-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, GHrB6FDDBUIspnkxP7/1VUrYENWnEUj8ygqY16H8dlj6QgVGq9JSdwCCzPzQ41zU F/N3pMyxC2uMZnrFDWMdUw== 0000950135-99-001273.txt : 19990310 0000950135-99-001273.hdr.sgml : 19990310 ACCESSION NUMBER: 0000950135-99-001273 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990309 FILER: COMPANY DATA: COMPANY CONFORMED NAME: FRESENIUS NATIONAL MEDICAL CARE HOLDINGS INC CENTRAL INDEX KEY: 0000042872 STANDARD INDUSTRIAL CLASSIFICATION: SURGICAL & MEDICAL INSTRUMENTS & APPARATUS [3841] IRS NUMBER: 133461988 STATE OF INCORPORATION: NY FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: SEC FILE NUMBER: 001-03720 FILM NUMBER: 99560977 BUSINESS ADDRESS: STREET 1: TWO LEDGEMONT CENTER STREET 2: 95 HAYDEN AVE CITY: LEXINGTON STATE: MA ZIP: 02173 BUSINESS PHONE: 6174029000 FORMER COMPANY: FORMER CONFORMED NAME: GRACE W R & CO /NY/ DATE OF NAME CHANGE: 19920703 FORMER COMPANY: FORMER CONFORMED NAME: GRACE W R & CO /CT/ DATE OF NAME CHANGE: 19900423 10-K405 1 FRESENIUS MEDICAL CARE 1 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ---------- FORM 10K FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO SECTIONS 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [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 [NO FEE REQUIRED] FOR THE TRANSITION PERIOD FROM _____ TO _____ . COMMISSION FILE NUMBER 1-3720 FRESENIUS MEDICAL CARE HOLDINGS, INC. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) NEW YORK 13-3461988 (STATE OR OTHER JURISDICTION (I.R.S. EMPLOYER OF INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.) (JURISDICTION OF INCORPORATION OR ORGANIZATION) TWO LEDGEMONT CENTER, 95 HAYDEN AVE., LEXINGTON, MA 02420 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) Registrant's telephone number, including area code: 781-402-9000 Securities registered pursuant to Section 12(b) of the Act: NONE Securities registered pursuant to Section 12(g) of the Act: Class D Special Dividend Preferred Stock, par value $.10 per share Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No 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 the Form 10-K. [X] State the aggregate market value of the voting stock held by non-affiliates of the registrant. The aggregate market value shall be computed by reference to the price at which the stock was sold, or the average bid and asked prices of such stock, as of a specified date within 60 days prior to the date of filing. (See definition of affiliate in Rule 405). $11,132,750 March 5, 1999. 2 Indicate the number of shares outstanding of each of the registrant's classes of common stock, as of the latest practicable date: As of March 9, 1999, 90,000,000 shares of common stock. DOCUMENTS INCORPORATED BY REFERENCE Registrant's Definitive Information Statement with respect to its 1998 Annual Meeting of Stockholders, to be filed on or before April 30, 1999. (Part III) 2 3 TABLE OF CONTENTS
PART I Item 1. Business ..................................................................................4 Item 2. Properties .................................................................................32 Item 3. Legal Proceedings .................................................................................34 Item 4. Submission of Matters to a Vote of Security Holders................................................51 PART II .................................................................................51 Item 5. Market Price for Registrant's Common Equity and Related Stockholder Matters........................51 Item 6. Selected Financial Data............................................................................52 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations..............53 Item 7A. Quantitative and Qualitative Disclosures About Market Risks........................................61 Item 8. Consolidated Financial Statements and Supplementary Data...........................................61 Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure...............62 PART III .................................................................................62 Item 10. Directors and Executive Officers of the Registrant ................................................62 Item 11. Executive Compensation.............................................................................62 Item 12. Security Ownership of Certain Beneficial Owners and Management.....................................62 Item 13. Certain Relationships and Related Transactions.....................................................62 PART IV .................................................................................62 Item 14. Exhibits, Consolidated Financial Statement Schedules, and Reports on Form 8-K......................62
3 4 ITEM 1. BUSINESS This section contains certain forward-looking statements that are subject to various risks and uncertainties. Such statements include, without limitation, discussions concerning the outlook of Fresenius Medical Care Holdings, Inc. (collectively with all its direct and indirect subsidiaries, the "Company"), government reimbursement, future plans and management's expectations regarding future performance. Actual results could differ materially from those contained in these forward-looking statements due to certain factors including, without limitation, changes in business, economic and competitive conditions, regulatory reforms, foreign exchange rate fluctuations, uncertainties in litigation or investigative proceedings, and the availability of financing. These and other risks and uncertainties, which are more fully described elsewhere in this 1998 Form 10-K and in the Company's reports filed from time to time with the Securities and Exchange Commission (the "Commission") could cause the Company's results to differ materially from the results that have been or may be projected by or on behalf of the Company. The Company, a New York corporation, is a subsidiary of Fresenius Medical Care AG, a German corporation ("Fresenius Medical Care" or "FMC"). The Company conducts its operations through three principal subsidiaries, National Medical Care, Inc., a Delaware corporation ("NMC"), Fresenius USA, Inc., a Massachusetts corporation ("Fresenius USA" or "FUSA") and SRC Holding Company, Inc., a Delaware corporation. The Company is primarily engaged in (i) providing kidney dialysis services, clinical laboratory testing and renal diagnostic services, and (ii) manufacturing and distributing products and equipment for dialysis treatment, which accounted for 82% and 18% of 1998 net revenues, respectively. - KIDNEY DIALYSIS AND OTHER SERVICES. The Company is the largest private provider in the U.S. of kidney dialysis and related services. At December 31, 1998, the Company operated 782 outpatient dialysis facilities in the U.S. (including Puerto Rico), treating approximately 58,600 chronic patients. The company treats approximately 24% of the dialysis patients in the U.S., and believes its next largest competitor treats approximately 13% of U.S. dialysis patients. Additionally, the Company provides inpatient dialysis services under contract to hospitals in the U.S. - DIALYSIS PRODUCTS. The Company manufactures a comprehensive line of dialysis products, including hemodialysis machines, peritoneal dialysis systems and disposable products. The Company manufactures innovative and technologically advanced products, including the Fresenius Polysulfone(TM) dialyzer, which the Company believes is the best-performing, mass-produced dialyzer on the market, and Delflex(R) peritoneal solutions with Safe-Lock(R) connectors. Effective June 1, 1998 the Company classified its non renal diagnostic services business ("Non Renal Diagnostic Services") and homecare business ("Homecare") as discontinued operations. The Company disposed of these businesses on June 26, 1998 and July 29, 1998 respectively. In connection with the sale of Homecare, the Company retained the assets and the operations associated with the delivery of IDPN. Additionally, the Company has retained liabilities which could result from the government's investigation into, among other issues, historical practices of the non-renal diagnostic service and homecare businesses and has indemnified the respective buyers in respect of certain liabilities with respect thereto. See "Legal Proceedings -- OIG Investigation." See "Notes to Consolidated Financial Statements -- Note 8 'Discontinued Operations.'" 4 5 THE MERGER The Merger, which was effective September 30, 1996, resulted from the culmination of the following transactions: (1) NMC, which was a subsidiary of W. R. Grace & Co. -- Conn. ("Grace Chemicals"), a wholly-owned subsidiary of Grace New York, borrowed $2,300,000 and paid a cash dividend of approximately $2,100,000 to Grace Chemicals; (2) the stock of NMC was transferred to Grace New York, so that NMC and Grace Chemicals became sibling subsidiaries of Grace New York; (3) the stock of Grace Chemicals was transferred to a newly formed Delaware subsidiary of Grace New York ("New Grace") and the shares of New Grace were spun-off to the Grace New York shareholders in a pro rata distribution; (4) Grace New York was recapitalized such that each Grace New York shareholder received one share of Class D Preferred Stock of Grace New York (the "Class D Preferred Stock") for each share of Grace New York common stock held; and (5) Grace New York, with NMC as its sole business, merged with a wholly-owned subsidiary of Fresenius Medical Care AG ("FMC"), and Fresenius AG's worldwide dialysis business (including its controlling interest in FUSA) ("FWD") was contributed as separate subsidiaries of FMC with the result that 44.8% of the ordinary shares of FMC were exchanged for the common stock held by Grace New York common shareholders in the merger transaction and the balance of the ordinary shares of FMC were received by Fresenius AG and the shareholders of FUSA, in consideration of the contribution of FWD to FMC. All of the Grace New York (now the Company) common stock is held by FMC, while the Class D Preferred Stock (which entitles its shareholders to a contingent dividend based on the consolidated performance of FMC in the years 1997-2001) and other previously issued classes of the Company preferred stock remain outstanding. On June 12, 1997, the Company changed its name from Fresenius National Medical Care Holdings, Inc. to Fresenius Medical Care Holdings, Inc. The Company's principal executive office is located at Two Ledgemont Center, 95 Hayden Avenue, Lexington, MA 02420-9192. Its telephone number is (781) 402-9000. RENAL INDUSTRY OVERVIEW END-STAGE RENAL DISEASE End-stage renal disease ("ESRD") is the state of advanced chronic kidney disease that is characterized by the irreversible loss of kidney function and requires routine dialysis treatment or kidney transplantation to sustain life. A normally functioning human kidney removes waste products and excess water from the blood, preventing toxin buildup, eventual poisoning of the body and water overload. Chronic kidney disease can be caused by a number of conditions, primarily nephritis, inherited diseases, hypertension and diabetes. Nearly 60% of all people with ESRD acquire the disease as a complication of one or more of these primary conditions. Based on the most recent information published by the Health Care Financing Administration ("HCFA") of the Department of Health and Human Services ("HHS"), the number of patients in the U.S. who received chronic dialysis grew from approximately 66,000 in 1982 to approximately 230,190 at December 31, 1997 or at a compound annual rate of 7.5%. The Company believes that, over the next five to ten years, the number of patients suffering from ESRD in the U.S. will continue to grow at approximately the same rate. The Company attributes the continuing growth in the number of dialysis patients principally to the aging of the general population and better treatment and survival of patients with hypertension, diabetes and other illnesses that lead to ESRD. Moreover, improved technology has enabled older patients and those who previously could not tolerate dialysis due to other illnesses to benefit from this life-prolonging treatment. There are currently only two methods for the treatment of ESRD: dialysis and kidney transplantation. Transplants are limited by the scarcity of compatible kidneys. Approximately 12,200 patients received kidney transplants in the U.S. during 1997. Therefore, most patients suffering from ESRD must rely on dialysis, which is the removal of toxic waste products and excess fluids from the body by artificial means. There are two major dialysis modalities commonly used today, hemodialysis and peritoneal dialysis. Generally, the method of treatment used by an ESRD patient is chosen by the physician in consultation with the patient, and is based on the patient's medical conditions and needs. According to HCFA data, as of December 31, 1997, there were more than 3,400 Medicare-certified ESRD treatment centers in the U.S. Ownership of these centers was fragmented. The Company estimates that at that time, the ten largest multi-facility providers accounted for approximately 1,800 facilities (56% of facilities) and 136,000 patients (59% of patients). Freestanding facilities (many privately owned by physicians) and hospital-affiliated facilities were the sites of treatment for the remaining 23% and 21% of patients, respectively. There was substantial further consolidation in the market in 1998 leading the Company to estimate that the top ten multi-center providers accounted for approximately 155,500 patients, or 63% of the estimated market at December 31, 1998 (percentage market share is an estimate as HCFA data specifying 100% of total market size are not yet available for 1998). 5 6 According to HCFA, as of December 31, 1997, approximately 86% of dialysis patients in the U.S. received in-center treatment (virtually all hemodialysis) and approximately 14% were treated at home. Of those treated at home, more than 94% received peritoneal dialysis. TREATMENT OPTIONS FOR ESRD Hemodialysis. Hemodialysis removes waste products and excess fluids from the blood extracorporeally. In hemodialysis, the blood flows outside the body by means of plastic tubes known as bloodlines into a specially designed filter, a dialyzer, which functions as an artificial kidney by separating waste products and excess water from the blood by diffusion and ultrafiltration. Dialysis solution carries away the waste products and excess water, and the cleansed blood is returned to the patient. The movement of the blood and dialysis solution is controlled by a hemodialysis machine, which pumps blood, adds anti-coagulants, regulates the purification process and controls the mixing of dialysis solution and the rate of its flow through the system. This machine may also monitor and record the patient's vital signs. According to HCFA, as of December 31, 1997, hemodialysis patients represented 87% of all dialysis patients in the U.S. Hemodialysis treatments are generally administered to a patient three times per week and typically last from two and one-half to four hours or longer. The majority of hemodialysis patients are referred to outpatient dialysis centers, such as those operated by the Company, where hemodialysis treatments are performed with the assistance of a nurse or dialysis technician under the general supervision of a physician. Hemodialysis is the only form of treatment (other than transplantation) currently available to patients who have very low residual or nonexistent renal function and are inadequately dialyzed using peritoneal dialysis. Peritoneal Dialysis. Peritoneal dialysis removes waste products and excess fluids from the blood by use of the peritoneum, the membrane lining covering the internal organs located in the abdominal area. Most peritoneal dialysis treatments are selfadministered by patients in their own homes and workplaces, either by a treatment known as continuous ambulatory peritoneal dialysis ("CAPD") or by a treatment introduced by Fresenius USA in 1980 known as continuous cycling peritoneal dialysis ("CCPD"). In both of these treatments, the patient has a catheter surgically implanted to provide access to the peritoneal cavity. Using this catheter, a sterile dialysis solution is introduced into the peritoneal cavity and the peritoneum operates as the dialyzing membrane. A typical CAPD peritoneal dialysis program involves the introduction and disposal of solution four times a day. With CCPD a machine is used to "cycle" solution to and from the patient's peritoneum during sleep. In both CAPD and CCPD the patient undergoes dialysis daily, and typically does not experience the buildup of toxins and fluids experienced by hemodialysis patients on the days they are not treated. In addition, because the patient is not required to make frequent visits to a hemodialysis clinic, and because the solution exchanges can be accomplished at convenient (although more frequent) times, a patient on peritoneal dialysis may experience much less disruption to his or her life than a patient on hemodialysis. Certain aspects of peritoneal dialysis, however, limit its use as a long-term therapy for some patients. First, certain patients cannot effect sterile connections of the peritoneal dialysis tubing to the catheter, leading to excessive episodes of peritonitis, a bacterial infection of the peritoneum which can result in serious adverse health consequences, including death. Second, treatment by current forms of peritoneal dialysis may not be as effective in removing wastes and fluids as hemodialysis; therefore, patients using peritoneal dialysis must have some residual renal function (which may deteriorate over time) or the amount of therapy must be increased. As residual renal function decreases, peritoneal dialysis is less effective. Therefore, in general, ESRD patients require hemodialysis treatments for some period during the term of their disease. STRATEGY The Company's strategy is in alignment with the Fresenius Medical Care's strategy and is used interchangeably below. The Company's objective is to capitalize on the continued rapid growth of the dialysis industry and its leading position in the market. The U.S. dialysis patient population is estimated to be growing at approximately 7.5% annually, driven primarily by the aging of the population and better treatment and survival of patients with illnesses that lead to ESRD, including diabetes and hypertension The Company's dialysis services and product sales businesses have grown faster than the market in terms of revenues over the past five years, and FMC believes that it is well positioned to continue this growth by focusing on the following strategies: 6 7 - Provide High Standards of Patient Care. The Company believes that its reputation for providing the highest standards of patient care is a competitive advantage in an environment increasingly focused on cost containment and quality outcomes. The Company believes that NMC's proprietary Patient Statistical Profile ("PSP") database, which contains clinical and demographic data on approximately 60,000 dialysis patients, is the most comprehensive body of information about dialysis patients in the world. The Company believes that this database provides a unique advantage in continuing to improve dialysis treatment outcomes, reduce mortality rates and improve the quality and effectiveness of dialysis products, all of which are becoming increasingly important to patients, physicians and payors. - Expand Presence in the U.S. Over the past several years, the Company has significantly expanded its U.S. provider operations through the acquisition by the Company of existing dialysis clinics and the development of new clinics. In 1998, the Company acquired 24 clinics and opened 52 new clinics. As a result, the Company now has an established presence in each of its targeted markets in the U.S. Prospectively, the Company expects to enhance its presence in the U.S. by focusing its expansion on the acquisition of individual or small groups of clinics, expansion of existing clinics, and opening of new clinics, rather than on large acquisitions. - Increase Revenues from Expanded and Enhanced Patient Services. One of the Company's objectives is to continue to expand its role within the broad spectrum of services provided to dialysis patients. The Company has begun to implement this strategy by providing expanded and enhanced patient services, including increased ancillary services, such as laboratory and diagnostic services, to both its own clinics and those operated by third parties. The Company estimates that its Spectra Renal Management business unit provides laboratory services for 38% of the dialysis patients in the United States. The Company has developed treatment plans using disease state management methodologies that it believes will be attractive to managed care payors, formed Optimal Renal Care, LLC, a joint venture with Permanente Medical Group of Southern California, a subsidiary of Kaiser Permanente which has the largest dialysis patient population of any managed care organization, and has formed Renaissance Health Care as a joint venture with certain of the Company's nephrologists. - Continue to Offer Complete Dialysis Product Lines. The Company offers broad and competitive hemodialysis and peritoneal dialysis product lines. These product lines enjoy broad market acceptance and enable customers to purchase all of their dialysis machines, systems and disposable products from a single source. Approximately 81% of Fresenius Medical Care's product revenues for the twelve months ended December 31, 1998 were from sales of disposable products. - Extend Position as a Technology Innovator. The Company is committed to being a technology leader in both hemodialysis and peritoneal dialysis products. FMC has an approximate 232 member research and development team focused on developing dialysis systems that are safer, more effective and easier to use and that can be easily customized to meet the differing needs of customers around the world. The Company believes that its extensive expertise in patient treatment and clinical data will further enhance its ability to develop more effective products and treatment methodologies. - Enhance Manufacturing Technologies and Efficiencies. Over the past several years, the Company has reduced manufacturing costs per unit through development of proprietary manufacturing technologies that have streamlined and automated its production processes. Fresenius Medical Care intends to further improve its proprietary, highly automated manufacturing systems to continue to reduce product manufacturing costs, concurrently achieving a high level of quality control and reliability. The Company believes that its core strategic principles, particularly its commitment to maintaining clinical quality, ensuring cost management and control and developing superior cost-effective products, are key elements in sustaining a competitive advantage in a health care environment increasingly focused on cost containment and quality outcomes. The Company believes that its strengths in clinical data systems, its professional affiliations with a broad network of providers and institutions, its physician relationships, its extensive geographic coverage in dialysis services and products and its ongoing internal development of an integrated approach to care should result in attractive partnering opportunities with managed-care enterprises. The Company believes that its strategy, based on its extensive clinical information database and large dialysis center and physician network, may enable the Company to improve overall ESRD patient care and therefore contain hospitalization and other ESRD treatment costs. 7 8 For a description of other elements of the Company's strategy see "--Dialysis Services" and "--Dialysis Products Business." For additional information in respect to the Company's industry sections, see Notes to Consolidated Financial Statements - Note 18, "Industry Segments and Information about Foreign Operations." DIALYSIS SERVICES OVERVIEW The Company is the largest provider in the U.S. of kidney dialysis and related services to patients suffering from chronic kidney disease. The Company also provides clinical laboratory testing and renal diagnostic services for dialysis patients in the U.S. and Puerto Rico (Company owned and non-Company owned clinics). Such diagnostic services include electrocardiograms, Doppler flow testing, nerve conduction velocity, and other tests. The Company's provider business is primarily operated through the Dialysis Services business unit ("Dialysis Services".) The clinical laboratory testing and renal diagnostic services are primarily provided by Spectra Renal Management ("SRM") DIALYSIS SERVICES As of December 31, 1998, the Company owned or managed 782 dialysis centers in the U.S. The centers are generally concentrated in areas of high population density and their surrounding areas. In 1998, the Company acquired 24 existing centers, developed 52 new centers and consolidated or sold 9 centers. The number of patients treated at the Company's centers has increased from approximately 53,366 at December 31, 1997 to approximately 58,627 at December 31, 1998. At the Company's centers, hemodialysis treatments are provided at individual "stations" through the use of dialysis machines. A registered nurse or dialysis technician attaches the necessary tubing to the patient and monitors the dialysis equipment and the patient's vital signs. The capacity of a center is a function of the number of stations and such factors as the type of treatment, patient requirements, length of time per treatment and local operating practices and ordinances regulating hours of operation. Most of the Company's centers operate two or three patient shifts per day. Each of the Company's dialysis centers is under the general supervision of a medical director ("Medical Director") and, in some cases, one or more Associate Medical Directors, who are physicians. See "--Physician and Other Relationships." Each dialysis center also has an administrator who supervises the day-to-day operations of the facility and the staff. The staff typically consists of registered nurses, licensed practical nurses, patient care technicians, a social worker, a registered dietician, a unit clerk and biomedical technicians. The Company engages in systematic efforts to measure, maintain and improve the quality of the services that it delivers at its dialysis centers. Each center collects and analyzes quality assurance and patient data, which in turn is regularly reviewed by Dialysis Services and corporate management. At each center, a quality assurance committee is responsible for reviewing quality of care reports generated by the Company's PSP system, setting goals for quality enhancement and monitoring the progress of quality assurance initiatives. The Company believes that it enjoys a reputation of providing high quality care to dialysis patients. The Company provides various ancillary medications and services to ESRD patients in the U.S. at its dialysis centers, the most significant of which is the administration of Erythropoietin ("EPO"), a bioengineered protein that stimulates the production of red blood cells. EPO is used to treat anemia, a medical complication frequently experienced by ESRD patients, and is administered to most of the Company's patients. Revenues from EPO accounted for approximately 26% of Dialysis Services' U.S. net revenues for the twelve months ended December 31, 1998 and materially contribute to Dialysis Services' operating earnings. EPO is produced by a single source manufacturer, Amgen Inc., and any interruption of supply could materially adversely affect the Company's business and results of operations. The Company has entered into a contract with Amgen Inc. covering the period from January 1999 to December 1999 with price guarantees and volume and outcome based discounts. Other ancillary services provided to ESRD patients in the U.S. include the administration of Calcijex(R) (calcium), INFED(R) (iron) and hepatitis vaccine and blood transfusions; the provision of interdialytic parenteral nutrition ("IDPN"), in which nutrients are added to the patient's blood during hemodialysis; the provision, through Spectra Renal Management, of clinical laboratory testing; the provision of electrocardiograms; nerve conduction studies to test the degree of deterioration of nerves; and Doppler flow testing of the effectiveness of the patient's vascular access for dialysis. These tests and other ancillary services are provided by specific prescription of the patient's attending physician. 