, DLJMBF, DLJESC, Tenet, TRCH, Victor
M.G. Chaltiel, the Putnam Purchasers, the Crescent
Purchasers and the Harvard Purchasers, relating to the
Shareholders Agreement dated as of August 11, 1994 between
DLJMB, DLJIP, DLJOP, DLJMBF, NME Properties, Continental
Bank, as voting trustee, and TRCH.(4)
4.3 Indenture, dated June 12, 1996 by RTC to PNC Bank including
form of RTC Note.(12)
4.4 First Supplemental Indenture, dated as of February 27, 1998,
among RTC, TRCH and PNC Bank under the 1996 indenture.(2)
4.5 Second Supplemental Indenture, dated as of March 31, 1998,
among RTC, TRCH and PNC Bank under the 1996 indenture.(2)
4.6 Indenture, dated as of November 18, 1998, between TRCH and
United States Trust Company of New York, as trustee, and
Form of Note.(5)
4.7 Registration Rights Agreement, dated as of November 18, 1998,
between TRCH and DLJ, BNY Capital Markets, Inc., Credit
Suisse First Boston Corporation and Warburg Dillon Read LLC,
as the initial purchasers.(5)
4.8 Purchase Agreement, dated as of November 12, 1998, between
TRCH and the initial purchasers.(5)
Noncompetition Agreement, dated August 11, 1994, between TRCH
10.1 and Tenet.(4)
10.2 Employment Agreement, dated as of August 11, 1994, by and
between TRCH and Victor M.G. Chaltiel (with forms of
Promissory Note and Pledge and Stock Subscription Agreement
attached as exhibits thereto).(4)*
10.3 Amendment to Mr. Chaltiel's employment agreement, dated as of
August 11, 1994.(4)*
10.4 Second Amendment to Mr. Chaltiel's employment agreement,
dated as of March 2, 1998.*(13)
10.5 Employment Agreement, dated as of March 2, 1998, by and
between TRCH and Barry C. Cosgrove.(6)*
10.6 Employment Agreement, dated as of March 2, 1998, by and
between TRCH and Leonard W.
Frie.(6)*
10.7 Employment Agreement, dated as of March 2, 1998, by and
between TRCH and John E. King.(6)*
10.8 Employment Agreement dated as of March 2, 1998 by and between
TRCH and Stan M. Lindenfeld.(6)*
10.9 Amendment to Dr. Lindenfeld's employment agreement, dated
September 1, 1998.*(13)
10.10 First Amended and Restated 1994 Equity Compensation Plan of
TRCH (with form of Promissory Note and Pledge attached as an
exhibit thereto), dated August 5, 1994.(4)*
10.11 Form of Stock Subscription Agreement relating to the 1994
Equity Compensation Plan.(4)*
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
Exhibit Page
Number Description Number
<C> <S> <C>
10.12 Form of Purchased Shares Award Agreement relating to the 1994
Equity Compensation Plan.(4)*
10.13 Form of Nonqualified Stock Option relating to the 1994 Equity
Compensation Plan.(4)*
10.14 1995 Equity Compensation Plan.(3)*
10.15 Employee Stock Purchase Plan.(3)*
10.16 Option Exercise and Bonus Agreement, dated as of September
18, 1995 between TRCH and Victor M.G. Chaltiel.(3)*
10.17 1997 Equity Compensation Plan.(7)
10.18 Amended and Restated Revolving Credit Agreement, dated as of
April 30, 1998, by and among TRCH, the lenders party
thereto, DLJ Capital Funding, Inc., as Syndication Agent,
First Union National Bank, as Documentation Agent, and The
Bank of New York, as Administrative Agent.(8)
10.19 Amendment No. 1 and Consent No. 1, dated as of August 5,
1998, to the Revolving Credit Agreement.(13)
10.20 Amendment No. 2, dated as of November 12, 1998, to the
Revolving Credit Agreement.(13)
10.21 Amended and Restated Term Loan Agreement, dated as of April
30, 1998, by and among TRCH, the lenders party thereto, DLJ
Capital Funding, Inc., as Syndication Agent, First Union
National Bank, as Documentation Agent, and The Bank of New
York, as Administrative Agent.(8)
10.22 Subsidiary Guaranty dated as of October 24, 1997 by Total
Renal Care, Inc., TRC West, Inc. and Total Renal Care
Acquisition Corp. in favor of and for the benefit of The
Bank of New York, as Collateral Agent, the lenders to the
Revolving Credit Agreement, the lenders to the Term Loan