8 9 The Company employs a centralized approach with respect to certain administrative functions common to its operations. For example, the Company has standardized operating and billing procedures which are contained in proprietary manuals used by each dialysis center. The Company believes that the centralization and standardization of these functions enhance its ability to perform services on a cost-effective basis. The Company's centers also offer services for home dialysis patients, the majority of whom are treated with peritoneal dialysis. For such patients, the Company's dialysis centers provide certain materials, training and patient support services, including clinical monitoring, supply of EPO, follow-up assistance and arrangements for the delivery of the supplies to the patient's residence. See "--Regulatory and Legal Matters--Reimbursement" and "--Legal Proceedings" for a discussion of billing for such products and services. The manner in which each center conducts its business is dependent, in large part, upon applicable laws, rules and regulations of the jurisdiction in which the center is located, as well as the Company's clinical policies. However, a patient's attending physician (who may be the center's Medical Director or an unaffiliated physician with staff privileges at the center) has medical discretion as to the particular treatment modality and medications to be prescribed for that patient. Similarly, the attending physician has discretion in selecting the particular medical products prescribed, although equipment, regardless of brand, is typically purchased by the center in consultation with the medical director through the Company's central purchasing operations. The Company also provides dialysis services under contract to hospitals in the U.S. on an "as needed" basis for patients suffering from acute kidney failure and for ESRD patients who are hospitalized. The Company services these patients either at their bedside, using portable dialysis equipment, or at a dialysis site maintained by the hospital. Contracts with hospitals provide for payment at negotiated rates that are higher than the Medicare reimbursement rates for chronic in-center treatments. ACQUISITIONS The Company's growth in revenues and operating earnings in prior years has resulted, in significant part, from its ability to effect acquisitions of health care businesses, particularly dialysis centers, on reasonable terms. In the U.S., doctors may be motivated to sell their centers to obtain relief from day-to-day administrative responsibilities and changing governmental regulations, to focus on patient care and to realize a return on their investment. While price is typically the key factor in securing acquisitions, the Company believes that it will be an attractive acquiror or partner to many dialysis center owners due to its reputation for patient treatment, its proprietary PSP database (which contains clinical and demographic data on approximately 60,000 dialysis patients), its comprehensive clinical and administrative systems, manuals and policies, its 9 10 ability to provide ancillary services to dialysis centers and patients and its reputation for technologically advanced products. The Company believes that these factors will also be advantages when opening new centers. The U.S. health care industry has experienced significant consolidation in recent years, particularly in the dialysis service sectors in which the Company competes, resulting, in some cases, in increased costs of acquisitions in these sectors. The entrance into the acquisition arena by new, smaller public dialysis companies, which have made acquisitions using their stock as consideration, has accelerated the increase in costs of acquisitions. Moreover, because of the ongoing consolidation in the dialysis services industry, the availability of acquisitions may decrease. The Company's ability to make acquisitions also will depend, in part, on the Company's available financial resources and the limitations imposed under two credit facilities (collectively, "the NMC Credit Facilities"). See "Management's Discussion and Analysis of Financial Condition and Results of Operations." The inability of the Company to continue to effect acquisitions in the provider business on reasonable terms could have an adverse impact on growth in its business and on its results of operations. The Company regularly evaluates and explores opportunities with various other health care companies and other businesses regarding acquisitions and joint business ventures. In 1998, the Company completed new acquisitions and acquisitions of previously managed clinics totalling 24 dialysis facilities in the U.S. providing care to approximately 3200 patients. These acquisitions and agreements expand the Company's presence in selected key areas of the United States. 10 11 SOURCES OF DIALYSIS SERVICES NET REVENUES The following table provides information for the periods indicated regarding the percentage of the Company's U.S. dialysis treatment services net revenues provided by (a) the Medicare ESRD program, (b) private/alternative payors, such as commercial insurance and private funds, (c) Medicaid and other government sources and (d) hospitals. YEAR ENDED DECEMBER 31, ------------------------------- 1998 1997 1996 ----- ----- ----- Medicare ESRD program ....... 57.0% 64.5% 63.0% Private/alternative payors .. 33.8 25.8 28.1 Medicaid and other government sources ..................... 4.1 4.6 4.0 Hospitals ................... 5.1 5.1 4.9 ----- ----- ----- Total ....................... 100.0% 100.0% 100.0% ===== ===== ===== Under the Medicare ESRD program, Medicare reimburses dialysis providers for the treatment of certain individuals who are diagnosed as having ESRD, regardless of age or financial circumstances. When Medicare assumes responsibility as the primary payor, it pays for dialysis and certain specified related services at 80% of the payment methodology commonly referred to as the composite rate method ("Composite Rate"). In addition, subject to various restrictions and co-payment limitations, Medicare pays separately for certain dialysis-related diagnostic and therapeutic services not included in the Composite Rate. A secondary payor, usually a Medicare supplemental insurer, a state Medicaid program or, to a lesser extent, the patient or the patient's private insurer, is responsible for paying any co-payment (typically 20%), other approved services not paid by Medicare and the annual deductible. Most of the states in which the Company currently operates dialysis centers provide Medicaid benefits to qualified recipients to supplement their Medicare entitlement. Prior to the time at which Medicare becomes the primary payor, most dialysis treatments are paid for by another third-party payor, such as the patient's private insurer, or by the patient. ESRD patients under age 65 who are covered by an employer health plan must wait 33 months (consisting of a three-month entitlement waiting period and an additional 30-month "coordination of benefits period") before Medicare becomes the primary payor. During this 33-month period, the employer health plan is responsible for payment as primary payor at its negotiated rate or, in the absence of such a rate, at the Company's usual and customary rates (which generally are higher than the rates paid by governmental payors, such as Medicare), and Medicare is the secondary payor. See "--Regulatory and Legal Matters--Reimbursement" A significant portion of the Company's revenues for dialysis services are derived from reimbursement provided by non-governmental third-party payors. A substantial portion of third-party health insurance in the U.S. is now furnished through some type of managed care plan, including health maintenance organizations ("HMOs"). Managed care plans are increasing their market share overall, and in the Medicare population in particular. This trend may accelerate as a result of the merger and consolidation of providers and payors in the health care industry, as well as the discussions among members of Congress and the executive branch regarding ways to increase the number of Medicare and Medicaid beneficiaries served through managed care plans. The Company estimates that approximately 10% of Dialysis Services' net revenues for the twelve months ended December 31, 1998 was attributable to managed care plans. Non-governmental payors generally reimburse for dialysis treatments at higher rates than governmental payors such as Medicare. However, managed care plans are becoming more aggressive in selectively contracting with a smaller number of providers willing to furnish services for lower rates and subject to a variety of service restrictions. For example, managed care plans and traditional indemnity third-party payors increasingly are demanding alternative fee structures, such as capitation arrangements whereby a provider receives a fixed payment per month per enrollee and bears the risk of loss if the costs of treating such enrollee exceed the capitation payment. These market forces are creating downward pressure on the reimbursements the Company receives for its services and products. The Company's ability to secure favorable rates with indemnity and managed care plans has largely been due to the relatively small number of ESRD patients which any single HMO has enrolled. By regulation, ESRD patients have been prohibited from joining an HMO unless they are otherwise eligible for Medicare coverage, due to age or disability, and are members of a managed care plan when they first experience kidney failure. HCFA has a pilot evaluation underway for treatment of Medicare ESRD patients by managed care companies under capitated contracts, with three organizations. If successful, this pilot program could result in the elimination of the pre-existing condition requiring ESRD patients to enroll in managed care organizations. As Medicare HMO enrollments increase and the number of ESRD patients in managed care plans also increases, managed care plans' leverage to negotiate lower rates may become greater. In addition, the HMO may have contracted with another provider, or may have tighter utilization controls with respect to certain ancillary services typically provided by the Company to ESRD patients, which could limit the Company's future payments for such services. 11 12 HCFA has initiated the ESRD demonstration projects that are likely to be conducted over the next three to four years and that will seek to evaluate the feasibility of "privatizing" the Medicare ESRD program. The Company believes that the elimination of "pre-existing conditions" exclusions would greatly facilitate the enrollment of ESRD patients into managed care plans. The likelihood and timing of this decision is impossible to predict. Should such legislation pass, the Company believes it would likely increase the number of patients enrolled in managed care plans, and might also cause these plans to look closer at "carving out" ESRD care to ESRD companies such as the Company's joint ventures (Optimal Renal Care and Renaissance Health Care). The Company has formed two joint ventures seeking to contract "at risk" with managed care organizations for the care of ESRD patients. Renaissance Health Care, Inc. is a 50/50 joint venture between the Company and participating nephrologists throughout the U.S. Optimal Renal Care, LLC is a 50/50 joint venture between Permanente Medical Group of Southern California, a subsidiary of Kaiser Permanente, and the Company. As managed care programs expand market share and gain greater bargaining power vis-a-vis health care providers, there will be increasing pressure to reduce the amounts paid for services and products furnished by the Company. These trends would be accelerated if future changes to the Medicare ESRD program require private payors to assume a greater percentage of the cost of care given to dialysis patients. The Company is presently seeking to expand the portion of its revenues attributable to non-governmental private payors. However, the Company believes that the historically higher rates of reimbursement paid by non-governmental payors may not be maintained at such levels. If substantially more patients of the Company join managed care plans or such plans reduce reimbursements to the Company, the Company's business and results of operations could be adversely affected, possibly materially. See "--Regulatory and Legal Matters--Reimbursement," "--Anti-Kickback Statutes, False Claims Act, Stark Law and Fraud and Abuse Laws--Changes in the Health Care Industry." PHYSICIAN AND OTHER RELATIONSHIPS The Company believes that its success in establishing and maintaining dialysis centers, in the U.S. depends in significant part upon its ability to obtain the acceptance of and referrals from local physicians, hospitals and managed care plans. A dialysis patient generally seeks treatment at a center that is convenient to the patient and at which the patient's nephrologist has staff privileges. Virtually all of the Company's clinics maintain open staff privileges for local nephrologists. The Company's ability to provide quality dialysis care and otherwise to meet the needs of local physicians is central to its ability to attract nephrologists to the Company's centers and to receive referrals from such physicians. See "--Anti- kickback Statutes, False Claims Act, Stark Law and Fraud and Abuse Laws." The conditions for coverage under the Medicare ESRD program require that treatment at a dialysis center be under the general supervision of a Medical Director. Generally, the Medical Director must be board certified or board eligible in internal medicine and have at least 12 months of training or experience in the care of patients at ESRD centers. Virtually all of the Company's Medical Directors maintain their own active private practices. The Company has written agreements with the physicians who serve as Medical Directors (and Associate Medical Directors) at its centers. The Medical Director agreements entered into by the Company generally have terms of three years, although some have terms of as long as five to ten years. The compensation of Medical Directors and other physicians under contract with the Company is individually negotiated and generally depends upon competitive factors in the local market, the physician's professional qualifications, experience and responsibilities and the size of and services provided by the center. Until January 1, 1995, Medical Director compensation typically included a component based on some measure of the financial performance of the clinics under the supervision of that Medical Director. See "-- Legal Proceedings--OIG Investigation." Since 1995, the Company has entered into new agreements, or amended existing agreements, for substantially all of its Medical Directors. Under the new arrangements, the aggregate compensation of the Medical Directors and other physicians under contract is fixed in advance for a period of one year or more and is based in part on various efficiency and quality incentives. The Company believes that compensation is paid at fair market value. Virtually all of the Medical Director agreements, as well as the typical contract under which the Company acquires existing dialysis centers, include noncompetition covenants covering specified activities within specified geographic areas for specified periods of time, although they do not prohibit the physicians from providing direct patient care services at other locations and, consistent with law, do not require a physician to refer patients to the Company or particular centers or to buy or use specific medical products. In certain states, non-competition covenants may not be enforceable. 12 13 COMPETITION Dialysis Services. The dialysis services industry is highly competitive. Ownership of dialysis centers in the U.S. is fragmented, with a large number of operators owning 10 or fewer centers and a small number of larger providers, the largest of which is the Company. In urban areas, where many of the Company's dialysis centers are located, there frequently are many competing centers in proximity to the Company's centers. The Company experiences direct competition from time to time from former Medical Directors or referring physicians who establish their own centers. Furthermore, a number of health care providers, some of which have significant operations or resources, may decide to enter the dialysis business in the future. Because in most cases the prices of dialysis services in the U.S. are directly or indirectly regulated by Medicare, competition for patients is based primarily on quality and accessibility of service and the ability to obtain referrals from physicians and hospitals. However, the growth of managed care has placed greater emphasis on service costs for patients insured by nongovernmental payors. The Company believes that it competes effectively in all of these areas. In particular, based upon the Company's knowledge and understanding of other providers of dialysis treatments, as well as from information obtained from publicly available sources, the Company believes that it is among the most cost-efficient providers of kidney dialysis services. In addition, as a result of its large size relative to most other dialysis service providers, the Company enjoys economies of scale in areas such as purchasing, billing, collections and data processing. Competition in the dialysis industry is particularly intense with respect to the acquisition of existing dialysis centers, which has resulted in an increase in the cost of such acquisitions, and in enlisting and retaining qualified physicians to act as Medical Directors. LABORATORY AND RENAL DIAGNOSTIC SERVICES The Company provides clinical laboratory testing and renal diagnostic services through its business unit known as Spectra Renal Management ("SRM"). SRM was created as a result of the acquisition of Spectra Laboratories, Inc. ("Spectra") in June of 1997 and its combination with the Company's existing laboratory business at the time ("LifeChem") and its renal diagnostic testing business. SRM is the leading U.S. dialysis clinical laboratory providing blood, urine and other bodily fluid testing services to assist physicians in determining whether a dialysis patient's therapy regimen, diet and medicines remain optimal. SRM oversees the operation of three laboratories, one in New Jersey (operated by LifeChem), one in Southern California (operated by LifeChem), and one in Northern California (Spectra). Spectra and LifeChem are operated as separate subsidiaries of the Company. In 1998, SRM performed approximately 38 million tests for more than 87,000 dialysis patients across the United States. SRM also provided testing services to clinical research projects and others. The Company plans to expand SRM into related markets such as hospital dialysis units and physician office practices, particularly nephrologists. LifeChem's clinical laboratory results have been a critical element in the development of the Company's proprietary PSP database, which contains clinical, laboratory and demographic data on approximately 60,000 dialysis patients. The Company uses PSP to assist physicians in providing quality care to dialysis patients. In addition, PSP is a key resource in ongoing research, both within the Company and at outside research institutions, to decrease mortality rates among dialysis patients and improve their quality of life. See "-- Regulatory and Legal Matters--Reimbursement" for a description of certain billing problems relating to LifeChem and "--Legal Proceedings--LifeChem." SRM oversees the delivery of IDPN therapy to ESRD clinics. Competition. SRM competes in the U.S. with large nationwide laboratories, dedicated dialysis laboratories and numerous local and regional laboratories, including hospital laboratories. In the laboratory services market, companies compete on the basis of performance, including quality of laboratory testing, timeliness of reporting test results and cost-effectiveness. The Company believes that SRM's services are competitive in these areas. In addition to laboratory services, SRM competes in the imaging diagnostic market. While the main competition is local hospitals, SRM is competitive based upon the quality and accessibility of the service. 13 14 DIALYSIS PRODUCTS BUSINESS The Company manufactures and distributes equipment and disposable products for the treatment of kidney failure by hemodialysis and by peritoneal dialysis. Such products include hemodialysis machines, peritoneal dialysis cyclers and related equipment, dialyzers, peritoneal dialysis solutions in flexible plastic bags, hemodialysis concentrates and solutions, granulate mixes, bloodlines, and disposable tubing assemblies and equipment for water treatment in dialysis centers. Other products manufactured by third parties and distributed by the Company include dialyzers, special blood access needles, heparin (used to prevent blood clotting) and commodity supplies such as bandages, clamps and syringes. OVERVIEW The following table shows, actual net revenues for 1998 and 1997 and pro forma net revenues for 1996, of the Company's products business related to hemodialysis products, peritoneal dialysis products and other activities, principally technical service:
YEAR ENDED DECEMBER 31, ------------------------------------------------------------------------------- 1998 1997 1996 -------------------- --------------------- --------------------- TOTAL % OF TOTAL % OF TOTAL % OF REVENUES TOTAL REVENUES TOTAL REVENUES TOTAL -------- ----- -------- ----- -------- ----- (Dollars in Thousands) Hemodialysis Products $280,899 62% $241,985 58% $294,645 66% Peritoneal Dialysis Products 119,988 27 127,275 30 137,020 31 Other 49,921 11 51,941 12 13,777 3 -------- --- -------- --- -------- --- Total $450,808 100% $421,201 100% $444,934 100% ======== === ======== === ======== ===
14 15 HEMODIALYSIS PRODUCTS The Company believes that Fresenius Medical Care is a leader in the hemodialysis product field and continually strives to extend and improve the capabilities of its hemodialysis systems to offer an advanced treatment mode at reasonable cost. In North America, the Company, through its Dialysis Products business unit ("Dialysis Products") offers a comprehensive hemodialysis product line, consisting of hemodialysis machines, modular accessories for dialysis machines, polysulfone and cuprophane dialyzers, bloodlines, dialysis solutions and concentrates, fistula needles, connectors, data management systems, machines and supplies for the reuse of dialyzers and other similar supplies. Dialysis Machines. Through Fresenius USA, the Company assembles, tests and calibrates hemodialysis machines and sells these machines in the U.S., Canada and Mexico. Components for these machines are provided by Fresenius Medical Care and other vendors. Hemodialysis machines manufactured by the Company provide a unique volumetric dialysate balancing and ultrafiltration control system. This system, first developed and introduced by Fresenius AG in 1977, provides for the safe and more efficient use of highly permeable dialyzers. The Company also provides machine upgrade kits to allow for advanced therapy modes, thus offering the customer maximum performance with highly permeable polysulfone dialyzers. The Company's hemodialysis machines are capable of operating with dialyzers manufactured by all manufacturers, and are compatible with a wide variety of bloodlines and dialysis concentrates. Fresenius USA has extended the Fresenius Series 2008 hemodialysis machine for the North American market through the development of the model 2008H, which combines the reliable hydraulic system of the Series 2008 with electronic systems developed by Fresenius USA. Dialysis machines sold by the Company employ the same modular design as those of Fresenius Medical Care, but are tailored to local markets. Modular design also permits the Company to offer dialysis centers a broad range of options to meet specific patient or regional treatment requirements. The display panel can also be adapted using different modules to meet local language requirements. Dialyzers. All dialyzers manufactured by the Company use hollow fiber polysulfone membranes, a synthetic material. The Company believes that the Fresenius Polysulfone(TM) dialyzer is the best-performing mass-produced dialyzer on the market. Fresenius Medical Care is the leading worldwide producer of polysulfone dialyzers. While competitors currently sell polysulfone membranes in the market, Fresenius Medical Care developed and is the only manufacturer with more than 13 years' experience in applying the technology required to mass produce polysulfone membranes. The Company believes that polysulfone has superior performance characteristics compared to other materials used in dialyzers, including a higher biocompatibility and greater clearing capacities for uremic toxins. The Company's Fresenius Polysulfone(TM) dialyzer line consists of a complete range of permeability (high, medium and low flux) to allow tailoring of the dialysis therapy to the individual patient. Fresenius Polysulfone(TM) dialyzers are also available in an "NR" Series for acute dialysis. The Company also sells dialyzer reprocessing and rinse machines manufactured by Fresenius USA for Seratronics, Inc. ("Seratronics"). These machines cleanse dialyzers after dialysis, permitting multiple usage for the same patient before disposal of the dialyzer. The Seratronics machines facilitate the reuse of disposable dialyzers and, therefore, permit hemodialysis providers to reduce operating costs. The reuse business of Seratronics is managed by the Company through Fresenius USA. Other Hemodialysis Products. The Company manufactures and distributes arterial, venous, single needle and pediatric bloodlines. The Company produces both liquid and dry dialysate concentrates. Liquid dialysate concentrate is mixed with purified water by the hemodialysis machine to produce dialysis solution, which is used in hemodialysis treatment to remove the waste products and excess water from the patient's blood. Dry acid concentrate, developed more recently, requires less storage space. The Company also produces dialysis solutions in bags, including solutions for priming and rinsing hemodialysis bloodlines, as well as connection systems for central concentrate supplies and devices for mixing dialysis solutions and supplying them to hemodialysis machines. Other distributed products include solutions for priming bloodlines, disinfecting and decalcifying hemodialysis machines, fistula needles, hemodialysis catheters, and products for acute renal treatment. Fresenius USA has developed the Fresenius Data System FDS08(TM) ("FDS08") computerized treatment monitoring and documentation system. The FDS08 can automatically monitor and record machine and treatment information from as many as 32 hemodialysis machines. The FDS08 is a PC-based system which has found many applications for improving record keeping and increasing staff efficiency. The FDS08 system has been used to pioneer new therapies such as remote monitoring of patients during nightly home hemodialysis, which enables a patient to be dialyzed at home while a staff caregiver monitors the machine performance via a modem link. Additionally the FDS08 system can be linked to Fresenius USA's new Hypercare(TM) Medical Records System which is presently in beta site testing. The Hypercare(TM) Medical Records System is a fully-integrated medical records system which can record and analyze trends in medical outcome factors in hemodialysis patients. 15 16 PERITONEAL DIALYSIS PRODUCTS The Company offers a full line of products for peritoneal dialysis patients. Peritoneal dialysis products manufactured by the Company include peritoneal dialysis solutions in bags, peritoneal dialysis cycling machines for CCPD and disposable products for both CAPD and CCPD, such as tubing, sterile solutions and sterile kits to prepare patients for dialysis. The Company also distributes (primarily to its own dialysis centers) other manufacturers' peritoneal dialysis products. Peritoneal Dialysis Systems. The Company manufactures a range of peritoneal dialysis solutions. The Company believes that its peritoneal solution products with Safe-Lock(R) connection systems offer significant advantages for CAPD and CCPD home patients, including ease of use and greater protection against touch contamination than other peritoneal dialysis systems presently available. The Safe-Lock(R) standard system involves the connection procedure of introducing and draining the dialysis solution into and from the abdominal cavity through the use of the same bag for introduction and drainage. To use Safe-Lock(R) products, a catheter that has been surgically implanted in the patient is fitted with one part of the Safe-Lock(R) connector, and the peritoneal dialysis solution bag and tubing are fitted with the other part of the Safe-Lock(R) connector. The Company also manufactures disposable double bag systems utilizing a special drainage bag and a snap-off Y-shaped piece that is connected to the Safe-Lock(R) connector at the catheter. These double bag systems further reduce possible entry of contaminants during peritoneal dialysis. The Company's Inpersol(R) line of peritoneal dialysis products acquired by Fresenius USA from Abbott Laboratories in 1993 (the "Abbott Acquisition") is interchangeable and competitive with the peritoneal dialysis products offered by Baxter, the Company's major competitor in this field. Therefore, the addition of the Inpersol(R) product line to the Company's other products enables the Company to expand the potential customer base for which it competes, because the Company now supplies peritoneal dialysis products usable by all peritoneal dialysis patients in the U.S. Cyclers. While there are two main forms of peritoneal dialysis therapy, the Company believes that CCPD therapy offers patients benefits over CAPD therapy for patients who need more therapy due to body size, ultrafiltration loss or any other reason. In a standard CAPD program, a patient typically undergoes four manual two-liter exchanges of peritoneal dialysis solution over a 24-hour period, with treatment occurring seven days per week. CAPD must be performed by the patient when he or she is awake. With CCPD therapy, peritoneal dialysis cyclers provide automated dialysis solution exchange. The cycler delivers a prescribed volume of dialysis solution into the peritoneal cavity through an implanted catheter, allows the solution to dwell for a specified time, and completes the process by draining the solution. Cycling may be performed by patients at home throughout the night while sleeping. CCPD delivers more effective therapy than CAPD due to the supine position of the patient during the night, higher volume exchanges and preferable cycle management. The Company's cycling equipment incorporates microprocessor technology, that can be easily programmed by the patient, hospital or clinic staff to perform specific prescribed therapy for a given patient. Since all components are monitored and programmable, these machines allow the physician to prescribe any of a number of current therapy procedures. With nighttime cycling, the patient has complete daytime freedom, wearing only the surgically-implanted catheter and capping device. In addition, the Company believes that CCPD reduces the risk of peritonitis due to less frequent handling of the catheter. Fresenius USA introduced the first CCPD machine in 1980 and, in 1994, introduced a new variant on CCPD therapy, PD-Plus(TM) that is offered by the Company in other parts of the world. Normally, a CCPD patient undergoes five or six two-liter solution exchanges at night, and carries no solution during the day. PD-Plus(TM) therapy provides a more tailored therapy using a simpler nighttime cycler, and, where necessary, one exchange during the day. Compared with typical CCPD therapy, the Company believes that PD-Plus(TM) therapy is less costly and easier to administer. In addition, compared with CAPD therapy, the Company believes that PD-Plus(TM) therapy improves toxin removal by more than 40% and therefore is attractive to patients and physicians alike. By increasing the effectiveness of peritoneal dialysis treatments, at an acceptable increase in cost over CAPD therapy, PD-Plus(TM) therapy may also effectively prolong the time period during which a patient will be able to remain on peritoneal dialysis before requiring hemodialysis. PD-Plus(TM) therapy, as developed by Fresenius USA, can only be performed using the Fresenius Freedom Cycler and special tubing using Safe-Lock(R) connectors. Other Peritoneal Dialysis Products. The Company also manufactures and distributes pediatric treatment systems for administration of low volumes of dialysis solutions, assist devices to facilitate automated bag exchange for handicapped patients, catheters, catheter implantation instruments, silicon glue, Pack-PD(TM) (a computer program which analyzes patient and peritoneal characteristics to present a range of treatment options for individual therapies), disinfectants, bag heating plates, adapters, and products to assist and enhance connector sterility. The Company also provides scientific and patient information products, including support materials, such as brochures, slides, videos, instructional posters and training manuals. Fresenius Medical Care has recently developed a new CAPD system, comprising tubing, connectors and a peritoneal dialysis double bag, together with the process technology for the manufacture of the system. The Fresenius Stay-Safe(TM) 16 17 peritoneal dialysis system utilizes a single switching mechanism that replaces the three tubing clamps to control drainage of solution, flushing of tubes that connect solution bags to catheters, the introduction of new solution, and the tight closure of the line. The control device also further reduces the possibility of catheter contamination during connection and disconnection by sealing the catheter access and surrounding the catheter adapter with a disinfectant solution. New Peritoneal Dialysis Products. Fresenius USA has recently introduced the IQcard(TM) system which has been developed to monitor patient compliance in Automated Peritoneal Dialysis Therapy. The IQcard is used with the Freedom(TM) Cycler PD+ to monitor the delivered dose of APD Therapy and record a full treatment history for each patient. It is estimated that patient non-compliance with prescribed Peritoneal Dialysis Therapy varies from 11% to 80%. Lack of compliance may be the most significant cause of inadequate dialysis and poor clinical outcomes. With IQcard, the physician has a tool for assessing patient compliance and make adjustments to the prescription as necessary to meet therapy goals. In March 1996, Fresenius USA received approval by the U.S. Food and Drug Administration ("FDA") of its new Premier twin bag CAPD system. This system comprises a single product, the Delflex(R) solution bag and the tubing and drainage set necessary for CAPD exchanges. The Premier twin bag system also utilizes Safe-Lock(R) connectors and, because fewer connections are required, may help to reduce patient complications associated with peritoneal dialysis therapy. The Premier twin bag system also includes new fill volumes which offer the physician the ability to prescribe larger dosages without requiring the patient to do more exchanges during the day. Fresenius USA began limited marketing of the Premier twin bag system during July 1996. Additionally, in December 1997, Fresenius Medical Care submitted to the FDA a file for review of a more advanced Premier twin bag system that utilizes additional features beyond those approved in March 1996. This application is still pending. MARKETING, DISTRIBUTION AND SERVICE Most of the Company's products are sold to hospitals, clinics and specialized treatment centers. With its comprehensive product line and years of experience in dialysis, the Company believes that it has been able to establish and maintain very close relationships with its clinic customer base on a global basis. Close interaction among the Company's sales force and research and development personnel enables concepts and ideas that develop in the field to be considered and integrated into product development. The Company maintains a direct sales force of trained salespersons engaged in the sale of both hemodialysis and peritoneal dialysis products. This sales force engages in direct promotional efforts, including visits to physicians, clinical specialists, hospitals, clinics and dialysis centers, and represents the Company at industry trade shows. The Company also sponsors medical conferences and scientific symposia as a means for disseminating product information. The sales force is assisted by clinical nurses who provide clinical support, training and assistance to customers. The Company also utilizes outside distributors to provide sales coverage in countries not serviced by its internal sales force. Fresenius USA's products are distributed in Canada through a wholly-owned subsidiary and in Mexico through distributors. Inpersol(R) products are not distributed by Fresenius USA in Canada or Mexico, where Abbott retains exclusive rights to those products. All of the Company's machines are shipped from its facilities in Walnut Creek, California. Fresenius USA's dialyzers and certain hemodialysis disposable products are shipped to regional distribution centers from Fresenius USA's facilities in Ogden, Utah. Certain other hemodialysis equipment is shipped from McAllen, Texas/Reynosa, Mexico to the Company's regional distribution centers. Fresenius USA's disposable peritoneal dialysis products are shipped from its facility in Ogden, Utah or from Abbott facilities to regional distribution centers, and, from these regional distribution centers the products are delivered directly to the customer, in most cases the patient, by Company drivers. The drivers store deliveries in the location desired by the patient rotate disposable products so that the oldest products are used first, and generally provide continuity of contact between Fresenius USA and patients who use Fresenius USA's peritoneal dialysis products. Products of the Renal Products Division of the Company are distributed through 25 warehouse facilities in the U.S. At the time of the Abbott Acquisition by Fresenius USA, Abbott Laboratories had agreements with numerous hospitals pursuant to which these hospitals could order the full line of Abbott Laboratories products, including renal dialysis products, from Abbott Laboratories. Abbott Laboratories agreed to act as Fresenius USA's distributor for the continued sale of Inpersol(R) products to hospitals through the third quarter of 1998. Fresenius USA undertook its own distribution effective October 1, 1998. The Company offers customer service, training and education, and technical support such as field service, spare parts, repair shops, maintenance, and warranty regulation. The Company also provides training sessions on the Company's equipment. The Company provides supportive literature on the benefits of its core business products. The Company's management believes its service organizations have a reputation for reliability and high quality service. 17 18 MANUFACTURING OPERATIONS The Company assembles equipment, including hemodialysis machines, dialyzer reuse devices and peritoneal dialysis cyclers, at its facility in Walnut Creek, California. Components of the Company's hemodialysis machines are supplied by Fresenius Medical Care as well as other suppliers, and the Company has experienced no difficulties in obtaining sufficient quantities of such components. In connection with the sale and installation of the machines, Company technicians and engineers calibrate the machines and add computer software for record keeping and monitoring. The Company owns a 344,000 square-foot facility in Ogden, Utah for the manufacture of disposable products, including polysulfone dialyzers and peritoneal dialysis solutions. This facility uses automated equipment for the production of polysulfone dialyzers and sterile solutions in flexible plastic containers. The design of the Company's Ogden facility is based on the design of a Fresenius Medical Care facility in St. Wendel, Germany, and was constructed in consultation with Fresenius AG. The Company, through Fresenius USA, also purchases dialyzers and polysulfone bundles from Fresenius Medical Care. The Company believes that it is the principal manufacturer of polysulfone dialyzers in the U.S. While the Company obtains the film used in the manufacture of its plastic bags from one supplier located in The Netherlands, the Company believes that there are readily available alternative sources of supply for which the FDA could grant expedited approval. The Company also intends to manufacture its own plastic film for peritoneal dialysis solution bags. The Company also manufactures dialysis products at 7 additional plants in the U.S.. Bloodlines and PD sets are produced at facilities in Reynosa, Mexico, and McAllen, Texas, and concentrates are produced at three facilities in the U.S.. Each step in the manufacture of the Company's products, from the initial processing of raw materials through the final packaging of the completed product, is carried out under controlled quality assurance procedures required by law and under Good Manufacturing Practices ("GMP"), as well as under comprehensive quality management systems, such as the internationally recognized ISO 9000-9004 and CE Mark standards, which are mandated by regulatory authorities in the countries in which the Company operates. Incoming raw materials for solutions are subjected to various physical, chemical and biological analyses to assure quality and consistency. During the production cycle, sampling and testing are performed in accordance with established quality assurance procedures. Pressure, temperature and time for various processes are monitored to assure consistency of semifinished goods. Environmental conditions are monitored to assure that particulate and bacteriological levels do not exceed specified maximums. Sampling and testing are done in accordance with physical and chemical procedures required to ensure sterility, safety and potency of finished products. The Company maintains continuing quality control and GMP education and training programs for its employees. See "-- Regulatory and Legal Matters." SOURCES OF SUPPLY Raw materials essential to the Company's dialysis products business are purchased worldwide from numerous suppliers and no serious shortages or delays in obtaining raw materials have been encountered. To assure continuous high quality, Fresenius Medical Care has single supplier agreements for many of its polymers, including polysulfone, polyvinylpyrrolidone, and polyurethane for dialyzer production, and for certain other raw materials. Wherever single supplier agreements exist, the Company believes alternative suppliers are available. However, use of raw materials obtained from alternative suppliers could cause costs to rise due to necessary adjustments in the production process or interruptions in supply. One of the Company's subsidiaries, Fresenius USA, obtains bloodlines under an agreement with Medisystems Corporation, whose principal source of bloodlines is a single FDA-approved plant located in Thailand. The agreement has an eight-year term ending in September 1999 and an additional multi year agreement is being negotiated. Fresenius USA is required to make minimum annual purchase commitments (currently approximately 15.0 million bloodline sets) through September 1999. The current agreement includes guaranteed price provisions, subject to permitted increases reflecting cost increases beyond the supplier's control. 18 19 RESEARCH AND DEVELOPMENT Current research and development activities of the Company are primarily conducted through Fresenius Medical Care and are strongly focused on the development of new products, technologies and treatment concepts to optimize the quality of treatment for dialysis patients, and on process technology for the manufacture of the Company's products. Research and development is conducted through the Fresenius Medical Care's Innovation & Technology Group which is divided into hemodialysis and peritoneal dialysis segments. These units work closely with the respective marketing and medical departments in each dialysis segment. Fresenius Medical Care intends to continue to maintain its central research and development operations for disposable products, including dialyzers and peritoneal solutions, at its St. Wendel facility and for durable products at its facilities in Schweinfurt and Bad Homburg, Germany. It expects that as its dialysis products business continues to expand internationally, research and development activities by its international operations, including the Company, will rely primarily on the research and development activities conducted at St. Wendel, Schweinfurt, and Bad Homburg, with local activities focusing on cooperative efforts with those facilities to develop new products and product modifications for local markets. The Company's product development staff works closely with the Fresenius Medical Care research and development group in this regard. Fresenius Medical Care employs approximately 232 persons in research and development (including medical doctors, engineers, technicians and research scientists), and conducts its activities at three locations in Germany (at the St. Wendel facility, the Schweinfurt facility and the Bad Homburg facility), and in Walnut Creek, California and Ogden, Utah. Fresenius Medical Care's research and development expenses were $31 million in 1998. The Company seeks to maintain its profile in scientific circles through articles in scientific and medical journals, participation in academic symposia, relationships with scientists and physicians in relevant fields and the organization of scientific meetings and workshops. The Company also establishes scientific advisory boards and works with medical and other consultants. PATENTS, TRADEMARKS AND LICENSES In connection with the Merger, Fresenius Medical Care and its subsidiaries acquired or licensed all intellectual property rights of Fresenius AG relating to Fresenius Worldwide Dialysis. As the owner of or licensee under patents and trademarks throughout the world, Fresenius Medical Care holds rights under more than 800 patents and patent applications relating to dialysis technology in major markets. Patented technologies that relate to dialyzers include Fresenius Worldwide Dialysis' polysulfone hollow fiber, Fresenius Worldwide Dialysis' in-line sterilization method, and sterile closures for in-line sterilized medical devices. For dialysis machines, patents include the process for volumetric mixing of concentrate with water, the location for a filter device for sterile filtering dialysate in the dialysis machine circuit, and conductivity sensor devices and a mathematical algorithm for using such devices. Pending patents include the safety concept for the control of the ultrafiltration rate in a dialysis machine used for high flux dialysis and the connector system for the Fresenius Worldwide Dialysis' biBag(TM) bicarbonate concentrate powder container. For peritoneal dialysis, Fresenius Medical Care holds rights on the Safe-Lock(R) system, the double bag for bicarbonate peritoneal dialysis solution, and its orientation of the two compartments. Pending patents include non-PVC film (Biofine(TM)) for general use in intravenous and peritoneal dialysis applications and a special film for a peelable, non-PVC double bag for peritoneal dialysis solutions. Fresenius USA's intellectual property includes the Inpersol(R) trademark and rights to certain manufacturing know-how Fresenius USA obtained from Abbott, and a paid-up non-exclusive global sublicense from Baxter to certain CAPD and connector technology. The patent family covering Fresenius Polysulfone(TM) high flux membranes has been subject to opposition by competitors in Europe and Japan. While Fresenius Medical Care believes that these patents are valid in the relevant jurisdictions, a successful opposition could have a material adverse effect on the Company. The Company believes that its success will depend, in large part, on Fresenius Medical Care's technology. While Fresenius Medical Care, as a standard practice, obtains such legal protections it believes are appropriate for its intellectual property, such intellectual property is subject to infringement or invalidation claims. In addition, technological developments in ESRD therapy could reduce the value of Fresenius Medical Care's existing intellectual property, which reduction could be rapid and unanticipated. 