Agreement, the Term Agent (as defined therein), the
Acknowledging Interest Rate Exchangers (as defined therein)
and the Acknowledging Currency Exchangers (as defined
therein).(9)
10.23 Borrower Pledge Agreement dated as of October 24, 1997 and
entered into by and between the Company, and The Bank of New
York, as Collateral Agent, the lenders to the Revolving
Credit Agreement, the lenders to the Term Loan Agreement,
the Term Agent (as defined therein), the Acknowledging
Interest Rate Exchangers (as defined therein) and the
Acknowledging Currency Exchangers (as defined therein).(9)
10.24 Amendment to Borrower Pledge Agreement, dated February 27,
1998, executed by TRCH in favor of The Bank of New York, as
Collateral Agent.(13)
10.25 Form of Subsidiary Pledge Agreement dated as of October 24,
1997 by Total Renal Care, Inc., TRC West, Inc. and Total
Renal Care Acquisition Corp., and The Bank of New York, as
Collateral Agent, the lenders to the Revolving Credit
Agreement, the lenders to the Term Loan Agreement, the Term
Agent (as defined therein), the Acknowledging Interest Rate
Exchangers (as defined therein) and the Acknowledging
Currency Exchangers (as defined therein).(9)
10.26 Subsidiary Pledge Agreement, dated as of February 27, 1998,
by RTC and The Bank of New York, as Collateral Agent, the
lenders to the Revolving Credit Agreement, the lenders to
the Term Loan Agreement, the Term Agent (as defined
therein), the Acknowledging Interest Rate Exchangers (as
defined therein) and the Acknowledging Currency Exchangers
(as defined therein).(13)
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
Exhibit Page
Number Description Number
<C> <S> <C>
10.27 Form of First Amendment to Borrower/Subsidiary Pledge
Agreement, dated April 30, 1998, by and among TRCH, RTC, TRC
and The Bank of New York, as Collateral Agent.(8)
10.28 Form of Acknowledgement and Confirmation, dated April 30,
1998, by TRCH, RTC, TRC West, Inc., Total Renal Care, Inc.,
Total Renal Care Acquisition Corp., Renal Treatment
Centers--Mid-Atlantic, Inc., Renal Treatment Centers--
Northeast, Inc., Renal Treatment Centers--California, Inc.,
Renal Treatment Centers--West, Inc., and Renal Treatment
Centers--Southeast, Inc. for the benefit of The Bank of New
York, as Collateral Agent and the lenders party to the Term
Loan Agreement or the Revolving Credit Agreement.(8)
10.29 Agreement and Plan of Merger dated as of November 18, 1997 by
and among TRCH, Nevada Acquisition Corp., a Delaware
corporation and wholly-owned subsidiary of TRCH, and
RTC.(10)
10.30 First Amendment to the Subsidiary Guaranty dated February 17,
1998.(2)
10.31 Special Purpose Option Plan.(11)
10.32 Guaranty, entered into as of March 31, 1998, by TRCH in favor
of and for the benefit of PNC Bank.(2)
10.33 First Amendment, dated as of August 5, 1998, to the Term Loan
Agreement.X
12.1 Statement re Computation of Ratios of Earnings to Fixed
Charges.(13)
21.1 List of our subsidiaries.(13)
23.1 Consent of PricewaterhouseCoopers LLP.X
24.1 Powers of Attorney with respect to TRCH.(13)
27.1 Financial Data Schedule.(13)
</TABLE>
- --------
X Included in this filing.
* Management contract or executive compensation plan or arrangement.
(1) Filed on March 18, 1996 as an exhibit to our Transitional Report on Form
10-K for the transition period from June 1, 1995 to December 31, 1995.
(2) Filed on March 31, 1998 as an exhibit to our Form 10-K for the year ended
December 31, 1997.
(3) Filed on October 24, 1995 as an exhibit to Amendment No. 2 to our
Registration Statement on Form S-1 (Registration Statement No. 33-97618).
(4) Filed on August 29, 1995 as an exhibit to our Form 10-K for the year ended
May 31, 1995.
(5) Filed on December 18, 1998 as an exhibit to our Registration Statement on
Form S-3 (Registration Statement No. 333-69227).
(6) Filed as an exhibit to our Form 10-Q for the quarter ended September 30,
1998.