19 20 COMPETITION The markets in which the Company sells its dialysis products are highly competitive. Among the Company's competitors in the sale of hemodialysis and peritoneal dialysis products are CGH Medical (an affiliate of Gambro AB), Baxter, Inc., Althin, Asahi Medical Co., Ltd., Bellco S.p.A. (a subsidiary of Sorin Biomedica S.p.A.), Bieffe Medital S.p.A., B. Braun Melsungen AG, Nissho Corporation (including Nissho Nipro Corporation Ltd.), Nikkiso Co., Ltd., Terumo Medical Corporation and Toray Medical Co., Ltd. Some the Company's competitors possess greater financial, marketing and research and development resources than the Company. The Company believes that in the dialysis product market, companies compete primarily on the basis of product performance, cost-effectiveness, reliability, assurance of supply and service and continued technological innovation. The Company believes its products are highly competitive in all of these areas. Independent dialysis centers and those operated by other chains that were customers of Fresenius Worldwide Dialysis prior to the Merger may elect to limit or terminate their purchases of the Company dialysis products in order to avoid purchasing products manufactured by a competitor. The Company believes, however, that customers will continue to consider its long-term customer relationships and reputation for product quality in making product purchasing decisions, and the Company intends to compete vigorously for such customers. EMPLOYEES At December 31, 1998, the Company employed approximately 23,138 employees, including part-time and per diem employees. Such persons are employed by the Company's principal businesses as follows: dialysis treatment and laboratory services, approximately 20,023 employees; and dialysis products, approximately 3,115 employees. Medical Directors of the Company's dialysis centers are retained as independent contractors. Management believes that its relations with its employees are good. Approximately 511, or 2% of the Company's employees are covered by union agreements. REGULATORY AND LEGAL MATTERS Regulatory Overview The operations of the Company are subject to extensive governmental regulation at the federal, state and local levels. regarding the operation of dialysis centers, laboratories and manufacturing facilities, the provision of quality health care for patients, the maintenance of occupational, health, safety and environmental standards and the provision of accurate reporting and billing for governmental payments and/or reimbursement. In addition, some states prohibit ownership of health care providers by for-profit corporations or establish other regulatory barriers to direct ownership by for-profit corporations. In those states, the Company works within the framework of local laws to establish alternative contractual arrangements for the provision of services to those facilities. Any failure by the Company or its subsidiaries to receive required licenses, certifications or other approvals for new facilities, significant delays in such receipt, loss of its various federal certifications, termination of licenses under the laws of any state or other governmental authority or changes resulting from health care reform or other government actions that reduce reimbursement or reduce or eliminate coverage for particular services rendered by the Company or its subsidiaries could have a material adverse effect on the business, financial condition and results of operations of the Company. The Company must comply with legal and regulatory requirements under which it operates, including the federal Medicare and Medicaid Fraud and Abuse Amendments of 1977, as amended (the "anti-kickback statutes"), the federal restrictions on certain physician referrals (commonly known as the "Stark Law") and other fraud and abuse laws and similar state statutes, as well as similar laws in other countries. Certain of NMC's and its subsidiaries' activities are subject to investigation (the "OIG Investigation") by the Office of the Inspector General ("OIG") of the HHS. See "--Legal Proceedings" for information about the OIG's investigations and about additional regulatory, investigatory and legal proceedings with respect to the Company. Moreover, there can be no assurance that applicable laws, or the regulations thereunder, will not be amended, or that enforcement agencies or the courts will not make interpretations inconsistent with those of the Company, any one of which could have a material adverse effect on its business, reputation, financial condition and results of operations of the Company. Sanctions for violations of these statutes may include criminal or civil penalties, such as imprisonment, fines or forfeitures, denial of payments, and suspension or exclusion from the Medicare and Medicaid programs. In the U.S., these laws have been broadly interpreted by a number of courts, and significant government funds and personnel have been devoted to their enforcement because such enforcement has become a high priority for the federal 20 21 government and some states. The Company, and the health care industry in general, will continue to be subject to extensive federal, state and foreign regulation, the full scope of which cannot be predicted. NMC had historically employed certain mechanisms to monitor its compliance with relevant laws, rules, regulations and business standards. Such compliance-related policies and activities included periodic reaffirmations of business ethics standards, internal audit reviews and legal reviews. To increase the effectiveness of its compliance activities, the Company initiated in the fall of 1996 a review and enhancement of NMC's compliance systems. It also hired a senior-level corporate compliance officer to assist with such efforts. In connection with its compliance program, the Company established a toll-free Employee Action Line accessible to all its employees to seek guidance and report potentially improper or unethical actions, or report violations of applicable law or policies. Confidentiality of callers is protected to the extent permitted by law, and the Company has a policy against retaliation or retribution against anyone who in good faith reports an ethical or legal concern. The Company seeks to ensure that cases are investigated thoroughly, objectively, and promptly. A Code of Ethics and Business Conduct was developed and distributed to all the Company employees in January 1997. This document emphasizes the Company's commitment to conduct business in accordance with the highest legal and ethical standards of business conduct, which every employee has an obligation to uphold. Compliance training for employees began in 1996. Currently, compliance training is performed by Company management under the supervision and guidance of the Company's Compliance Officer. The compliance training program, featuring both live and video presentations, focuses on the current regulatory environment, the Company's commitment to compliance, a page-by-page review of the Code of Ethics and Business Conduct, a discussion of the Employee Action Line, and an analysis of hypothetical cases involving compliance and ethics challenges. Substantially all of the Company's employees throughout the United States received compliance training by the end of the first quarter of 1998. Training for new employees is ongoing. Compliance-related communications to all employees have been and will continue to be made regularly. In addition, compliance audits are a part of the Company's overall compliance program. For example, the Company's Compliance Officer oversees training and audits required under Spectra's Laboratories' Corporate Integrity Agreement as discussed below. Prior to Spectra's acquisition by the Company, Spectra settled an investigation by the government and entered into a Corporate Integrity Agreement ("Agreement"). This Agreement provides for a government-mandated compliance program which, among its provisions, requires an annual independent review to assess the effectiveness of internal controls and the implementation and operation of the program. Under its provisions, a material breach of the Agreement may result in exclusion of Spectra from the Medicare and Medicaid programs. A similar agreement was executed by Spectra to settle state Medicaid claims. In February 1999 the government advised Spectra that it may be in material breach of the Agreement. Spectra is currently reviewing the government's areas of concern and will take any necessary corrective action. While there can be no assurances, the Company does not believe that the outcome of this matter will have an adverse effect on the Company. PRODUCT REGULATION In the U.S., the FDA and comparable state regulatory agencies impose requirements on certain subsidiaries of the Company as a manufacturer and a seller of medical products and supplies under their jurisdiction. These require that products be manufactured in accordance with GMP and that the Company comply with FDA requirements regarding the design, safety, advertising, labeling, recordkeeping and reporting of adverse events related to the use of its products. In addition, in order to clinically test, produce and market certain medical products and supplies (including hemodialysis and peritoneal dialysis equipment and solutions, dialyzers, bloodlines and cell separators) for human use, the Company must satisfy mandatory procedures and safety and efficacy requirements established by the FDA or comparable state and foreign governmental agencies. Such rules generally require that products be approved by the FDA as safe and effective for their intended use prior to being marketed. A "510(k)" pre-market notification or pre-market approval application is required before certain new FDA-regulated devices may be sold or marketed in the U.S. The FDA generally classifies medical devices as class I devices, which are subject to general controls (e.g., labeling, pre-marketing notification and adherence to GMP); class II devices, which are subject to special controls (e.g., performance standards, post-marketing surveillance, patient registries and FDA guidelines); and class III devices, which include life-sustaining, lifesupporting and implantable devices, or new devices which are not substantially equivalent to devices in interstate commerce prior to 1976 and which require pre-market approvals. The FDA 21 22 will generally grant 510(k) clearance if the submitted data establish that the proposed device is "substantially equivalent" to a legally marketed class I or class II medical device, or a class III medical device for which the FDA does not require pre-marketing approval. The FDA may request additional data or require pre-marketing approval for any device. The approval process is expensive, time consuming and subject to unanticipated delays. There can be no assurance that the Company will obtain necessary regulatory approvals or clearances within reasonable time frames, if at all. Any such delay or failure to obtain regulatory approval or clearances could have a materially adverse effect on the business, financial condition and results of operations of the Company. The Company's peritoneal dialysis solutions have been designated as drugs by the FDA and, as such, are subject to additional FDA regulation under the Food, Drug and Cosmetic Act of 1938 ("FDC Act"). In order for a new drug to receive marketing approval in the U.S., the Company must follow a series of steps which may include: (a) pre-clinical laboratory and animal tests in accordance with good laboratory practices, (b) an Investigational New Drug application which must become effective before human clinical trials may begin, (c) well-controlled human clinical trials to establish the safety and efficacy of the new drug product, (d) a New Drug Application ("NDA") or an Abbreviated New Drug Application ("ANDA") and (e) approval of the NDA or ANDA prior to any commercial sale or shipment of the drug. FDA approval must be obtained for each product designated as a drug. Generally, approval of an NDA, if obtained, takes one and a half or more years and may take longer should the FDA raise questions or have concerns about a new drug. The FDA may also prohibit the sale or importation of products, order product recalls or require post-marketing testing and surveillance programs to monitor a product's effects. The Company believes that it has filed for or obtained all necessary approvals for the manufacture and sale of its products in jurisdictions in which those products are currently produced or sold. See "--Legal Proceedings--FDA Matters" and "--Legal Proceedings--District of New Jersey Investigation" for information about certain FDA matters, including warning letters and import alerts that the FDA issued from 1991 through 1993 with respect to certain products assembled by NMC and the Consent Decree entered into thereafter; 1994 and 1995 FDA audits of certain Fresenius USA manufacturing facilities; and a District of New Jersey federal grand jury investigation into NMC's historical activities 22 23 FACILITIES AND OPERATIONAL REGULATION The Clinical Laboratory Improvement Amendments of 1988 ("CLIA") subject virtually all clinical laboratory testing facilities, including those of the Company, to the jurisdiction of HHS. CLIA establishes national standards for assuring the quality of laboratories based upon the complexity of testing performed by a laboratory. Certain of the operations of the Company also subject it to federal laws governing the repackaging and dispensing of drugs (including oxygen) and the maintenance and tracking of certain life sustaining and life-supporting equipment. The operations of the Company are subject to various U.S. Department of Transportation, Nuclear Regulatory Commission and Environmental Protection Agency requirements and other federal, state and local hazardous and medical waste disposal laws. As currently in effect, laws governing the disposal of hazardous waste do not classify most of the waste produced in connection with the provision of dialysis, or laboratory services as hazardous, although disposal of nonhazardous medical waste is subject to specific state regulation. SRM, Spectra and LifeChem, however, do generate hazardous waste which is subject to specific disposal requirements. The operations of the Company are also subject to various air emission and wastewater discharge regulations. Federal, state and local regulations require the Company to meet various standards relating to, among other things, the management of facilities, personnel qualifications and licensing, maintenance of proper records, equipment, quality 23 24 assurance programs, the operation of pharmacies, and dispensing of controlled substances. All of the operations of the Company in the U.S. are subject to periodic inspection by federal and state agencies and other governmental authorities to determine if the operations, premises, equipment, personnel and patient care meet applicable standards. To receive Medicare reimbursement, the Company's dialysis centers, renal diagnostic support business and laboratories must be certified by HCFA. All of the Company's dialysis centers, and laboratories that furnish Medicare services are so certified. Certain facilities of the Company and certain of their employees are also subject to state licensing statutes and regulations. These statutes and regulations are in addition to federal and state rules and standards that must be met to qualify for payments under Medicare, Medicaid and other government reimbursement programs. Licenses and approvals to operate these centers and conduct certain professional activities are customarily subject to periodic renewal and to revocation upon failure to comply with the conditions under which they were granted. See "--Legal Proceedings--FDA Matters" for information about 1995 FDA audits of Fresenius USA's facilities. The Occupational Safety and Health Administration ("OSHA") regulations require employers to provide employees who work with blood or other potentially infectious materials with prescribed protections against blood-borne and air-borne pathogens. The regulatory requirements apply to all health care facilities, including dialysis centers, laboratories and renal diagnostic support business, 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 hepatitis B vaccinations, personal protective equipment, blood-borne pathogens training, post-exposure evaluation and follow-up, waste disposal techniques and procedures, engineering and work practice controls and other OSHA-mandated programs for blood-borne and air-borne pathogens. Some states in which the Company operates have Certificate of Need ("CON") laws that require any person or entity seeking to establish a new health care service or to expand an existing service to apply for and receive an administrative determination that the service is needed. The Company currently operates in 13 states and the District of Columbia and Puerto Rico that have CON laws applicable to dialysis centers. These requirements may provide a barrier to entry to new companies seeking to provide services in these states, but also may constrain the Company's ability to expand its operations in these states. 24 25 REIMBURSEMENT Dialysis Services. The Company's dialysis centers provide outpatient hemodialysis treatment and related services for ESRD patients. In addition, some of the Company's centers offer services for the provision of peritoneal and hemodialysis treatment at home. The Medicare program is the primary source of Dialysis Services' revenues from dialysis treatment. For example, in 1998, approximately 57% of Dialysis Services revenues resulted from Medicare's ESRD program. As described below, Dialysis Services is reimbursed by the Medicare program in accordance with the Composite Rate for certain products and services rendered at the Company's dialysis centers. As described in the next paragraph, other payment methodologies apply to Medicare reimbursement for other products and services provided at the Company's dialysis centers and for products (such as those sold by the Company) and support services furnished to ESRD patients receiving dialysis treatment at home (such as those of Dialysis Products). Medicare reimbursement rates are fixed in advance and are subject to adjustment from time to time by the U.S. Congress. Although this form of reimbursement limits the allowable charge per treatment, it provides the Company with predictable and recurring per treatment revenues and allows the Company to retain any profit earned. When Medicare assumes responsibility as primary Dialysis Products payor (see "Reimbursement--Coordination of Benefits"), Medicare is responsible for payment of 80% of the Composite Rate set by HCFA for dialysis treatments. The Composite Rate governs the Medicare reimbursement available for a designated group of dialysis services, including the dialysis treatment, supplies used for such treatment, certain laboratory tests and certain medications. The Composite Rate consists of labor and nonlabor components with adjustments made for regional wage costs, subject to a national payment floor and ceiling currently ranging from $117 to $139 per treatment, with exceptions based on specified criteria. In certain instances, products sold by Fresenius USA and Dialysis Products are included in the non-labor component of the Composite Rate as described below. The method under which the Company is reimbursed for home dialysis is based on which supplier is selected to provide dialysis supplies and equipment. If the center is designated as the supplier ("Method I"), the center provides all dialysis treatment related services, including equipment and supplies, and is reimbursed using a methodology based on the Composite Rate. If Dialysis Products is designated as the direct supplier ("Method II"), Dialysis Products provides the patient directly with all necessary equipment and supplies and is reimbursed by Medicare subject to a capitated ceiling. Clinics provide home support services to Method II patients and these services are reimbursed at a monthly fee for service basis subject to a capitated ceiling. The reimbursement rates under Method I and Method II differ, although both are prospectively determined and are subject to adjustment from time to time by Congress. Certain items and services that the Company furnishes at its dialysis centers are not included in the Composite Rate and are eligible for separate Medicare reimbursement, typically on the basis of established fee schedule amounts. Such items and services include certain drugs (such as EPO), blood transfusions and certain diagnostic tests. The rate of utilization by the Company's facilities of items and services that are not included in the Composite Rate is a subject of the OIG Investigation. See "--Legal Proceedings--OIG Investigation." Medicare payments are subject to change by legislation and pursuant to deficit reduction measures. The Composite Rate was unchanged from commencement of the ESRD program in 1972 until 1983. From 1983 through December 1990, numerous congressional actions resulted in a net reduction of the average reimbursement rate from $138 per treatment in 1983 to approximately $125 per treatment in 1990. Congress increased the ESRD reimbursement rate, effective January 1, 1991, to an average rate of $126 per treatment. In 1990, Congress required that the Prospective Payment Assessment Commission ("PROPAC") study dialysis costs and reimbursement and make reports annually to Congress with a recommendation as to the appropriateness of changes to the ESRD reimbursement rates. In 1993, PROPAC recommended a 2.5% increase in the Composite Rate for independent freestanding dialysis facilities, which was not implemented by Congress. In March 1994 and again in 1995, PROPAC recommended that no changes be made in the reimbursement rate. In March 1996, PROPAC recommended a 2% increase in the Composite Rate for independent freestanding dialysis facilities. In March 1997, the Medicare Payment Advisory Commission ("MedPAC") recommended a 2.8% increase in the Composite Rate for both independent freestanding dialysis facilities and hospital-based dialysis facilities for fiscal year 1998 which was not implemented by Congress. Congress is not required to, and no congressional action was taken to, implement the MedPAC recommendations and Congress could establish a different reimbursement rate. The Company is unable to predict what, if any, future changes may occur in the rate 25 26 of Medicare reimbursement. Any significant decreases in the Medicare reimbursement rates could have a material adverse effect on the Company's provider business and, because the demand for products is affected by Medicare reimbursement, on its products business. Increases in operating costs that are affected by inflation, such as labor and supply costs, without a compensating increase in reimbursement rates, also may adversely affect the Company's business and results of operations. The patient or third-party insurance payors, including employer-sponsored health insurance plans, commercial insurance carriers and the Medicaid program, are responsible for paying any co-payment amounts for approved services not paid by Medicare (typically the annual deductible and 20% co-insurance), subject to the specific coverage policies of such payors. The extent to which the Company is actually paid the full co-payment amounts depends on the particular responsible party. Each third-party payor, including Medicaid, makes payment under contractual or regulatory reimbursement provisions which may or may not cover the full 20% co-payment or annual deductible. Where the patient has no third-party insurance or the third party insurance does not cover copayment or deductible and is not eligible for Medicaid, the patient is responsible for paying the co-payments or the deductible, which the Company frequently does not collect fully despite reasonable collection efforts. In certain cases, the Company through NMC has paid, or provided loans for the payment of, premiums for supplemental medical insurance (under which Medicare Part B coverage is provided) and/or for Medigap insurance (which covers co-payment amounts) on behalf of financially needy patients. NMC believes that, in most cases, this practice was lawful prior to the effective date of the Health Insurance Portability and Accountability Act, Public Act 104-191 ("HIPAA"). The practice of providing loans or grants for the payment of supplemental medical insurance premiums by NMC was one of the subjects of review by the government as part of the OIG Investigation. See "--Legal Proceedings--OIG Investigation" and "--Legal Proceedings--Supplemental Medical Insurance." The government, however, advised the Company orally that it is no longer pursuing this issue. Furthermore, as a result of the passage of the HIPAA, the Company terminated making such payments on behalf of its patients. Instead, the Company, together with other representatives of the industry, obtained an advisory opinion from the OIG, whereby, consistent with specified conditions, the Company and other similarly situated providers may make contributions to a non-profit organization that has volunteered to make these payments on behalf of indigent ESRD patients, including patients of the Company. Laboratory Tests. A substantial portion of SRM's net revenues are derived from Medicare, which pays for clinical laboratory services provided to dialysis patients in two ways. First, payment for certain routine tests is included in the Composite Rate paid to the centers. As to such services, the dialysis centers obtain the services from a laboratory and pay the laboratory for such services. In accordance with industry practice, SRM usually provides such testing services under capitation agreements with its customers pursuant to which it bills a fixed amount per patient per month to cover the laboratory tests included in the Composite Rate at the designated frequencies. In October 1994, the OIG issued a special fraud alert in which it stated its view that the industry practice of providing tests covered by the Composite Rate at below fair market value raised issues under the anti-kickback statutes, as such an arrangement with an ESRD facility appeared to be an offer of something of value (Composite Rate tests at below market value) in return for the ordering of additional tests billed directly to Medicare. See "--Anti-kickback Statutes, False Claims Act, Stark Law and Fraud and Abuse Laws" for a description of this statute. LifeChem's use of capitation rates in billing for tests in the Composite Rate is a subject of the OIG Investigation. See "--Legal Proceedings-- OIG Investigation" and "--Legal Proceedings--LifeChem." Second, laboratory tests performed by SRM for Medicare beneficiaries that are not included in the Composite Rate are separately billable directly to Medicare. Such tests are paid at 100% of the Medicare fee schedule amounts, which are limited by national ceilings on payment rates, called National Limitation Amounts ("NLAs"). Congress has periodically reduced the fee schedule rates and the NLAs, with the most recent reductions in the NLAs occurring in January 1998. (As part of the Balanced Budget Act of 1997, Congress lowered the NLAs from 76% to 74% effective January 1, 1998.) Congress has also approved a five year freeze on the inflation updates based on the Consumer Price Index (CPI) for 1998-2002. In addition, LifeChem's practice of billing Medicare directly for certain laboratory tests is a subject of the OIG Investigation and, therefore, recent changes in such direct billing practices could materially affect SRM's revenues. The issue of whether LifeChem inappropriately provided to physicians information regarding the diagnosis codes required to assure reimbursement for laboratory services is a subject of the OIG Investigation. Medicare carriers have aggressively implemented Local Medical Review Policies (LMRPs) limiting the coverage of certain clinical laboratory services to an established list of diagnosis codes supporting medical necessity. These LMRPs set forth medical necessity criteria based on diagnosis coding as well as frequency of service provisions. Provisions in the Balanced Budget Act of 1997, require the Secretary of HHS to adopt uniform coverage and payment policies for laboratory testing by July 1, 1999. The adoption of additional coverage policies would reduce the number of covered services and could materially affect SRM's revenues. See "--Legal Proceedings--OIG Investigation" and "--Legal Proceedings--LifeChem." See "--Legal Proceedings--OIG Investigation" and "--Legal Proceedings--LifeChem," for information relating to LifeChem's voluntary disclosure of, and repayments associated with, certain billing problems and related proceedings. Laboratory tests may be ordered only by physicians based on the needs of their patients. LifeChem services are promoted to physicians by sales representatives who are Company employees. Such sales practices are a subject of the OIG Investigation. See "--Legal Proceedings--OIG Investigation" and "--Legal Proceedings--LifeChem." 26 27 IDPN. Among its other services, SRM administers IDPN to chronic dialysis patients who suffer from gastrointestinal malfunctions. These services are covered by the Medicare program under the Medicare Parenteral and Enteral Nutrition ("PEN") benefit, which requires extensive documentation and individual physician certification of medical necessity for each patient. Treatment by IDPN has been shown to increase the body content of vital, high biologic value proteins like albumin. Deficiency of such proteins has been shown to be associated with substantially higher risk of death, both long-term and short-term (one year), among dialysis patients. Prior to September 1993, IDPN claims were processed by two regional Medicare specialty PEN carriers, which are private companies under contract with HCFA responsible for processing claims and implementing certain Medicare benefits. In late 1993, administration of Medicare PEN claims was transferred to four newly created regional Durable Medical Equipment Regional Carriers ("DMERCs"). The DMERCs implemented policies for IDPN reimbursement that resulted in a sharp reduction in the number of IDPN claims approved for payment. As a result of these payment reductions, several competitors of Homecare ceased providing IDPN. Some of these competitors' patients subsequently became Homecare patients for IDPN. The Company believes that the reduction in IDPN claims paid by Medicare represented an unauthorized policy coverage change. Accordingly, NMC, along with certain other IDPN providers, is pursuing various administrative and legal avenues, including administrative appeals, to address this problem. Although NMC contends that its IDPN claims were consistent with published Medicare coverage guidelines and ultimately will be approved for payment, there can be no assurance that the claims on appeal will be approved for payment. See "Legal Proceedings--IDPN Coverage Issues" SRM has continued to provide IDPN therapy to malnourished dialysis patients because the Company believes that to be the only clinically and ethically responsible course of action. Analyses of data from the Company's PSP database, both internal and as published in peer-reviewed medical journals, indicate that malnutrition measured by a serum albumin value of 3.4 g/dl or less is associated with significantly increased mortality risk in the chronic dialysis population and that IDPN is effective in increasing serum albumin and moderating mortality risk for such malnourished patients. These studies show that when these initial albumin levels were 3.0 g/dl or less, IDPN treatment was accompanied by a 70% improvement in survival. Similarly, when the initial albumin was 3.4 g/dl or less, survival with IDPN treatment was improved by about 15%. IDPN treatment is therefore associated with improved odds of survival at albumin concentration lower than 3.4 g/dl and the amount of improvement increases as albumin concentrates falls. A statistical review conducted in March 1996 suggests that about 5% of dialysis patients suffer from albumin concentration that is 3.0 g/dl or less. Because the management of the Company has believed that the obligation of medical professionals and companies that support medical care to ESRD patients extends beyond the mere provision of paid-for-service to advocacy for needed treatment, the Company has accepted increasing financial risk by continuing to offer IDPN. In April 1996, HCFA published new medical review policies which restrict substantially the number of patients for whom IDPN is reimbursed by Medicare. The new policies became final and effective for claims submitted on or after July 1, 1996. NMC and other PEN providers continue to review to what extent possible modifications to the new policies might be obtained in legislative or administrative forums. While the new policy permits continued coverage of IDPN and other PEN therapies, and while the potential impact of the new policy is subject to further analysis, NMC believes that the new policy has made it substantially more difficult to qualify patients for future coverage by, among other things, requiring certain patients to undergo onerous and/or invasive tests in order to qualify for coverage. The new policy also eliminates all reimbursement for infusion pumps. NMC, together with other interested parties, may seek to effect certain changes in the new policy (other than with respect to the elimination of pump revenues), and NMC has developed changes to its patient qualification procedures in order to comply with the policy. This policy continues to limit significantly the number of patients eligible for Medicare coverage of IDPN and other PEN therapies. 27 28 If NMC is unable to collect its IDPN accounts receivable or if IDPN/PEN coverage is reduced or eliminated, the Company's business, financial position and results of operations would be materially adversely affected. See "--Legal Proceedings--IDPN Coverage Issues." See "--Legal Proceedings--OIG Investigation" for information on issues raised by the OIG with respect to the provision of IDPN by Homecare and related billing practices. EPO. Since June 1, 1989, the Medicare program has provided coverage for the administration of EPO to dialysis patients, with reimbursement made separately from the Composite Rate. Medicare reimbursement for EPO was reduced from $11.00 to $10.00 per 1,000 units, effective January 1, 1994. The OIG and the Clinton Administration recently announced an intention to seek a 10% reduction in Medicare reimbursement for EPO. Future changes in the EPO reimbursement rate, inclusion of EPO in the Composite Rate, changes in the typical dosage per administration or increases in the cost of EPO purchased by NMC could adversely affect the Company's business and results of operations, possibly materially. See "--Legal Proceedings--Qui Tam Actions." Coordination of Benefits. Medicare entitlement begins for most patients in the fourth month after the initiation of chronic dialysis treatment at a dialysis center. During the first three months, considered to be a waiting period, the patient or patient's insurance, Medicare or a state renal program are responsible for payment. Patients who have Medicare and are also covered by an employer group health plan ("EGHP") are subject to a 30 month coordination period during which the EGHP is the primary payor and Medicare the secondary payor. During this coordination period the EGHP pays a negotiated rate or in the absence of such a rate, the Company's standard rate or a rate defined by its plan documents. The payments are generally higher than the Medicare Composite Rate. Insurance will therefore cover a total of 33 months, the 3 month waiting period plus the 30 month coordination period. Patients who already have Medicare based on age when they become ESRD patients are dual eligible patients. If these patients have an EGHP that is paying primary then these patients will have a 30 month coordination period. If Medicare is already the primary payor when ESRD entitlement begins, Medicare remains the primary payor, the EGHP is the secondary payor and no coordination period will apply. Most patients over 65 are retired and fall into this second category. Patients who do not have a health insurance retirement benefit plan can purchase Medigap plans offered by AARP and many other insurance companies. Possible Changes in Medicare. Because the Medicare program represents a substantial portion of the federal budget, in order to reduce the federal government deficit, and for other reasons, the U.S. Congress takes action in almost every legislative session to modify the Medicare program by refining the amounts payable to health care providers. Legislation or regulations may be enacted in the future that could substantially modify or reduce the amounts paid for services and products offered by the Company and its subsidiaries. In this regard, both the executive branch and members of Congress from both parties have recently proposed significant reductions in the Medicare program as part of initiatives to reduce the federal government deficit. It is also possible that statutes may be adopted or regulations may be promulgated in the future that impose additional eligibility requirements for participation in the federal and state health care programs. Such new legislation or regulations may adversely affect the Company's businesses and results of operations. ANTI-KICKBACK STATUTES, FALSE CLAIMS ACT, STARK LAW AND FRAUD AND ABUSE LAWS Various operations of the Company are subject to federal and state statutes and regulations governing financial relationships between health care providers and potential referral sources and reimbursement for services and items provided to Medicare and Medicaid patients. Such laws include the anti-kickback statutes, health care fraud statutes, the False Claims Act, the Stark Law, other federal fraud and abuse laws and similar state laws. These laws apply because the Company's Medical Directors and other physicians with whom the Company has financial relationships refer patients to, and order diagnostic and therapeutic services from, the Company's dialysis centers and other operations. As is generally true in the dialysis industry, at each dialysis facility a small number of physicians account for all or a significant portion of the patient referral base. An ESRD patient generally seeks treatment at a center that is convenient to the patient and at which the patient's nephrologist has staff privileges. Virtually all of the Company's centers maintain open staff privileges for local nephrologists. The ability of the Company to provide quality dialysis care and to otherwise meet the needs of patients and local physicians is central to its ability to attract nephrologists to dialysis facilities and to receive referrals from such physicians. 28 29 The federal government, many states and private third-party insurance payors have made combating health care waste, fraud and abuse one of their highest enforcement priorities, resulting in increasing resources devoted to this problem. Consequently, the OIG and other enforcement authorities are increasing scrutiny of arrangements between physicians and health care providers for possible violations of the anti-kickback statutes or other federal laws. Certain competitors of NMC who have faced federal criminal charges under these statutes have entered into settlement agreements under which they have agreed to pay substantial fines and penalties and have entered into corporate integrity agreements. See "--Legal Proceedings" for information concerning the OIG's investigations of NMC's activities under these provisions. ANTI-KICKBACK STATUTES The federal anti-kickback statutes establish criminal prohibitions against and civil penalties for the knowing and willful solicitation, receipt, offer or payment of any remuneration, whether direct or indirect, in return for or to induce the referral of patients or the ordering or purchasing of items or services payable in whole or in part under Medicare, Medicaid or other federal health care programs. Certain federal courts have interpreted the anti-kickback statutes broadly, for example as prohibiting payments intended to induce the referral of Medicare business, irrespective of any other legitimate motives. However, one federal appellate court, in a civil case, has found that a violation of the anti-kickback statutes requires specific knowledge of the anti-kickback statutes and specific intent to disobey the law. Federal district courts in other circuits, however, have expressly declined to follow this precedent. Sanctions for violations of the anti-kickback statutes include criminal and civil penalties, such as imprisonment or criminal fines of up to $25,000 per violation, and civil penalties of up to $50,000 per violation, and exclusion from the Medicare or Medicaid programs and other federal programs. In addition, certain provisions of federal criminal law that may be applicable provide that if a corporation is found guilty of a criminal offense it may be fined no more than twice any pecuniary gain to the corporation, or, in the alternative, no more than $500,000 per offense. Because of the breadth of the anti-kickback statutes, substantial uncertainty has resulted regarding which practices violate the statutes and which practices are legitimate. Three methods the OIG uses periodically to give guidance to providers about the anti-kickback statutes are "safe harbor" regulations, special fraud alerts and advisory opinions. The safe harbor regulations, which were first promulgated in final form on July 29, 1991 and have subsequently been amended, create safe harbors from prosecution, in addition to the statutory exceptions, for certain business arrangements that would otherwise be prohibited by the anti-kickback statutes. To date, a number of regulatory safe harbors have been finalized and additional safe harbor regulations are under consideration. An arrangement that satisfies all of the standards of the applicable safe harbors is deemed not to be subject to prosecution. Arrangements that fall outside of the safe harbors do not necessarily violate the anti-kickback statutes; rather, such arrangements are not afforded protection from prosecution and may be subject to scrutiny by enforcement agencies. Special fraud alerts are intended to inform providers of the OIG's enforcement priorities and to identify suspect practices the OIG believes may violate the anti-kickback statutes. See "--Legal Proceedings" for information concerning the OIG's investigations of certain of NMC's activities, including Medical Director contracts and compensation, sales practices related to the provision of laboratory services and payments made to dialysis facilities in connection with "hang fees" relating to the provision of IDPN services. Effective February 1997, the OIG must respond to requests for advisory opinions concerning whether certain activities violate the anti-kickback statutes. See "--Legal Proceedings--The Health Insurance Portability and Accountability Act of 1996" for a reference to the advisory opinion provision. Some states also have enacted statutes similar to the anti-kickback statutes, which may include criminal penalties, applicable to referrals of patients regardless of payor source, and may contain exceptions different from state to state and from those contained in the federal anti-kickback statutes. FALSE CLAIMS ACT AND RELATED CRIMINAL PROVISIONS The federal False Claims Act (the "False Claims Act") imposes civil penalties for making false claims with respect to governmental programs, such as Medicare and Medicaid, for services not rendered, or for misrepresenting actual services rendered, in order to obtain higher reimbursement. Moreover, private individuals may bring qui tam or "whistle blower" suits against providers under the False Claims Act, which authorizes the payment of a portion of any recovery to the individual bringing suit. Such actions are initially required to be filed under seal pending their review by the Department of Justice. A few federal district courts have recently interpreted the False Claims Act as applying to claims for reimbursement that violate the anti- kickback statutes under certain circumstances. The False Claims Act generally provides for the imposition of civil penalties of $5,000 to $10,000 per claim and for treble damages, resulting in the possibility of substantial financial penalties for small billing errors that are replicated in a large number of claims, as each individual claim could be deemed to be a separate violation of the False Claims Act. Criminal provisions that are similar to the False Claims Act provide that if a corporation is convicted of presenting a claim or making a statement that it knows to be false, fictitious or fraudulent to any 29 30 federal agency it may be fined not more than twice any pecuniary gain to the corporation, or, in the alternative, no more than $500,000 per offense. Some states also have enacted statutes similar to the False Claims Act which may include criminal penalties, substantial fines, and treble damages. THE HEALTH INSURANCE PORTABILITY AND ACCOUNTABILITY ACT OF 1996 HIPAA was enacted in August 1996 and substantively changed federal fraud and abuse laws by expanding their reach to all federal health care programs, establishing new bases for exclusions and mandating minimum exclusion terms, creating an additional exception to the anti-kickback penalties for risk-sharing arrangements, requiring the Secretary of HHS to issue advisory opinions, increasing civil money penalties to $10,000 (formerly $2,000) per item or service and assessments to three times (formerly twice) the amount claimed, creating a specific health care offense and related health fraud crimes, and expanding investigative authority and sanctions applicable to health care fraud. It also prohibits provider payments which could be deemed an inducement to patient selection of a provider. In addition to establishing minimum periods of exclusion from government health programs, the statute authorizes exclusion of an individual with a direct or indirect ownership or control interest in a sanctioned entity if the individual "knows or should know" of the activity leading to the conviction or exclusion of the entity or where the individual is an officer or managing employee of the entity. The law requires the Secretary of HHS to issue advisory opinions regarding what constitutes a violation under the anti-kickback statutes and whether an arrangement satisfies a statutory exception or regulatory safe harbor to the anti-kickback law. While applicable only to the party requesting the advisory opinion, these opinions may provide general guidance and insight. Significantly, the law expands criminal sanctions for health care fraud involving any governmental or private health benefit program, including freezing of assets and forfeiture of property traceable to commission of a health care offense. BALANCED BUDGET ACT OF 1997 The Balanced Budget Act of 1997 ("the BBA") contained sweeping adjustments to both the Medicare and Medicaid programs, as well as further expansion of the fraud and abuse laws. Specifically, the BBA created a civil monetary penalty for violations of the federal anti-kickback statute whereby violations will result in damages equal to three times the amount involved as well as a penalty of $50,000 per violation. In addition, the new provisions expanded the exclusion requirements so that any person or entity convicted of three health care offenses is automatically excluded from federally funded health care programs for life. Individuals or entities convicted of two offenses are subject to mandatory exclusion of 10 years, while any provider or supplier convicted of any felony may be denied entry into the Medicare program by the Secretary of HHS if deemed to be detrimental to the best interests of the Medicare program or its beneficiaries. The BBA also provides that any person or entity that arranges or contracts with an individual or entity that has been excluded from a federally funded health care program will be subject to civil monetary penalties if the individual or entity "knows or should have known" of the sanction. The BBA also requires that a variety of providers, including home health agencies, equipment suppliers and rehabilitation agencies, post a $50,000 surety bond in an effort to deter "sham" providers and suppliers from entering the Medicare program. In addition, the BBA requires HCFA to issue advisory opinions in response to inquiries as to whether physician referrals for designated health services are prohibited by the Stark law. While applicable only to the party requesting the advisory opinion, these opinions may provide general guidance and insight. Finally, the BBA creates a Medicare+Choice Program that is designed to provide a variety of options to Medicare beneficiaries, almost all of whom may enroll in a Medicare+Choice Plan. The options include provider sponsored organizations, coordinated care plans, HMOs with and without point of service options involving out-of-network providers, and medical savings accounts offered as a demonstration project. 30 31 STARK LAW The original Stark Law, known as "Stark I" and enacted as part of the Omnibus Budget Reconciliation Act of 1989, prohibits a physician from referring Medicare patients for clinical laboratory services to entities with which the physician (or an immediate family member) has a financial relationship, unless certain exceptions apply. Sanctions for violations of the Stark Law may include denial of payment, refund obligations, civil monetary penalties and exclusion of the provider from the Medicare and Medicaid programs. The Stark Law prohibits the entity receiving the referral from filing a claim or billing for services arising out of the prohibited referral. Provisions of OBRA 93, known as "Stark II," amended Stark I to revise and expand upon various statutory exceptions, to expand the services regulated by the statute to a list of "Designated Health Services," and to prohibit Medicaid referrals where a financial relationship exists. The provisions of Stark II generally became effective on January 1, 1995. The additional Designated Health Services include: physical therapy services; occupational therapy services; radiology services, including magnetic resonance imaging, computer axial tomography scans and ultrasound services; durable medical equipment and supplies; parenteral and enteral nutrients, equipment and supplies; home health services; outpatient prescription drugs; and inpatient and outpatient hospital services. The Company has determined that the Stark Law does apply to dialysis-related Designated Health Services not paid for under the Composite Rate as well as to certain services provided by SRM's renal support business. However, pursuant to proposed regulations implementing Stark II, published on January 9, 1998, erythropoietin (EPO) provided to ESRD patients as part of a renal dialysis treatment plan is specifically exempted as a Designated Health Service. Further, in the proposed regulations discussing Durable Medical Equipment, ESRD equipment and supplies are excluded from coverage as a Designated Health Service because the ESRD benefit is distinguished under Medicare from the DME benefit. Outpatient prescription drugs and in-hospital treatments would also be excluded. Prior to the effective date of Stark II, NMC had compensated the substantial majority of its Medical Directors on the basis of a percentage of net pre-tax earnings of the facilities. In response to Stark II, since January 1, 1995, Dialysis Services has compensated its Medical Directors on a fixed compensation arrangement intended to comply with the requirements of Stark II. The compensation of Medical Directors is a subject of the OIG Investigation. See "--Legal Proceedings--OIG Investigation" and "--Medical Director Compensation." On August 14, 1995, HCFA promulgated a final regulation implementing Stark I and its statutory restrictions on referrals for clinical laboratory services. One of the provisions of the regulation significantly affecting dialysis providers is HCFA's interpretation that the Stark Law applies to dialysis-related laboratory services. However, in proposed regulations published on January 9, 1998, HCFA proposed a regulatory exception for clinical laboratory services paid for as part of the Composite Rate. The proposed Stark II regulations follow the provisions set forth in the Stark I regulation in that any service included as part of the Composite Rate is not considered a Designated Health Service. The government has not yet finalized the Stark II regulations. Several states in which the Company operates have enacted self-referral statutes similar to the Stark Law. Such state self-referral laws may apply to referrals of patients regardless of payor source and may contain exceptions different from each other and from those contained in the Stark Law. OTHER FRAUD AND ABUSE LAWS The Company's operations are also subject to a variety of other federal and state fraud and abuse laws, principally designed to ensure that claims for payment to be made with public funds are complete, accurate and fully comply with all applicable program rules. The civil monetary penalty provisions are triggered by violations of numerous rules under the statute, including the filing of a false or fraudulent claim and billing in excess of the amount permitted to be charged for a particular item or service. As a result of the HIPPA amendments, monetary penalties of up to $10,000 plus three times the amount of the claim for each item or service for which an improper claim for payment was made, may be imposed, resulting in the possibility of substantial financial penalties for small billing errors that are replicated in a large number of claims. Violations may also result in suspension of payments, exclusion from the Medicare and Medicaid programs, as well as other federal health care benefit programs, or forfeiture of assets. In addition to the statutes described above, other criminal statutes may be applicable to conduct that is found to violate any of the statutes described above. 31 32 HEALTH CARE REFORM Health care reform is considered by many in the U.S. to be a national priority. Members of Congress from both parties and the executive branch are continuing to consider many health care proposals, some of which are comprehensive and far-reaching in nature. As noted above, the Medicare+Choice Program was developed as part of the amendments in the BBA. This program is designed to expand the options for Medicare beneficiaries and may have a significant impact on the manner in which health care is delivered in the future. Several states are also currently considering health care proposals. It cannot be predicted what additional action, if any, the federal government or any state may ultimately take with respect to health care reform or when any such action will be taken. Health care reform may bring radical changes in the financing and regulation of the health care industry, which could have a material adverse effect on the business of the Company and the results of its operations. CHANGES IN THE HEALTH CARE INDUSTRY. Significant changes in the health care industry are occurring as a result of market driven forces that are creating significant downward pressure on reimbursement rates that the Company and its subsidiaries will receive for their services and products. A substantial portion of third-party health insurance is now furnished through some type of managed care plan, including HMOs. Managed care plans are increasing their market share, and this trend may accelerate as a result of the merger and consolidation of providers and payors in the health care industry and as a result of the discussions among members of Congress and the executive branch regarding ways to increase the number of Medicare and Medicaid beneficiaries served through such managed care plans. At the same time, private purchasing cooperatives and the government are attempting to limit premium increases for these plans. In such an environment, controlling underlying medical costs is the only vehicle for ensuring satisfactory managed care plan margins. Managed care plans have been aggressive in seeking lower reimbursement levels for virtually all providers. For some populations, plans have sought to limit their own financial risk by negotiating capitation agreements under which providers assume responsibility for delivering a range of services at a fixed payment amount. Capitation effectively "locks in" a base of patients for providers who accept such arrangements. If substantially more patients of the Company join managed care plans or if such plans reduce reimbursements or capitate competitor companies, the Company's business and results of operations could be adversely affected, possibly materially. ITEM 2. PROPERTIES The table below describes the Company's principal facilities as of the date hereof.
FLOOR AREA (APPROXIMATE CURRENTLY OWNED LOCATION SQUARE FEET) OR LEASED USE -------- ------------ --------------- --- Lexington, Massachusetts 200,000 leased Corporate headquarters and administration. Walnut Creek, California 85,000 leased Warehousing; machine manufacture and assembly. Ogden, Utah 334,000 owned Production of disposable products. Delran, New Jersey 42,000 leased Manufacture of liquid hemodialysis concentrate solutions. Perrysburg, Ohio 35,000 leased Manufacture of dry hemodialysis concentrates. Livingston, California 32,000 leased Manufacture of liquid hemodialysis concentrate solutions. McAllen, Texas 92,856 leased/ Manufacture of bloodlines. owned(1) Reynosa, Mexico 48,745 owned Manufacture of bloodlines.