(7) Filed on August 29, 1997 as an exhibit to our Registration Statement on
Form S-8 (Registration Statement No. 333-34695).
(8) Filed on May 18, 1998 as an exhibit to Amendment No. 1 to our annual
report for the year ended December 31, 1997 on Form 10-K/A.
(9) Filed on December 19, 1997 as an exhibit to our Current Report on Form 8-
K.
(10) Filed on December 19, 1997 as Annex A to our Registration Statement on
Form S-4 (Registration Statement No. 333-42653).
(11) Filed on February 25, 1998 as an exhibit to our Registration Statement on
Form S-8 (Registration Statement No. 333-46887).
(12) Filed as an exhibit to RTC's Form 10-Q for the quarter ended June 30,
1996.
(13) Filed on March 31, 1999 as an exhibit to our Form 10-K for the year ended
December 31, 1998.
<PAGE>
EXHIBIT 10.33
TOTAL RENAL CARE HOLDINGS, INC.
FIRST AMENDMENT
TO AMENDED AND RESTATED TERM LOAN AGREEMENT
This FIRST AMENDMENT TO AMENDED AND RESTATED TERM LOAN AGREEMENT (this
"Amendment") is dated as of August 5, 1998, and entered into by and among TOTAL
RENAL CARE HOLDINGS, INC., a Delaware corporation (the "Borrower"), the
financial institutions listed on the signature pages hereof (the "Lenders",
each a "Lender"), DLJ CAPITAL FUNDING, INC., as Syndication Agent (the
"Syndication Agent"), THE BANK OF NEW YORK, as collateral agent and as
administrative agent for the Lenders (in such capacity, the "Administrative
Agent"), and, for purposes of Section 4 hereof, the Credit Support Parties (as
defined in Section 4 hereof) listed on the signature pages hereof, and is made
with reference to that certain Amended and Restated Term Loan Agreement dated
as of April 30, 1998 (the "Term Loan Agreement"), by and among the Borrower,
Lenders, Syndication Agent and Administrative Agent. Capitalized terms used
herein without definition shall have the same meanings herein as set forth in
the Term Loan Agreement.
RECITALS
WHEREAS, the Borrower, the Lenders, the Administrative Agent and the
Syndication Agent desire to amend the Term Loan Agreement for the purpose of
(i) revising the representation contained in Section 4.19 thereof; (ii)
revising the event of default contained in Section 9.1(o) thereof, and (iii)
making certain other changes thereto as set forth herein;
NOW, THEREFORE, in consideration of the premises and the agreements,
provisions and covenants herein contained, the parties hereto agree as follows:
Section 1. AMENDMENTS TO THE TERM LOAN AGREEMENT
1.1 Amendments to Section 4: Representations and Warranties
Section 4.19 of the Term Loan Agreement is hereby amended by deleting it in
its entirety and substituting the following therefor:
"4.19 Medicare Participation/Accreditation
The facilities operated by the Borrower and its Subsidiaries (the
"Facilities') are qualified for participation in the Medicare and Medicaid
programs (together with their respective intermediaries or carriers, the
"Government Reimbursement Programs') and are entitled to reimbursement
under the Medicare program for services rendered to qualified Medicare
beneficiaries, and comply in all material respects with the conditions of
participation in all Government Reimbursement Programs. There is no pending
or, to Borrower's knowledge, threatened proceeding or investigation by any
of the Government Reimbursement Programs with respect to (i) the Borrower's
or any of its Subsidiaries' qualification or right to participate in any
Government Reimbursement Program, (ii) the compliance or non-compliance by
the Borrower or any of its Subsidiaries with the terms or provisions of any
Government Reimbursement Programs, or (iii) the right of the Borrower or
any of its Subsidiaries to receive or retain amounts received or due or to
become due from any Government Reimbursement Programs, which proceeding or
investigation, together with all other such proceedings and investigations
could reasonably be expected to have a Material Adverse Effect."
1.2 Amendment to Section 9: Events of Default
Section 9.1(o) of the Term Loan Agreement is hereby amended by deleting it in
its entirety and substituting the following therefor:
"(o) The Borrower or any Subsidiary, in each case to the extent it is
engaged in the business of providing services for which Medicare or
Medicaid reimbursement is sought, shall for any reason,
<PAGE>
including, without limitation, as the result of any finding, designation or
decertification, lose its right or authorization, or otherwise fail to be
eligible, to participate in Medicaid or Medicare programs or to accept
assignments or rights to reimbursements under Medicaid regulations or
Medicare regulations, or the Borrower or any Subsidiary has, for any
reason, had its right to receive reimbursements under Medicaid or Medicare
regulations suspended, and such loss, failure or suspension (together with
all other such losses, failures and suspensions continuing at such time)
shall have resulted in a Material Adverse Effect."