32 33 Fremont, California 72,000 leased Clinical laboratory testing Woodland Hills, California 24,000 leased Clinical laboratory testing Rockleigh, New Jersey 85,000 leased Clinical Laboratory testing
- ---------- (1) Land is leased, building is owned. The lease on the Walnut Creek facility expires in 2002. The Company owns one warehouse and leases 18 warehouses throughout the U.S. These warehouses are used as regional distribution centers for Dialysis Services' peritoneal dialysis products business. All such warehouses are subject to leases with remaining terms not exceeding four years. At December 31, 1998, Dialysis Services distributed its products through 25 warehouse facilities The Company leases its corporate headquarters in Lexington, Massachusetts. This lease expires on October 31, 2007. The Company's subsidiaries lease most of the dialysis centers, and manufacturing, laboratory, distribution and administrative and sales facilities in the U.S. on terms which the Company believes are customary in the industry. The Company's subsidiaries own those dialysis centers and manufacturing facilities that it does not lease. 33 34 ITEM 3. LEGAL PROCEEDINGS As discussed in greater detail below, most aspects of NMC's U.S. businesses are the subject of criminal or civil investigations by several federal agencies and authorities, the outcome of which cannot be predicted. If the government were successfully to pursue claims arising from any of these investigations, NMC and one or more of its subsidiaries could be subject to civil or criminal penalties, including substantial fines, suspension of payments or exclusion from the Medicare and Medicaid programs as well as other federal health care benefit programs, which provide over 60% of NMC's revenues. In addition, NMC could be required to change billing or other practices which could adversely affect NMC's revenues. In addition, as discussed below, NMC has become aware that it is the subject of qui tam or "whistleblower" actions with respect to some or all of the issues raised by the government investigations, which whistleblower actions are filed under seal as a matter of law in the first instance, thereby preventing disclosure to the Company and to the public except by court order. In the process of unsealing federal whistleblower complaints, it is not unusual for courts to allow the government to inform the Company and its counsel of a complaint prior to the time the Company may be legally permitted to disclose it to the public. NMC may be the subject of other "whistleblower" actions not known to the Company. Fresenius Medical Care and the Company have guaranteed NMC's obligations relating to or arising out of the OIG Investigation and the qui tam proceedings, and indemnified Grace Chemicals for any such liabilities. An adverse determination with respect to any of the issues addressed by the subpoenas, or any of the other issues that have been or may be identified by the government, could result in the payment of substantial fines, penalties and forfeitures, the suspension of payments or exclusion of the Company or one or more of its subsidiaries from the Medicare program and other federal programs, and changes in billing and other practices that could adversely affect the Company's revenues. Any such result could have a material adverse effect on the Company's business, financial condition and results of operations. 34 35 OIG INVESTIGATION In October 1995, NMC received five investigative subpoenas from the OIG. The subpoenas were issued in connection with an investigation being conducted by the OIG, the U.S. Attorney for the District of Massachusetts and others concerning possible violations of federal laws, including the anti-kickback statutes and the False Claims Act. The subpoenas call for extensive document production relating to various aspects of NMC's business. In connection with the OIG Investigation, the Company continues to receive additional subpoenas directed to NMC or the Company to obtain supplemental information and documents regarding the above-noted issues, or to clarify the scope of the original subpoenas. The Company is cooperating with the OIG Investigation. The Company believes that the government continues to review and evaluate the voluminous information the Company has provided. As indicated above, the government continues, from time to time, to seek supplementing and/or clarifying information from the Company. The Company understands that the government has utilized a grand jury to investigate these matters. The Company expects that this process will continue while the government completes its evaluation of the issues. The OIG Investigation covers the following areas: (a) NMC's dialysis services business, principally relating to its Medical Director contracts and compensation; (b) NMC's treatment of credit balances resulting from overpayments received under the Medicare, Medicaid, CHAMPUS and other government and commercial payors, its billing for home dialysis services, and its payment of supplemental medical insurance premiums on behalf of indigent patients; (c) LifeChem's laboratory business, including testing procedures, marketing, customer relationships, competition, overpayments totaling approximately $4.9 million that were received by LifeChem from the Medicare program with respect to laboratory services rendered between 1989 and 1993, a 1997 review of dialysis facilities' standing orders, and the provision of discounts on products from NMC's products division, grants, equipment and entertainment to customers; and (d) Homecare and, in particular, information concerning IDPN utilization, documentation of claims and billing practices including various services, equipment and supplies and payments made to third parties as compensation for administering IDPN therapy. The government has indicated that the areas identified above are not exclusive, and that it may pursue additional areas. As noted, the penalties applicable under the anti-kickback statutes, the False Claims Act and other federal and state statutes and regulations applicable to NMC's business can be substantial. While NMC asserts that it is able to offer legal and/or factual defenses with respect to many of the areas the government has identified, it is expected that the government will assert that NMC has violated multiple statutory and regulatory provisions. Additionally, nine and possibly other qui tam actions alleging that NMC submitted false claims to the government have been filed under seal by former or current NMC employees or other individuals who may have familiarity with one or more of the issues under investigation. As noted, under the False Claims Act, any such private plaintiff could pursue an action against NMC in the name of the U.S. at his or her own expense if the government declines to do so. During the appropriately three and one-half years since the initial subpoenas were served NMC and the government have met periodically to discuss issues in connection with the OIG Investigation, including theories of liability. Recently, NMC and the government have begun to explore the possibility of settling the matters which are encompassed by the OIG Investigation and, as referenced below, have reached and agreement in principle in connection with the diagnostics investigation matter. There can be no assurance that any of the other matters subject to the OIG Investigation will be settled. If, however, one or more of the matters encompassed by the OIG Investigation is settled, it may result in NMC acknowledging that its past practices violated federal statutes, as well as NMC incurring substantial civil and criminal financial penalties which could have a material adverse effect on the Company. If one or more of these matters is not settled, the government may be expected to initiate litigation in which it would seek substantial civil and criminal financial penalties and other sanctions that could result in the exclusion of NMC and its subsidiaries from the Medicare program, Medicaid program and other federal health care programs. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Contingencies." 35 36 An adverse determination with respect to any of the issues addressed by the subpoenas, or any of the other issues that have been or may be identified by the government, could result in the payment of substantial fines, penalties and forfeitures, the suspension of payments or exclusion of the Company or one or more of its subsidiaries from the Medicare program and other federal programs, and changes in billing and other practices that could adversely affect the Company's revenues. Any such result could have a material adverse effect on the Company's business, financial condition and results of operations. Under the terms of the Merger, any potential resulting monetary liability has been retained by NMC, and the Company has indemnified Grace Chemicals against all potential liability arising from or relating to the OIG Investigation. The Company has provided the U.S. government with a guarantee of payment of the obligations, if any, arising from the OIG Investigation. In support of this guarantee, the Company has delivered to the U.S. government a standby letter of credit in the amount of $150 million. MEDICAL DIRECTOR COMPENSATION The government is investigating whether Dialysis Services' compensation arrangements with its Medical Directors constitute payments to induce referrals, which would be illegal under the anti-kickback statutes, rather than payment for services rendered. Dialysis Services compensated the substantial majority of its Medical Directors on the basis of a percentage of the earnings of the dialysis center for which the Medical Director was responsible from the inception of NMC's predecessor in 1972 until January 1, 1995, the effective date of Stark II. Under the arrangements in effect prior to January 1, 1995, the compensation paid to Medical Directors was adjusted to include "add backs," which represented a portion of the profit earned by MPG on products purchased by the Medical Director's facility from MPG and (until January 1, 1992) a portion of the profit earned by LifeChem on laboratory services provided to patients at the Medical Director's facility. These adjustments were designed to allocate a profit factor to each dialysis center relating to the profits that could have been realized by the center if it had provided the items and services directly rather than through a subsidiary of NMC. The percentage of profits paid to any specific Medical Director was reached through negotiation, and was typically a provision of a multi-year consulting agreement. To comply with Stark II if Designated Health Services are involved, Medical Director compensation must not exceed fair market value and may not take into account the volume or value of referrals or other business generated between the parties. Since January 1, 1995, Dialysis Services has compensated its Medical Directors on a fixed compensation arrangement intended to comply with the requirements of Stark II. In renegotiating its Medical Director compensation arrangements in connection with Stark II, Dialysis Services took and continues to take account of the compensation levels paid to its Medical Directors in prior years. Certain government representatives have expressed the view in meetings with counsel for NMC that arrangements where the Medical Director was or is paid amounts in excess of the "fair market value" of the services rendered may evidence illegal payments to induce referrals, and that hourly compensation is a relevant measure for evaluating the "fair market value" of the services. Dialysis Services does not compensate its Medical Directors on an hourly basis and has asserted to the government that hourly compensation is not a determinative measure of fair market value. Although the Company believes that the compensation paid to its Medical Directors is generally reflective of fair market value, there can be no assurances that the government will agree with this position or that the Company ultimately will be able to defend its position successfully. Because of the wide variation in local market factors and in the profit percentage contractually negotiated between Dialysis Services and its Medical Directors prior to January 1, 1995, there is a wide variation in the amounts that have been paid to Medical Directors. As a result, the compensation that Dialysis Services has paid and is continuing to pay to a material number of its Medical Directors could be viewed by the government as being in excess of "fair market value," both in absolute terms and in terms of hourly compensation. NMC has asserted to the government that its compensation arrangements do not constitute illegal payments to induce referrals. NMC has also asserted to the government that OIG auditors repeatedly reviewed Dialysis Services' compensation arrangements with its Medical Directors in connection with their audits of the costs claimed by Dialysis Services; that the OIG stated in its audit reports that, with the exception of certain technical issues, Dialysis Services had complied with applicable Medicare laws and regulations pertaining to the ESRD program; and that Dialysis Services reasonably relied on these audit reports in concluding that its program for compensating Medical Directors was lawful. There has been no 36 37 indication that the government will accept NMC's assertions concerning the legality of its arrangements generally or NMC's assertion that it reasonably relied on OIG audits, or that the government will not focus on specific arrangements that DSD has made with one or more Medical Directors and assert that those specific arrangements were or are unlawful. The government is also investigating whether Dialysis Services' profit sharing arrangements with its Medical Directors influenced them to order unnecessary ancillary services and items. NMC has asserted to the government that the rate of utilization of ancillary services and items by its Medical Directors is reasonable and that it did not provide illegal inducements to Medical Directors to order ancillary services and items. CREDIT BALANCES In the ordinary course of business, medical service providers like Dialysis Services receive overpayments from Medicare intermediaries and other payors for services that they provide to patients. Medicare intermediaries commonly direct such providers to notify them of the overpayment and not remit such amounts to the intermediary by check or otherwise unless specifically requested to do so. In 1992, HCFA adopted a regulation requiring certain Medicare providers, including dialysis centers, to file a quarterly form listing unrecouped overpayments with the Medicare intermediary responsible for reimbursing the provider. The first such filing was required to be made as of June 30, 1992 for the period beginning with the initial date that the provider participated in the Medicare program and ending on June 30, 1992. The government is investigating whether Dialysis Services intentionally understated the Medicare credit balance reflected on its books and records for the period ending June 30, 1992 by reversing entries out of its credit balance account and taking overpayments into income in anticipation of the institution of the new filing requirement. Dialysis Services's policy was to notify Medicare intermediaries in writing of overpayments upon receipt and to maintain unrecouped Medicare overpayments as credit balances on the books and records of Dialysis Services for four years; overpayments not recouped by Medicare within four years would be reversed from the credit balance account and would be available to be taken into income. NMC asserts that Medicare overpayments that have not been recouped by Medicare within four years are not subject to recovery under applicable regulations and that its initial filing with the intermediaries disclosed the credit balance on the books and records of Dialysis Services as shown in accordance with its policy, but there can be no assurance that the government will accept NMC's views. The government has inquired whether other divisions including Homecare, LifeChem and DSI have appropriately treated Medicare credit balances as well as credit balances of other payors. The government is also investigating whether Dialysis Services failed to disclose Medicare overpayments that resulted from Dialysis Services' obligation to rebill commercial payors for amounts originally billed to Medicare under HCFA's initial implementation of the OBRA 93 amendments to the secondary payor provisions of the Medicare Act. Dialysis Services experienced delays in reporting a material amount of overpayments after the implementation of the OBRA 93 amendments. NMC asserts that most of these delays were the result of the substantial administrative burdens placed on Dialysis Services as a consequence of the changing and inconsistent instructions issued by HCFA with respect to the OBRA 93 amendments and were not intentional. Substantially all overpayments resulting from the rebilling effort associated with the OBRA 93 amendments have now been reported. Procedures are in place that are designed to ensure that subsequent overpayments resulting from the OBRA 93 amendments will be reported on a timely basis. SUPPLEMENTAL MEDICAL INSURANCE Dialysis Services provided grants or loans for the payment of premiums for supplemental medical insurance (under which Medicare Part B coverage is provided) on behalf of a small percentage of its patients who are financially needy. The practice of providing loans or grants for the payment of supplemental medical insurance premiums by NMC was one of the subjects of review by the government as part of the OIG Investigation. The Government, however, advised the Company orally that it is no longer pursuing this issue. Furthermore, as a result of the passage of HIPAA, the Company terminated making such payments on 37 38 behalf of its patients. Instead, the Company, together with other representatives of the industry, obtained an advisory opinion from the OIG, whereby, consistent with specified conditions, the Company and other similarly situated providers may make contributions to a non-profit organization that has volunteered to make these payments on behalf of indigent ESRD patients, including patients of the Company. In addition, the government has indicated that it is investigating the method by which NMC made Medigap payments on behalf of its indigent patients. OVERPAYMENTS FOR HOME DIALYSIS SERVICES NMC acquired HIC, an in-center and home dialysis service provider, in 1993. At the time of the acquisition, HIC was the subject of a claim by HCFA that HIC had received payments for home dialysis services in excess of the Medicare reasonable charge for services rendered prior to February 1, 1990. NMC settled the HCFA claim against HIC in 1994. The government is investigating whether the settlement concerning the alleged overpayments made to HIC resolved all issues relating to such alleged overpayments. The government is also investigating whether HDS received payments similar to the payments that HIC received, and whether HDS improperly billed for home dialysis services in excess of the monthly cost cap for services rendered on or after February 1, 1990. The government is investigating whether NMC was overpaid for services rendered. NMC asserts that the billings by HDS were proper, but there can be no assurance that the government will accept NMC's view. LIFECHEM Overpayments. On September 22, 1995, LifeChem voluntarily disclosed certain billing problems to the government that had resulted in LifeChem's receipt of approximately $4.9 million in overpayments from the Medicare program for laboratory services rendered between 1989 and 1993. LifeChem asserts that most of these overpayments relate to errors caused by a change in LifeChem's computer systems and that the remainder of the overpayments were the result of the incorrect practice of billing for a complete blood count with differential when only a complete blood count was ordered and performed, and of the incorrect practice of billing for a complete blood count when only a hemoglobin or hematocrit test was ordered. LifeChem asserts that the overpayments it received were not caused by fraudulent activity, but there can be no assurance that the government will accept LifeChem's view. LifeChem made these disclosures to the government as part of an application to be admitted to a voluntary disclosure program begun by the government in mid-1995. At the time of the disclosures, LifeChem tendered repayment to the government of the $4.9 million in overpayments. After the OIG Investigation was announced, the government indicated that LifeChem had not been accepted into its voluntary disclosure program. The government has deposited the $4.9 million check with NMC's approval. The matters disclosed in LifeChem's September 22, 1995 voluntary disclosure are a subject of the OIG Investigation. On June 7, 1996, LifeChem voluntarily disclosed an additional billing problem to the government that had resulted in LifeChem's receipt of between $40,000 and $160,000 in overpayments for laboratory services rendered in 1991. LifeChem advised the government that this overpayment resulted from the submission for payment of a computer billing tape that had not been subjected to a "billing rules" program designed to eliminate requests for payments for laboratory tests that are included in the Composite Rate and that were not eligible for separate reimbursement. LifeChem also advised the government that there may have been additional instances during the period from 1990 to 1992 when other overpayments were received as a result of the submission of computer billing tapes containing similar errors and that it was in the process of determining whether such additional overpayments were received. On June 21, 1996, LifeChem advised the government that the 1991 billing problem disclosed on June 7, 1996 resulted in an overpayment of approximately $112,000. LifeChem also advised the government that certain records suggested instances in July 1990 and August 31 through September 11, 1990, when billing tapes may have been processed without rules processing. LifeChem continued its effort to determine whether any other overpayments occurred relating to the "billing rules" problem and, in March 1997, advised the government that an additional overpayment of approximately $260,000 was made by Medicare. 38 39 Capitation for routine tests and panel design. In October 1994, the OIG issued a special fraud alert in which it stated its view that the industry practice of offering to perform or performing the routine tests covered by the Composite Rate at a price below fair market value, coupled with an agreement by a dialysis center to refer all or most of its non-Composite Rate tests to the laboratory, violates the anti-kickback statutes. In response to this alert, LifeChem changed its practices with respect to testing covered by the Composite Rate to increase the amount charged to both Dialysis Services and third-party dialysis centers and reduce the number of tests provided for the fixed rate. The government is investigating LifeChem's practices with respect to these tests. Benefits provided to dialysis centers and persons associated with dialysis centers. The government is investigating whether Dialysis Services or any third-party dialysis center or any person associated with any such center was provided with benefits in order to induce them to use LifeChem services. Such benefits could include, for example, discounts on products or supplies, the provision of computer equipment, the provision of money for the purchase of computer equipment, the provision of research grants and the provision of entertainment to customers. NMC has identified certain instances in which benefits were provided to customers who purchased medical products from NMC Medical Products Inc., NMC's products company, and used LifeChem's laboratory services. The government asserts that the provision of such benefits violates, among other things, the anti-kickback statutes. In December 1998, the former Vice President of Sales responsible for NMC's laboratory and products divisions plead guilty to the payment of illegal kickbacks to obtain laboratory business for NMC. In February 1999, the former President of NMC Medical Products, Inc., was indicted by the government for the payment of these same and/or similar kickbacks. Business and testing practices. As noted above, the government has identified a number of specific categories of documents that it is requiring NMC to produce in connection with LifeChem business and testing practices. In addition to documents relating to the areas discussed above, the government has also required LifeChem to produce documents relating to the equipment and systems used by LifeChem in performing and billing for clinical laboratory blood tests, the design of the test panels offered and requisition forms used by LifeChem, the utilization rate for certain tests performed by LifeChem, recommendations concerning diagnostic codes to be used in ordering tests for patients with given illnesses or conditions, internal and external audits and investigations relating to LifeChem's billing and testing. Subsequently, the government served an investigative subpoena for documents concerning the Company's 1997 review of dialysis facilities' standing orders, and responsive documents were provided. Recently the government served investigative subpoenas requiring NMC to update its production on the above issues and to produce contract files for twenty-three identified dialysis clinic customers. The government is investigating each of these areas, and asserts that LifeChem and/or NMC have violated the False Claims Act and/or the Anti-Kickback Statute through the test ordering, paneling, requisitioning, utilization, coding, billing and auditing practices described above. IDPN Administration kits. As discussed above, one of the activities of SRM is to provide IDPN therapy to dialysis patients at both NMC-owned facilities and at facilities owned by other providers. IDPN therapy was provided by Homecare prior to its divestiture. IDPN therapy is typically provided to the patient 12-13 times per month during dialysis treatment. Bills are submitted to Medicare on a monthly basis and include separate claims for reimbursement for supplies, including, among other things, nutritional solutions, administration kits and infusion pumps. In February 1991, the Medicare carrier responsible for processing Homecare's IDPN claims issued a Medicare advisory to all parenteral and enteral nutrition suppliers announcing a coding change for reimbursement of administration kits provided in connection with IDPN therapy for claims filed for items provided on or after April 1, 1991. The Medicare allowance for administration kits during this period was approximately $625 per month per patient. The advisory stated that IDPN providers were to indicate the "total number of actual days" when administration kits were "used," instead of indicating that a one-month supply of administration kits had been provided. In response, Homecare billed for administration kits on the basis of the number of days that the patient was on an IDPN treatment program during the billing period, which typically represented the entire month, as opposed to the number of days the treatment was actually 39 40 administered. During the period from April 1991 to June 1992, Homecare had an average of approximately 1,200 IDPN patients on service. In May 1992, the carrier issued another Medicare advisory to all PEN suppliers in which it stated that it had come to the carrier's attention that some IDPN suppliers had not been prorating their billing for administration kits used by IDPN patients and that providers should not bill for administration kits on the basis of the number of days that the patient was on an IDPN treatment program during the billing period. The advisory stated further that the carrier would be conducting "a special study to determine whether or not overpayments have occurred as a result of incorrect billing" and that "if overpayments have resulted, providers that have incorrectly billed" would "be contacted so that refunds can be recovered." Homecare revised its billing practices in response to this advisory for claims filed for items provided on or after July 1, 1992. Homecare was not asked to refund any amounts relating to its billings for administration kits following the issuance of the second advisory. The government asserts that NMC submitted false claims for administration kits during the period from 1988 to June 30, 1996, and that Homecare's billing for administration kits during this period violated, among other things, the False Claims Act. Infusion Pumps and IV Poles. During the time period covered by the subpoenas, Medicare regulations permitted IDPN providers to bill Medicare for the infusion pumps and, until 1992, for IV poles provided to IDPN patients in connection with the administration of IDPN treatments. These regulations do not expressly specify that a particular pump and IV pole be dedicated to a specific patient, and NMC asserts that these regulations permitted Homecare to bill Medicare for an infusion pump and IV pole so long as the patient was infused using a pump and IV pole. Despite the absence of an express regulatory specification, Homecare developed a policy to deliver to a dialysis center a dedicated infusion pump and IV pole for each patient, although the Company cannot represent that Homecare followed this policy in every instance. The government is investigating the propriety of Homecare's billings for infusion pumps and IV poles and asserts that Homecare's billings violate the False Claims Act. As noted above, under the new policies published by HCFA with respect to IDPN therapy, the Company has not been able to bill for infusion pumps after July 1, 1996. The government discontinued reimbursement for IV poles in 1992. "Hang fees" and other payments. IDPN therapy is typically provided to the patient during dialysis by personnel employed by the dialysis center treating the patient with supplies provided and billed to Medicare by Homecare in accordance with the Medicare parenteral nutrition supplier rules. In order to compensate dialysis centers for the costs incurred in administering IDPN therapy and monitoring the patient during therapy, Homecare followed the practice common in the industry of paying a "hang fee" to the center. Dialysis centers are responsible for reporting such fees to HCFA on their cost reports. For Dialysis Services dialysis centers, the fee was $30 per administration, based upon internal Dialysis Services cost calculations. For third-party dialysis centers, the fee was negotiated with each center, typically pursuant to a written contract, and ranged from $15 to $65 per administration. The Company has identified instances in which other payments and amounts beyond that reflected in a contract were paid to these third-party centers. The Company has stopped paying "hang fees" to both Dialysis Services and third-party facilities. In July 1993, the OIG issued a management advisory alert to HCFA in which it stated that "hang fees" and other payments made by suppliers of IDPN to dialysis centers "appear to be illegal as well as unreasonably high." The government is investigating the nature and extent of the "hang fees" and other payments made by Homecare as well as payments by Homecare to physicians whose patients have received IDPN therapy. The government asserts that the payments by Homecare to dialysis centers violate, among other things, the anti-kickback statutes. Utilization of IDPN. Since 1984, when HCFA determined that Medicare should cover IDPN and other parenteral nutrition therapies, the Company has been an industry leader in identifying situations in which IDPN therapy is beneficial to ESRD patients. It is the policy of the Company to seek Medicare reimbursement for IDPN therapy only when it is prescribed by a patient's treating physician and when it believes that the 40 41 circumstances satisfy the requirements published by HCFA and its carrier agents. Prior to 1994, HCFA and its carriers approved for payment more than 90% of the IDPN claims submitted by Homecare. After 1993, the rate of approval for Medicare reimbursement for IDPN claims submitted by Homecare for new patients, and by the infusion industry in general, fell to approximately 9%. The Company contends that the reduction in rates of approval occurred because HCFA and its carriers implemented an unauthorized change in coverage policy without giving notice to providers. While NMC continued to offer IDPN to patients pursuant to the prescription of the patients' treating physicians and to submit claims for Medicare reimbursement when it believed the requirements stated in HCFA's published regulations were satisfied, other providers responded to the drop in the approval rate for new Medicare IDPN patients by abandoning the Medicare IDPN business, cutting back on the number of Medicare patients to whom they provide IDPN, or declining to add new Medicare patients. Beginning in 1994 the number of patients to whom NMC provided IDPN increased as a result. The government is investigating the utilization rate of IDPN therapy among NMC patients, whether NMC submitted IDPN claims to Medicare for patients who were not eligible for coverage, and whether documentation of eligibility was adequate. NMC asserts that the utilization rate of IDPN therapy among its dialysis patients, which, in 1995, averaged less than 3.5%, is the result of the factors discussed above and that it is the policy of Homecare to seek Medicare reimbursement for IDPN therapy prescribed by the patients' treating physician in accordance with the requirements published by HCFA and its carrier agents. There can be no assurance that the government will accept NMC's view. The government asserts that Homecare submitted IDPN claims for individuals who were not eligible for coverage and/or with inadequate documentation of eligibility. The Company believes that it has presented to the government substantial defenses which support NMC's interpretation of coverage rules of IDPN as HCFA and its carriers published and explained them, and which demonstrated that HCFA and its carriers improperly implemented unpublished, more restrictive criteria after 1993. Nevertheless, the government is expected to assert in the OIG Investigation that, on a widespread basis, NMC submitted and received payments on claims for IDPN to Medicare for patients who were not eligible for coverage, and for whom the documentation of eligibility was inadequate. In addition, the government asserts that, in a substantial number of cases, documentation of eligibility was false or inaccurate. With respect to some claims, the Company has determined that false or inaccurate documentation was submitted, deliberately or otherwise. The government continues to investigate the IDPN claims. QUI TAM ACTIONS The Company and NMC have become aware that nine qui tam actions have been filed in various jurisdictions. Each of these actions is under seal and in each action, pursuant to court order the seal has been modified to permit the Company, NMC and other affiliated defendants to disclose the complaint to any relevant investors, financial institutions and/or underwriters, their successors and assigns and their respective counsel and to disclose the allegations in the complaints in their respective SEC and NYSE periodically required filings. The first qui tam action was filed in the United States District Court for the Southern District of Florida in 1996, amended on July 8, 1996 and disclosed to the Company on July 10, 1996. It alleges, among other things, that Grace Chemicals and NMC violated the False Claims Act in connection with certain billing practices regarding IDPN and the administration of EPO and that as a result of this allegedly wrongful conduct, the United States suffered actual damages in excess of $200 million. The Amended Complaint also seeks the imposition of a constructive trust on the proceeds of the NMC dividend to Grace Chemicals for the benefit of the United States on the ground that the Merger constitutes a fraudulent conveyance that will render NMC unable to satisfy the claims asserted in the Amended Complaint. The second qui tam action was filed in the United States District Court for the Middle District of Florida in 1995 and disclosed to the Company on or before November 7, 1996. It alleges, among other things, that NMC and certain NMC subsidiaries violated the False Claims Act in connection with the 41 42 alleged retention of over-payments made under the Medicare program, the alleged submission of claims in violation of applicable cost caps and the payment of supplemental Medicare insurance premiums as an alleged inducement to patients to obtain dialysis products and services from NMC. The complaint alleges that as a result of this allegedly wrongful conduct, the United States suffered damages in excess of $10 million including applicable fines. The third qui tam action was filed in the United States District Court for the Eastern District of Pennsylvania in February 1996 and was disclosed to the Company in November 1996. It alleges, among other things, that a pharmaceutical manufacturer, an unaffiliated dialysis provider and NMC violated the False Claims Act in connection with the submission of claims to the Medicare program for a nonsterile intravenous drug and for intravenous drugs which were allegedly billed in excess of permissible Medicare reimbursement rates. The complaint also asserts that the defendants violated the Medicare and Medicaid anti-kickback statutes in connection with the receipt of discounts and other in kind payments as alleged inducements to purchase intravenous drugs. The complaint is focused on the business relationship between the pharmaceutical manufacturer and several providers, one of which is NMC. The complaint asserts that as a result of this allegedly wrongful conduct, the United States suffered damages. On June 28, 1997, in response to relator's motion to dismiss and the United States' declination to intervene, the District Court ordered the complaint dismissed without prejudice. The fourth qui tam action was filed in the United States District Court for the Eastern District of Pennsylvania in May 1995 and was disclosed to the Company in August 1997. It alleges, among other things, that Biotrax violated the False Claims Act in connection with its submission of claims to the Medicare program for diagnostic tests and induced overutilization of such tests in the medical community through improper marketing practices also in violation of the False Claims Act. The fifth qui tam action was filed in the United States District Court for the Eastern District of Pennsylvania in August 1996 and was disclosed to the Company in August 1997. It alleges, among other things, that Biotrax and NMC Diagnostic Services induced overutilization of diagnostic tests by several named and unnamed physician defendants in the local medical community, through improper marketing practices and fee arrangements, in violation of the False Claims Act. The sixth qui tam action was filed in the United States District Court for the Eastern District of Pennsylvania in November 1996 and was disclosed to the Company in August 1997. It alleges, among other things, that NMC, DSI and Biotrax violated the False Claims Act in connection with the submission of claims to the Medicare program by improperly upcoding and otherwise billing for various diagnostic tests. The seventh qui tam action was filed in the United States District Court for the District of Delaware in January 1997 and was disclosed to the Company in September 1997. It alleges, among other things, that NMC and Biotrax violated the False Claims Act in connection with the submission of claims to the Medicare program for diagnostic tests, and induced overutilization of such tests through improper marketing practices which provided impermissible incentives to health care providers to order these tests. The eighth qui tam action was filed in the United States District Court for the District of New Jersey in February 1997 and was disclosed to the Company in September 1997. It alleges, among other things, that DSI and NMC violated the False Claims Act in connection with the submission of claims to the Medicare program for reimbursement for diagnostic tests, by causing unnamed physicians to overutilize these tests though a variety of fee arrangements and other impermissible inducements. The ninth qui tam was filed in the United States District Court for the District of Massachusetts in 1994 and was disclosed to the Company in February 1999. It alleges among other things that NMC violated the False Claims Act and the Anti-Kickback Statute in connection with certain billing and documentation practices regarding IDPN therapy, home oxygen therapy and certain medical billings in NMC's Chicago office. 42 43 Each of the qui tam complaints asserts that as a result of the allegedly wrongful conduct, the United States suffered damages and that the defendants are liable to the United States for three times the amount of the alleged damages plus civil penalties of up to $10,000 per false claim. An adverse result in any of the qui tam actions could have a material adverse affect on the Company's business, financial condition or results of operations. OIG AGREEMENTS As a result of discussions with representatives of the United States in connection with the OIG Investigation, certain agreements (the "OIG Agreements") have been entered into to guarantee the payment of any obligations of NMC to the United States (an "Obligation") relating to or arising out of the OIG Investigation and the qui tam action filed in the Southern District of Florida (the "Government Claims"). For the purposes of the OIG Agreements, an Obligation is (a) a liability or obligation of NMC to the United States in respect of a Government Claim pursuant to a court order (i) which is final and nonappealable or (ii) the enforcement of which has not been stayed pending appeal or (b) a liability or obligation agreed to be an Obligation in a settlement agreement executed by Fresenius Medical Care, the Company or NMC, on the one hand, and the United States, on the other hand. As stated elsewhere herein, the outcome of the OIG Investigation cannot be predicted. Pursuant to the OIG Agreements, upon consummation of the Merger, Fresenius Medical Care, the Company and NMC provided the United States with a joint and several unconditional guarantee of payment when due of all Obligations (the "Primary Guarantee"). As credit support for this guarantee, NMC delivered an irrevocable standby letter of credit in the amount of $150 million. The United States will return such letter of credit (or any renewal or replacement) for cancellation when all Obligations have been paid in full or it is determined that NMC has no liability in respect of the Government Claims. Under the terms of the Merger, any potential resulting monetary liability has been retained by NMC, and the Company has indemnified Grace Chemicals against all potential liability arising from or relating to the OIG Investigation. Fresenius Medical Care and the United States state in the OIG Agreements that they will negotiate in good faith to attempt to arrive at a consensual resolution of the Government Claims and, in the context of such negotiations, will negotiate in good faith as to the need for any restructuring of the payment of any Obligations arising under such resolution, taking into account the ability of Fresenius Medical Care to pay the Obligations. The OIG Agreements state that the foregoing statements shall not be construed to obligate any person to enter into any settlement of the Government Claims or to agree to a structured settlement. Moreover, the OIG Agreements state that the statements described in the first sentence of this paragraph are precatory and statements of intent only and that (a) compliance by the United States with such provisions is not a condition or defense to the obligations of Fresenius Medical Care under the OIG Agreements and (b) breach of such provisions by the United States cannot and will not be raised by Fresenius Medical Care to excuse performance under the OIG Agreements. Neither the entering into of the OIG Agreements nor the providing of the Primary Guarantee and the $150 million letter of credit is an admission of liability by any party with respect to the OIG Investigation, nor does it indicate the liability which may result therefrom. The foregoing describes the material terms of the OIG Agreements, copies of which were previously filed with the Commission and copies of which may be examined without charge at the public reference facilities maintained by the Commission at Room 1024, 450 Fifth Street, N.W. Washington, D.C. 20549, and at the Regional Offices of the Commission located at Suite 1400, Citicorp Center, 500 West Madison Street, Chicago, Illinois 60661-2551 and Room 1300, 7 World Trade Center, New York, New York 10048. Copies of such material will also be made available by mail from the Public Reference Branch of the Commission at 450 Fifth Street, N.W. Washington, D.C. 20549, at prescribed rates. The foregoing description does not purport to be complete and is qualified in its entirety by reference to such agreements. 43 44 DIAGNOSTICS SUBPOENA In October 1996, Biotrax International, Inc. ("Biotrax") and NMC Diagnostics, Inc. ("DSI"), both of which are subsidiaries of NMC, received an investigative subpoena from the OIG. The subpoena calls for the production of extensive documents and was issued in connection with an investigation being conducted by the OIG in conjunction with the U.S. Attorney for the Eastern District of Pennsylvania concerning the possible submission of false or improper claims to, and their payment by, the Medicare program. The subpoena calls for the production of documents on corporate organization, business plans, document retention, personnel files, sales and marketing and Medicare billing issues relating to certain procedures offered by the prior owner of the Biotrax business before its assets were acquired by NMC in March 1994 and by DSI following the acquisition. The Company has reviewed the subpoena with its legal counsel and has made extensive document production in response to the subpoena. The Company and the government have been negotiating a resolution to this matter, and negotiations have progressed to the point of a possible settlement. The Company and the government have reached an agreement in principle in which, among other things, the government has agreed to release the Company from liability in this matter in exchange for a payment of approximately $16.5 million from the Company. The Company and the government are currently negotiating the terms of a settlement agreement. The agreement is not final. For this reason, the eventual outcome of this matter, its duration, and its effect, if any, on NMC or the Company cannot be predicted at this time. The Company divested Non Renal Diagnostic Services on June 26, 1998. See "Management Discussion and Analysis of Financial Condition and Results of Operations - Divestitures." EASTERN DISTRICT OF VIRGINIA In December 1994, a subsidiary of NMC received a subpoena from a federal grand jury in the Eastern District of Virginia investigating the contractual relationships between subsidiaries of NMC that provide dialysis services and third parties that provide medical directorship and related services to those subsidiaries. There has been no communication from the government since a January 1995 document production and the outcome of this investigation and its effect, if any, on NMC cannot be predicted at this time. DISTRICT OF NEW JERSEY INVESTIGATION NMC has received multiple subpoenas from a federal grand jury in the District of New Jersey investigating, among other things, whether NMC sold defective products, the manner in which NMC handled customer complaints and certain matters relating to the development of a new dialyzer product line NMC is cooperating with this investigation and has provided the grand jury with extensive documents. In February, 1996, NMC received a letter from the U.S. Attorney for the District of New Jersey indicating that it is the target of a federal grand jury investigation into possible violations of criminal law in connection with its efforts to persuade the FDA to lift a January 1991 import hold issued with respect to NMC's Dublin, Ireland manufacturing facility. In June 1996, NMC received a letter from the U.S. Attorney for the District of New Jersey indicating that the U.S. Attorney had declined to prosecute NMC with respect to a submission related to NMC's effort to lift the import hold. The letter added that NMC remains a subject of a federal grand jury's investigation into other matters. NMC has produced documents in response to a June 1996 subpoena from the federal grand jury requesting certain documents in connection with NMC's imports of the FOCUS(R) dialyzer from January 1991 to November 1995. The government investigators and the Company have narrowed the issues with respect to which the government has previously expressed concerns and have recently conducted discussions in order to resolve this investigation. However, the outcome and impact, if any, of these discussions and potential resolution on the Company's business, financial condition or results of operations cannot be predicted at this time. FDA MATTERS Since 1993, NMC has engaged in a number of voluntary recalls of products that it manufactured or that were manufactured by third parties and distributed by NMC. None of these product recalls has resulted in fines or penalties for NMC. In 1995, Fresenius USA completed a voluntary action with respect to the Optum(R) exchange device that Fresenius USA acquired from Abbott, which was classified by the FDA as a recall. The FDA reviewed Fresenius USA's actions with respect to this device and determined that they were adequate. 44 45 During the period from 1991 through 1993, the FDA issued warning letters concerning four of the six Dialysis Products facilities in the U.S., as well as import alerts concerning hemodialysis bloodlines manufactured at NMC's Reynosa, Mexico facility and Focus(R) brand hemodialyzers manufactured at NMC's Dublin, Ireland facility. As a result of the import alerts, NMC was prohibited from importing the products covered by the alerts into the U.S. until the FDA confirmed compliance with GMP requirements at the facilities where such products were manufactured. In January 1994, NMC and certain members of its senior management entered into the Consent Decree providing that the importation of bloodlines and hemodialyzers could resume upon certification by NMC that the relevant manufacturing facility complied with GMP requirements and successful completion of an FDA inspection at the relevant facility to confirm compliance. The Consent Decree also required NMC to certify, and be inspected for, GMP compliance at all of Dialysis Products's manufacturing facilities in the U.S. Under the Consent Decree, Dialysis Products committed to maintaining ongoing compliance with GMP and related requirements at both U.S. and non-U.S. manufacturing facilities. As a result of the Consent Decree, NMC's U.S. facilities were required to undertake significant GMP improvements. NMC submitted all required certifications for its U.S. and non-U.S. facilities in accordance with timetables specified in the Consent Decree, and the bloodline import alert was lifted in March 1994. During the course of 1994 and 1995, NMC also worked with the FDA and demonstrated that its other manufacturing facilities in the U.S. were in compliance with GMP requirements. The hemodialyzer manufacturing facility in Dublin, Ireland was inspected by the FDA in April and December 1994 but did not pass inspection. NMC completed all remaining corrective actions, and in December 1995 the FDA determined that the Dublin facility was in compliance with GMP requirements and lifted the import alert. No fines or penalties have been imposed on NMC as a result of the FDA's actions or in connection with the Consent Decree. By policy, however, the FDA generally will undertake more frequent and more rigorous inspections of facilities that have been subject to consent decrees. The Consent Decree was lifted in January 1997. In February 1997, the Company closed its Dublin, Ireland facility. On January 24, 1995, the FDA issued a warning letter and import alert relating to NMC's manufacture of Diafilter(R) products at its Limerick, Ireland facility. That facility was not expressly named in the Consent Decree described above. Because NMC voluntarily ceased importing Diafilters(R) into the U.S. in December 1994, and, for business reasons, decided to shut down the Diafilter(R) business at the Limerick facility on January 23, 1995, no subsequent compliance review was deemed necessary by the FDA. NMC was not restricted from importing into the U.S. the other products manufactured at the Limerick facility. In 1994 and 1995, the FDA inspected Fresenius USA's manufacturing facilities in Maumee, Ohio, Ogden, Utah and Walnut Creek, California. At each location, violations of certain GMPs were found. At the Walnut Creek facility, violations of pre-market notification filing requirements were also found, although these findings were subsequently reversed when the devices in question were determined to be covered by appropriate filings. The FDA issued warning letters with respect to each facility, as a result of which the issuance of new 510(k) notices and new export clearances was placed on administrative hold. Fresenius USA responded to the inspection findings at Maumee in a manner it believes addresses the FDA's findings. Fresenius USA subsequently closed the Maumee facility in connection with the relocation of production from that facility to a facility in Lewisberry, Pennsylvania. Fresenius USA undertook an exhaustive review of the FDA's findings relating to Walnut Creek and submitted a detailed response to those findings. The Ogden plant was reinspected in 1995 and the administrative holds have been lifted from both Ogden and Walnut Creek. The Walnut Creek facility was inspected again in January and February of 1996 and Fresenius USA was advised that all GMP issues raised by the FDA have been resolved. Fresenius USA believes that its facilities are currently in compliance in all material respects with applicable state, local and federal requirements. In August 1996, Fresenius USA undertook a voluntary North American recall of certain lots of its peritoneal dialysis solutions which were associated with aseptic peritonitis. This condition is an inflammation of the abdominal cavity not caused by infection. The patients affected in the episode 45 46 recovered quickly after using non-suspect product lots. In the recall, Fresenius USA notified hospitals and dialysis centers that received the recalled lots as well as individual patients. Patients with recalled lots were provided with replacement solution, and a toll free telephone number for patient inquiries was established. Fresenius USA cooperated with the FDA and other government agencies in resolving the matter. In addition, the FDA may inspect facilities in the ordinary course of business to ensure compliance with GMP and other applicable regulations. The Company intends to address expeditiously any FDA findings resulting from such inspections. COMMERCIAL INSURER LITIGATION In 1997, the Company, NMC, and certain named NMC subsidiaries, were served with a civil complaint filed by Aetna Life Insurance Company in the U.S. District Court for the Southern District of New York (Aetna Life Insurance Company v. National Medical Care, Inc. et al, 97-Civ-9310). Based in large part on information contained in prior securities filings, the lawsuit alleges inappropriate billing practices for nutritional therapy, diagnostic and clinical laboratory tests and misrepresentations. The complaint seeks unspecified damages and costs. This matter is at a relatively early stage in the litigation process, with substantial discovery just beginning and its outcome and impact on the Company cannot be predicted at this time. However, the Company, NMC and its subsidiaries believe that they have substantial defenses to the claims asserted, and intend to continue to vigorously defend the lawsuit. It is also possible that one or more other private payors may assert that NMC received excess payments and similarly, may seek reimbursement and other damages from NMC. An adverse result could have