Section 2. CONDITIONS TO EFFECTIVENESS
Section 1 of this Amendment shall become effective as of April 30, 1998, only
upon the satisfaction of all of the following conditions precedent (the date of
satisfaction of such conditions being referred to herein as the "First
Amendment Effective Date"):
A. Required Lenders (as such term is defined in the Revolving Credit
Agreement) shall have entered into an amendment and consent thereto that
consents to this Amendment, which amendment and consent shall be in form
and substance satisfactory to the Administrative Agent and Syndication
Agent, and all conditions to the effectiveness thereof (other than
effectiveness hereof) shall have been satisfied or waived.
Section 3. BORROWER'S REPRESENTATIONS AND WARRANTIES
In order to induce Lenders to enter into this Amendment and to amend the Term
Loan Agreement in the manner provided herein, Borrower represents and warrants
to each Lender that the following statements are true, correct and complete:
A. Corporate Power and Authority. Each Credit Party has all requisite
corporate power and authority to enter into this Amendment and to carry out the
transactions contemplated by, and perform its obligations under, the Term Loan
Agreement as amended by this Amendment (the "Amended Agreement").
B. Authorization of Agreements. The execution and delivery of this Amendment
have been duly authorized by all necessary corporate action on the part of each
Credit Party. The performance of the Amended Agreement has been duly authorized
by all necessary corporate action on the part of each Credit Party.
C. No Conflict. The execution and delivery by each Credit Party of this
Amendment, and the performance by each Credit Party of the Amended Agreement do
not and will not (i) violate any provision of any law or any governmental rule
or regulation applicable to Borrower or any of its Subsidiaries, the
Certificate or Articles of Incorporation or Bylaws of Borrower or any of its
Subsidiaries or any order, judgment or decree of any court or other agency of
government binding on Borrower or any of its Subsidiaries, (ii) conflict with,
result in a breach of or constitute (with due notice or lapse of time or both)
a default under any contractual obligation of Borrower or any of its
Subsidiaries, (iii) result in or require the creation or imposition of any Lien
upon any of the properties or assets of Borrower or any of its Subsidiaries
(other than Liens created under any of the Loan Documents in favor of
Administrative Agent on behalf of Lenders), or (iv) require any approval of
stockholders or any approval or consent of any Person under any contractual
obligation of Borrower or any of its Subsidiaries.
D. Governmental Consents. The execution and delivery by each Credit Party of
this Amendment, and the performance by each Credit Party of the Amended
Agreement do not and will not require any registration with, consent or
approval of, or notice to, or other action to, with or by, any federal, state
or other governmental authority or regulatory body.
E. Binding Obligation. This Amendment and the Amended Agreement have been
duly executed and delivered by each Credit Party and are the legally valid and
binding obligations of each Credit Party, enforceable against each Credit Party
in accordance with their respective terms, except as may be limited by
bankruptcy, insolvency, reorganization, moratorium or similar laws relating to
or limiting creditors' rights generally or by equitable principles relating to
enforceability.
2
<PAGE>
F. Incorporation of Representations and Warranties From Term Loan
Agreement. The representations and warranties contained in Section 4 of the
Term Loan Agreement (after giving effect to this Amendment) are and will be
true, correct and complete in all material respects on and as of the First
Amendment Effective Date to the same extent as though made on and as of that
date, except to the extent such representations and warranties specifically
relate to an earlier date, in which case they were true, correct and complete
in all material respects on and as of such earlier date.
G. Absence of Default. No event has occurred and is continuing or will result
from the consummation of the transactions contemplated by this Amendment that
would constitute an Event of Default, other than any Events of Default that
will be cured upon the effectiveness of this Amendment.
Section 4. ACKNOWLEDGEMENT AND CONSENT
Borrower is a party to the Borrower Pledge Agreement pursuant to which
Borrower has pledged certain Collateral to Administrative Agent to secure the
Obligations. TRC is a party to the Subsidiary Guaranty and the Subsidiary
Pledge Agreement pursuant to which TRC has (i) guarantied the Obligations and
(ii) pledged certain Collateral to Administrative Agent to secure the
Obligations and to secure the obligations of TRC under the Subsidiary Guaranty.
Each of the other Guarantors listed on the signature pages hereof is a party to
the Subsidiary Guaranty pursuant to which such Guarantor has guarantied the
Obligations. Borrower and the Guarantors are collectively referred to herein as
the "Credit Support Parties", and the Borrower Pledge Agreement, the Subsidiary
Pledge Agreement and the Subsidiary Guaranty are collectively referred to
herein as the "Credit Support Documents".
Each Credit Support Party hereby acknowledges that it has reviewed the terms
and provisions of the Term Loan Agreement and this Amendment and consents to
the amendment of the Term Loan Agreement effected pursuant to this Amendment.
Each Credit Support Party hereby confirms that each Credit Support Document to
which it is a party or otherwise bound and all Collateral encumbered thereby
will continue to guaranty or secure, as the case may be, to the fullest extent
possible the payment and performance of all "Guarantied Obligations" and
"Secured Obligations," as the case may be (in each case as such terms are
defined in the applicable Credit Support Document), including without
limitation the payment and performance of all such "Guarantied Obligations" and
"Secured Obligations," as the case may be, in respect of the Obligations of
Borrower now or hereafter existing under or in respect of the Amended Agreement
and the Notes defined therein.
Each Credit Support Party acknowledges and agrees that any of the Credit
Support Documents to which it is a party or otherwise bound shall continue in
full force and effect and that all of its obligations thereunder shall be valid
and enforceable and shall not be impaired or limited by the execution or
effectiveness of this Amendment. Each Credit Support Party represents and
warrants that all representations and warranties contained in the Amended
Agreement and the Credit Support Documents to which it is a party or otherwise
bound are true, correct and complete in all material respects on and as of the
First Amendment Effective Date to the same extent as though made on and as of
that date, except to the extent such representations and warranties
specifically relate to an earlier date, in which case they were true, correct
and complete in all material respects on and as of such earlier date.
Each Credit Support Party acknowledges and agrees that (i) notwithstanding
the conditions to effectiveness set forth in this Amendment, such Credit
Support Party is not required by the terms of the Term Loan Agreement or any
other Loan Document to consent to the amendments to the Term Loan Agreement
effected pursuant to this Amendment and (ii) nothing in the Term Loan
Agreement, this Amendment or any other Loan Document shall be deemed to require
the consent of such Credit Support Party to any future amendments to the Term
Loan Agreement.
3
<PAGE>
Section 5. MISCELLANEOUS
A. Reference to and Effect on the Term Loan Agreement and the Other Loan
Documents.
(i) On and after the First Amendment Effective Date, each reference in
the Term Loan Agreement to "this Agreement", "hereunder", "hereof",
"herein" or words of like import referring to the Term Loan Agreement, and
each reference in the other Loan Documents to the "Term Loan Agreement",
"thereunder", "thereof" or words of like import referring to the Term Loan
Agreement shall mean and be a reference to the Amended Agreement.
(ii) Except as specifically amended by this Amendment, the Term Loan
Agreement and the other Loan Documents shall remain in full force and
effect and are hereby ratified and confirmed.
(iii) The execution, delivery and performance of this Amendment shall
not, except as expressly provided herein, constitute a waiver of any
provision of, or operate as a waiver of any right, power or remedy of
Administrative Agent or any Lender under, the Term Loan Agreement or any of
the other Loan Documents.
B. Fees and Expenses. Borrower acknowledges that all costs, fees and expenses
as described in Section 11.5 of the Term Loan Agreement incurred by
Administrative Agent, Syndication Agent, Co-Arrangers, and Special Counsel,
with respect to this Amendment and the documents and transactions contemplated
hereby shall be for the account of Borrower.
C. Headings. Section and subsection headings in this Amendment are included
herein for convenience of reference only and shall not constitute a part of
this Amendment for any other purpose or be given any substantive effect.
D. Applicable Law. THIS AMENDMENT AND THE RIGHTS AND OBLIGATIONS OF THE
PARTIES HEREUNDER SHALL BE GOVERNED BY, AND SHALL BE CONSTRUED AND ENFORCED IN
ACCORDANCE WITH, THE INTERNAL LAWS OF THE STATE OF NEW YORK (INCLUDING WITHOUT
LIMITATION SECTION 5-1401 OF THE GENERAL OBLIGATIONS LAW OF THE STATE OF NEW
YORK), WITHOUT REGARD TO CONFLICTS OF LAWS PRINCIPLES.
E. Counterparts; Effectiveness. This Amendment may be executed in any number
of counterparts and by different parties hereto in separate counterparts, each
of which when so executed and delivered shall be deemed an original, but all
such counterparts together shall constitute but one and the same instrument;
signature pages may be detached from multiple separate counterparts and
attached to a single counterpart so that all signature pages are physically
attached to the same document. This Amendment (other than the provisions of
Section 1 hereof, the effectiveness of which is governed by Section 2 hereof)
shall become effective upon the execution of a counterpart hereof by Borrower,
Required Lenders, Administrative Agent, and each of the Credit Support Parties
and receipt by Borrower and Administrative Agent of written or telephonic
notification of such execution and authorization of delivery thereof.
[Remainder of page intentionally left blank]
4
<PAGE>
IN WITNESS WHEREOF, the parties hereto have caused this Amendment to be duly
executed and delivered by their respective officers thereunto duly authorized
as of the date first written above.
BORROWER: TOTAL RENAL CARE HOLDINGS, INC.
By:
-------------------------------------
Name:
-------------------------------------
Title:
-------------------------------------
5
<PAGE>
CREDIT SUPPORT PARTIES: TOTAL RENAL CARE HOLDINGS, INC.,
(for purposes of Section 4 only) as
a Credit Support Party
By:
-------------------------------------
Name:
-------------------------------------
Title:
-------------------------------------
TRC WEST, INC., (for purposes of
Section 4 only) as a Credit Support
Party
By:
-------------------------------------
Name:
-------------------------------------
Title:
-------------------------------------
TOTAL RENAL CARE ACQUISITION CORP.,
(for purposes of Section 4 only) as
a Credit Support Party
By:
-------------------------------------
Name:
-------------------------------------
Title:
-------------------------------------
RENAL TREATMENT CENTERS, INC., (for
purposes of Section 4 only) as a
Credit Support Party
By:
-------------------------------------
Name:
-------------------------------------
Title:
-------------------------------------
RENAL TREATMENT CENTERS-- MID-
ATLANTIC, INC., (for purposes of
Section 4 only) as a Credit Support
Party
By:
-------------------------------------
Name:
-------------------------------------
Title:
-------------------------------------
6
<PAGE>
RENAL TREATMENT CENTERS--NORTHEAST,
INC., (for purposes of Section 4
only) as a Credit Support Party
By:
-------------------------------------
Name:
-------------------------------------
Title:
-------------------------------------
RENAL TREATMENT CENTERS--CALIFORNIA,
INC., (for purposes of Section 4
only) as a Credit Support Party
By:
-------------------------------------
Name:
-------------------------------------
Title:
-------------------------------------
RENAL TREATMENT CENTERS--WEST, INC.,
(for purposes of Section 4 only) as
a Credit Support Party
By:
-------------------------------------
Name:
-------------------------------------
Title:
-------------------------------------
RENAL TREATMENT CENTERS--SOUTHEAST,
INC., (for purposes of Section 4
only) as a Credit Support Party
By:
-------------------------------------
Name:
-------------------------------------
Title:
-------------------------------------
7
<PAGE>
AGENTS: THE BANK OF NEW YORK, Individually
and as Administrative Agent and
Collateral Agent
By:
-------------------------------------
Name:
-------------------------------------
Title:
-------------------------------------
DLJ CAPITAL FUNDING, INC.,
Individually and as Syndication
Agent
By:
-------------------------------------
Name:
-------------------------------------
Title:
-------------------------------------
8
<PAGE>
LENDERS: [omitted]
9
<PAGE>
EXHIBIT 23.1
CONSENT OF INDEPENDENT ACCOUNTANTS
We hereby consent to the incorporation by reference in the Registration
Statements on Form S-8 (No. 33-84610, No. 33-83018, No. 33-99862, No. 33-99864,
No. 333-1620, No. 333-34693, No. 333-34695, No. 333-46887 and No. 333-75361) of
Total Renal Care Holdings, Inc. of our report dated March 29, 1999, relating to
the financial statements, which appears in this Annual Report on Form 10-K/A
(Amendment No. 1). We also consent to the incorporation by reference of our
report dated March 29, 1999 relating to the Financial Statement Schedule, which
appears in this Form 10-K/A (Amendment No. 1).
PricewaterhouseCoopers LLP
Seattle, Washington
October 8, 1999