a material adverse effect on the Company's business, financial condition or results of operations. OBRA 93 OBRA 93 affected the payment of benefits under Medicare and employer health plans for certain eligible ESRD patients. In July 1994, HCFA issued an instruction to Medicare claims processors to the effect that Medicare benefits for the patients affected by OBRA 93 would be subject to a new 18-month "coordination of benefits" period. This instruction had a positive impact on NMC's dialysis revenues because, during the 18-month coordination of benefits period, patients' employer health plans were responsible for payment, which was generally at rates higher than that provided under Medicare. In April 1995, HCFA issued a new instruction, reversing its original instruction in a manner that would substantially diminish the positive effect of the original instruction on NMC's dialysis business. HCFA further proposed that its new instruction be effective retroactive to August 1993, the effective date of OBRA 93. NMC ceased to recognize the incremental revenue realized under the original Program Memorandum as of July 1, 1995, but it continued to bill employer health plans as primary payors for patients affected by OBRA 93 through December 31, 1995. As of January 1, 1996, NMC commenced billing Medicare as primary payor for dual eligible ESRD patients affected by OBRA 93, and then began to rebill in compliance with the revised policy for services rendered between April 24 and December 31, 1995. On May 5, 1995, NMC filed a complaint in the U.S. District Court for the District of Columbia (National Medical Care, Inc. and Bio-Medical Applications of Colorado, Inc. d/b/a Northern Colorado Kidney Center v. Shalala, C.A. No. 95-0860 (WBB)) seeking to preclude HCFA from retroactively enforcing its April 24, 1995 implementation of the OBRA 93 provisions relating to the coordination of benefits for dual eligible ESRD patients. On May 9, 1995, NMC moved for a preliminary injunction to 46 47 preclude HCFA from enforcing its new policy retroactively, that is, to billings for services provided between August 10, 1993 and April 23, 1995. On June 6, 1995, the court granted NMC's request for a preliminary injunction and in December of 1996, NMC moved for partial summary judgment seeking a declaration from the Court that HCFA's retroactive application of the April 1995 rule was legally invalid. HCFA cross-moved for summary judgment on the grounds that the April 1995 rule was validly applied prospectively. In January 1998, the court granted NMC's motion for partial summary judgment and entered a declaratory judgment in favor of NMC, holding HCFA's retroactive application of the April 1995 rule legally invalid, and based on its finding, the Court also permanently enjoined HCFA from enforcing and applying the April 1995 rule retroactively against NMC. The Court took no action on HCFA's motion for summary judgment pending completion of the outstanding discovery. On October 5, 1998 NMC filed it's own motion for summary judgment requesting that the Court declare HCFA's prospective application of the April 1995 rule invalid and permanently enjoin HCFA from prospectively enforcing and applying the April 1995 rule. The Court has not yet ruled on the parties' motions. The Company believes that the Court's favorable rulings to date provide a stronger legal basis for NMC to collect outstanding amounts from commercial payors on the retroactive portion of the case during the first half of 1998. HCFA elected not to appeal from the Court's June 1995 and January 1998 orders. HCFA may, however, appeal all rulings at the conclusion of the litigation. If HCFA should successfully appeal so that the revised interpretation would be applied retroactively NMC may be required to refund the payments received from employer health plans for services provided after August 10, 1993 under HCFA's original implementation, and to re-bill Medicare for the same services, which would result in a net loss to NMC of approximately $120 million attributable to all periods prior to December 31, 1995. Also, in such event, the Company's business, financial position and results of operations would be materially adversely affected. SECURITIES AND EXCHANGE COMMISSION INVESTIGATION In 1996, the Company (then called W.R. Grace & Co.) received a formal order of investigation issued by the Commission directing an investigation into, among other things, whether Grace violated the federal securities laws by filing periodic reports with the Commission that contained false and misleading financial information. Pursuant to this formal order of investigation, the Company has produced documents pursuant to subpoenas from the Southeast Regional Office of the Commission relating to reserves (net of applicable taxes) established by the Company and NMC during the period from January 1, 1990 to the date of the subpoena and certain corporate records and personnel material. On December 22, 1998, the Commission, in respect of the above-mentioned investigation, (a) filed a civil complaint against Grace in the United States District Court in Miami, Florida, alleging that from 1991 through 1995, Grace inappropriately used certain accounting reserves to report inaccurate results for Grace and its Health Care Group, the bulk of which was comprised of Grace's then wholly owned subsidiary NMC, and (b) instituted in respect of substantially similar allegations public administrative and cease-and-desist proceedings against seven former personnel of Grace and NMC. NMC and the Company are neither defendants (or otherwise parties) in the Commission's above-mentioned civil action nor respondents (or otherwise parties) in the Commission's above-mentioned administrative proceedings. While there can be no assurance, the Company believes that the outcome of this investigation will have no material adverse effect on the business, financial condition and results of operations of the Company. IDPN COVERAGE ISSUES SRM administers IDPN therapy to chronic dialysis patients who suffer from severe gastrointestinal malfunctions. IDPM therapy was provided by Homecare prior to its divestiture. After 1993, Medicare claims processors sharply reduced the number of IDPN claims approved for payment as compared to prior periods. NMC believes that the reduction in IDPN claims represented an unauthorized policy coverage change. Accordingly, NMC and other IDPN providers pursued various administrative and legal remedies, including administrative appeals, to address this reduction. In November 1995, NMC filed a complaint in the U.S. District Court for the Middle District of Pennsylvania seeking a declaratory judgment and injunctive relief to prevent the implementation of this policy coverage change. (National Medical Care, Inc. v. Shalala, 3:CV-95-1922 (RPC)). Subsequently, the District Court affirmed a prior report of the magistrate judge dismissing NMC's complaint, without 47 48 considering any substantive claims, on the grounds that the underlying cause of action should be submitted fully to the administrative review processes available under the Medicare Act. NMC decided not to appeal the Court's decision, but rather, to pursue the claims through the available administrative processes. NMC was successful in pursuing these claims through the administrative process, receiving favorable decisions from Administrative Law Judges in more than 80% of its cases. In early 1998, a group of claims which had been ruled on favorably were remanded by the Medical Appeals Council to a single Administrative Law Judge (the "ALJ") with extensive instructions concerning the review of these decisions. A hearing was scheduled on the remanded claims to take place in July, but later postponed until October 1998. Prior to the July hearing date, the United States Attorney for the District of Massachusetts requested that the hearing be stayed pending resolution of the OIG Investigation, on the basis that proceeding could adversely effect the government's investigation as well as the government's efforts to confirm its belief that these claims are false. Prior to the ALJ issuing a decision on the stay request, the U.S. Attorney's Office requested that NMC agree to a stay in the proceedings in order to achieve a potential resolution of the IDPN claims subject to the OIG Investigation as well as those which are subject to the administrative appeals process. NMC has agreed to this request, and together with the U.S. Attorney's Office has requested a stay. The ALJ has agreed to this request in order to allow the parties the opportunity to resolve both the IDPN claims which are the subject of the OIG Investigation and the IDPN claims which are the subject of the administrative proceedings. At this time, it is not possible to determine whether NMC and the government will be able to resolve issues surrounding the IDPN claims. Further proceedings on all other government appeals from the Administrative Law Judges' decisions favorable to the Company have also been stayed by agreement of the parties. Although NMC management believes that those IDPN claims were consistent with published Medicare coverage guidelines and ultimately will be approved for payment, there can be no assurance that the claims on appeal will be approved for payment. Such claims represent substantial accounts receivable of NMC, amounting to approximately $150 million as of December 31, 1998. If NMC is unable to collect its IDPN receivable, either through the administrative appeal process or through negotiation, or if IDPN coverage is reduced or eliminated, depending on the amount of the receivable that is not collected and/or the nature of the coverage change, NMC's business, financial condition and results of operations could be materially adversely affected. NMC's IDPN receivables are included in the net assets of the Company's discontinued operations. However, these receivables have not been sold and will remain classified as discontinued operations until they have been settled. See Notes to Consolidated Financial Statements - Note 8 - "Discontinued Operations." SHAREHOLDER LITIGATION In 1995, nine purported class action lawsuits were brought against the Company (prior to the Merger, when it was Grace) and certain of its then officers and directors in various federal courts. These lawsuits were consolidated in a case entitled Murphy, et al. v. W.R. Grace & Co., et al. No. 95-CV-9003 (JFK) (the "Murphy Action"), which is pending in the U.S. District Court for the Southern District of New York. The first amended class action complaint in this lawsuit, which purports to be a class action on behalf of all persons and entities who purchased publicly traded securities of the Company during the period from March 13, 1995 through October 17, 1995, generally allege that the defendants violated federal securities laws by concealing information and issuing misleading public statements and reports concerning NMC's financial position and business prospects, a proposed spin-off of NMC, and the matters that are the subject of the OIG Investigation and the investigation by the federal grand jury in the District of New Jersey. The Murphy Action sought unspecified damages, attorneys' and experts' fees and costs and such other relief as the court deems proper. In October 1995, a purported derivative lawsuit was filed in the U.S. District Court for the Southern District of Florida, Northern Division against the Company (prior to the Merger, when it was known as Grace), certain of its then directors and its former President and Chief Executive Officer, alleging, inter alia, that such individuals breached their fiduciary duties by failing to properly supervise the 48 49 activities of NMC in the conduct of its business (Bennett v. Bolduc, et al. 95-8638-CIV-MORENO). In December 1995, the plaintiff in this action filed a new action, based on similar allegations, in the U.S. District Court for the Southern District of New York (Bennett v. Bolduc, et al. 95-CV-10737 (AGS)) (the "Bennett Action"). The action in Florida was dismissed in favor of the Bennett Action. A second action making similar allegations was filed in October 1995 in New York State Supreme Court, New York County (Bauer v. Bolduc, et al. 95-125751). This action was stayed in favor of the Bennett Action, which was consolidated, for discovery purposes only, with the Murphy Action described above. The complaint in the Bennett Action sought unspecified damages, attorneys' and experts' fees and costs and such other relief as the court deems proper. In February 1996, a purported class action was filed in New York State Supreme Court, New York County, against the Company (prior to the Merger, when it was known as Grace) and certain of Grace's then current and former directors, alleging that the defendants breached their fiduciary duties, principally by failing to provide internal financial data concerning NMC and by failing to negotiate with certain other companies that had made proposals for business combinations involving NMC (Rosman v. W. R. Grace, et al. 96-102347). The lawsuit sought injunctive relief ordering defendants to carry out their fiduciary duties and preventing or rescinding the Merger or any related transactions with Fresenius AG, unspecified monetary damages, an award of plaintiff's attorneys' and experts' fees and costs, and such other relief as the court may deem just and proper. Grace Chemicals indemnified the Company and its affiliates for any losses related to these lawsuits, which were settled in January 1998 without the contribution of any payment in connection with the settlements by the Company or any of its affiliates. ADMINISTRATIVE APPEALS The Company regularly pursues various administrative appeals relating to reimbursement issues in connection with its dialysis facilities. One such appeal consists of a challenge to the Medicare regulation which capped reimbursement for the bad debts incurred by dialysis facilities. In 1998, the United States Court of Appeals for the District of Columbia ruled in favor of the Company in connection with the bad debt issue, holding that the Secretary of Health & Human Services had not adequately justified the bad debt regulation, and ruling that the government's order adopting the rule was arbitrary and capricious. The Court of Appeals remanded the matter to the Secretary to provide a more adequate explanation of the bad debt cap or to abandon it. Subsequently, the Court modified its holding to continue the bad debt regulation in effect pending remand. The Company has recently begun settlement discussions with the government in an attempt to recover reimbursement for disallowed bad debt expenses. The Company cannot predict the outcome of these discussions. OTHER LITIGATION AND POTENTIAL EXPOSURES In recent years, physicians, hospitals and other participants in the health care industry have become subject to an increasing number of lawsuits alleging professional negligence, malpractice, product liability, workers' compensation or related claims, many of which involve large claims and significant defense costs. The Company and NMC and their subsidiaries have been, and the Company can be expected to continue from time to time to be, subject to such suits due to the nature of the Company's business. Although the Company maintains insurance at a level which it believes to be prudent, there can be no assurance that the coverage limits will be adequate or that all asserted claims will be covered by insurance. In addition, there can be no assurance that liability insurance will continue to be available at acceptable costs. A successful claim against the Company or any of its subsidiaries in excess of insurance coverage could have a material adverse effect upon the Company and the results of its operations. Any claims, regardless of their merit or eventual outcome, also may have a material adverse effect on the reputation and business of the Company. The Company, NMC and their subsidiaries operate a large number and wide variety of facilities throughout the U.S. In such a decentralized system it is often difficult to maintain the desired level of oversight and control over the thousands of individuals employed by many affiliate companies. The Company relies upon its management structure, regulatory and legal resources, and the effective operation of its compliance program to direct, manage and monitor the activities of these employees. However, on occasion, the Company, NMC and their subsidiaries have identified instances 49 50 where employees, deliberately or inadvertently, have submitted inadequate or false billings while employed by an affiliated company. The illegal actions of such persons may subject NMC to liability under the False Claims Act, among other laws, and the Company cannot predict whether such law enforcement authorities may use such information to initiate further investigations of the business practices disclosed or any other business activities of the Company. In addition, the Company asserts claims and suits arising in the ordinary course of business, the ultimate resolution of which would not, in the opinion of the Company, have a material adverse effect on its financial condition. For additional related information, see "Item 1, 'Business -- Regulatory and Legal Matters.'" 50 51 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to a vote of the Company's security holders during the fourth quarter of 1998. PART II ITEM 5. MARKET PRICE FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS All of the Company's common stock is held by Fresenius Medical Care. The NMC Credit Facilities and the indentures pertaining to the Senior Subordinated Notes of Fresenius Medical Care and one of its subsidiaries impose certain limits on the Company's payment of dividends. See Item 7 - "Managements Discussion and Analysis of Financial Condition and Results of Operations". 51 52 ITEM 6. SELECTED FINANCIAL DATA
Successor Predecessor --------------------------------------- ------------------------------------- Three Nine Months Months Year Ended Year Ended Ended Ended (DOLLARS IN MILLIONS, EXCEPT SHARES AND PER Dec. 31, Dec. 31, Dec. 31, Sept. 30, Year Ended December 31, SHARE DATA) 1998 1997 1996 1996 1995 1994 ---------- ---------- -------- --------- ------- --------- STATEMENT OF OPERATIONS DATA CONTINUING OPERATIONS NET SALES $ 2,571 $ 2,166 $ 505 $ 1,615 $ 2,033 $ 1,818 COST OF SALES 1,707 1,456 340 969 1,176 1,027 ------- ------- ------- ------- ------- ------- GROSS PROFIT 864 710 165 649 857 791 SELLING, GENERAL AND ADMINISTRATIVE AND RESEARCH AND DEVELOPMENT 529 452 106 501 625 561 ------- ------- ------- ------- ------- ------- OPERATING INCOME 335 258 59 145 232 230 INTEREST EXPENSE (NET) 209 176 43 16 26 16 ------- ------- ------- ------- ------- ------- INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES AND CUMULATIVE EFFECT OF CHANGES IN ACCOUNTING FOR START UP COSTS 126 80 16 129 206 214 INCOME TAX EXPENSE 74 46 11 66 109 112 ------- ------- ------- ------- ------- ------- INCOME FROM CONTINUING OPERATIONS BEFORE CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING FOR START UP COSTS $ 52 $ 34 $ 5 $ 63 $ 97 $ 102 ------- ------- ------- ------- ------- ------- DISCONTINUED OPERATIONS LOSS FROM DISCONTINUED OPERATIONS, NET OF INCOME TAXES (9) (14) (2) -- -- -- LOSS ON DISPOSAL OF DISCONTINUED OPERATIONS, NET OF INCOME TAX BENEFIT (97) -- -- -- -- -- ------- ------- ------- ------- ------- ------- LOSS FROM DISCONTINUED OPERATIONS (106) (14) (2) -- -- -- ------- ------- ------- ------- ------- ------- CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING FOR START UP COSTS, NET OF TAX BENEFIT (5) -- -- -- -- -- NET INCOME (LOSS) $ (59) $ 20 $ 3 $ 63 $ 97 $ 102 ======= ======= ======= ======= ======= ======= NET INCOME PER COMMON AND COMMON EQUIVALENT SHARE: CONTINUING OPERATIONS $ 0.57 $ 0.37 $ 0.06 $ 0.66 $ 1.01 $ 1.08 DISCONTINUED OPERATIONS (1.18) (0.15) (0.02) -- -- -- CUMULATIVE EFFECT OF ACCOUNTING CHANGE (0.05) -- -- -- -- -- NET INCOME (0.66) 0.22 0.04 0.66 1.01 1.08 WEIGHTED AVERAGE NUMBER OF SHARES OF COMMON STOCK AND COMMON STOCK EQUIVALENTS: PRIMARY (000'S) 90,000 90,000 90,000 95,188 95,822 93,936
Successor Predecessor ---------------------------------------------------------- At December 31, At December 31, ---------------------------------------------------------- 1998 1997 1996 1995 1994 ------ ------ ------ ------ ------ BALANCE SHEET DATA: WORKING CAPITAL $ 294 $ 394 $ 282 $ 125 $ 145 TOTAL ASSETS 4,613 4,771 4,370 1,998 1,644 TOTAL LONG TERM DEBT AND CAPITAL LEASE OBLIGATIONS 1,014 1,622 1,438 35 17 STOCKHOLDERS' EQUITY 1,949 1,987 1,764 1,363 1,159
52 53 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following is a discussion of the financial condition and results of operations of the Company. The discussion should be read in conjunction with the financial statements included elsewhere in this document. This section contains certain forward-looking statements that are subject to various risks and uncertainties. Such statements include, without limitation, discussions concerning the outlook of the Company, government reimbursement, future plans and management's expectations regarding future performance. Actual results could differ materially from those contained in these forward-looking statements due to certain factors including, without limitation, changes in business, economic and competitive conditions, regulatory reforms, foreign exchange rate fluctuations, uncertainties in litigation or investigative proceedings, and the availability of financing. These and other risks and uncertainties, which are more fully described elsewhere in this Item 7 and in the Company's reports filed from time to time with the Commission, could cause the Company's results to differ materially from the results that have been or may be projected by or on behalf of the Company. OVERVIEW The Company is primarily engaged in (a) providing kidney dialysis services, clinical laboratory testing and renal diagnostic services and (b) manufacturing and distributing products and equipment for dialysis treatment. Throughout the Company's history, a significant portion of the Company's growth has resulted from the development of new dialysis centers and the acquisition of existing dialysis centers, as well as from the acquisition and development of complementary businesses in the health care field. The Company derives a significant portion of its health care services net revenues from Medicare, Medicaid and other government health care programs (approximately 60% in 1998). The reimbursement rates under these programs, including the Composite Rate, the reimbursement rate for EPO (which accounted for approximately 26% of dialysis service's domestic net revenues in 1998), and the reimbursement rate for other dialysis and non-dialysis related services and products, as well as other material aspects of these programs, have in the past and may in the future be changed as a result of deficit reduction and health care reform measures. The Company's business, financial position and results of operations also could be materially adversely effected by an adverse outcome in the OIG investigations, any whistleblower action, the pending challenge by the Company of changes effected by Medicare in approving reimbursement claims relating to the administration of IDPN or the adoption in 1996 of a new coverage policy that has changed IDPN coverage prospectively. The Company's business, financial position and results of operations would also be materially adversely affected by an adverse outcome in the pending litigation concerning the implementation of certain provisions of OBRA 93 relating to the coordination of benefits between Medicare and employer health plans in the case of certain dual eligible ESRD patients. The Company also derives a significant portion of its net revenues from reimbursement by non-government payors. Historically, reimbursement rates paid by these payors generally have been higher than Medicare and other government program rates. However, non-government payors are imposing cost containment measures that are creating significant downward pressure on reimbursement levels that the Company receives for its services and products. 53 54 RESULTS OF OPERATIONS The following table summarizes certain operating results of the Company by principal business unit for the periods indicated. Intercompany eliminations primarily reflect sales of medical supplies by Dialysis Products to Dialysis Services. The table presents the year 1996 where there is a combination of 9 months of operations on a predecessor basis and 3 months of operations on a successor basis. The entire year for 1997 and 1998 operations was on a successor basis. These bases of accounting are not entirely compatible. In particular, the successor basis has a significant increase in interest expense and depreciation and amortization when compared to the predecessor basis. This information has been reorganized and prior period information has been reclassified to conform with the business unit reporting requirements of FMC and to distinguish between continued and discontinued operations.
YEAR ENDED DECEMBER 31, ----------------------------------- (DOLLARS IN MILLIONS) 1998 1997 1996 ------- ------- ------- NET REVENUES Dialysis Services ............................. $2,133 $1,770 $1,560 Dialysis Products ............................. 660 627 368 Intercompany Eliminations ..................... (222) (231) (211) ------ ------ ------ Total Net Revenues ................................ $2,571 $2,166 $1,717 ====== ====== ====== Operating Earnings: Dialysis Services ............................. $ 340 $ 265 $ 258 Dialysis Products ............................. 107 67 40 ------ ------ ------ Total Operating Earnings .......................... 447 332 298 ------ ------ ------ Other Expenses: General Corporate ............................. $ 108 $ 70 $ 69 Research & Development ........................ 4 4 3 Interest Expense, Net ......................... 209 178 49 ------ ------ ------ Total Other Expenses .............................. 321 252 121 ------ ------ ------ Earnings Before Income Taxes and cumulative effect of change ................... 126 80 177 in accounting for start up costs Provision for Income Taxes ........................ 74 46 75 ------ ------ ------ Net earnings from continuing operations before cumulative effect of change in accounting for start up costs ............... $ 52 $ 34 $ 102 ------ ------ ------ Discontinued Operations: Net Revenues .................................. $ 121 $ 283 $ 363 ====== ====== ====== Loss before income taxes ...................... (14) (21) (5) Benefit for income Taxes ...................... (5) (7) (2) ------ ------ ------ Loss from operations .......................... (9) (14) (3) ------ ------ ------ Loss on disposal before income taxes........ (140) -- -- Income tax benefit ......................... (43) -- -- ------ ------ ------ Loss on disposal ........................... (97) -- -- ------ ------ ------ Total Loss on Discontinued Operations ............. $ (106) $ (14) $ (3) ====== ====== ====== Cumulative effect of change in accounting for start up costs, net of tax benefits ........ (5) -- -- ------ ------ ------ ------ ------ ------ Net Income/(loss) ................................. $ (59) $ 20 $ 99 ====== ====== ======
54 55 1998 COMPARED TO 1997 Net revenues from continuing operations for 1998 increased by 19% ($405 million) over 1997. Net earnings from continuing operations before cumulative effect of change in accounting for start up costs for 1998 increased 53% ($18 million) over 1997 as a result of increased operating earnings, partially offset by higher interest expenses and increased general corporate expenses. DIALYSIS SERVICES Dialysis Services net revenues for 1998 increased by 21% ($363 million) over 1997, primarily as a result of a 14% increase in the number of treatments provided, the beneficial impact of the extension of the Medicare Secondary Payor (MSP) provision, higher EPO utilization relative to the comparable 1997 period and increased laboratory testing revenues. The treatment increase was a result of base business growth and the impact of 1997 and 1998 acquisitions. The laboratory testing revenue increase was primarily due to the full year revenue impact of Spectra Laboratories acquired by the Company in June 1997, partially offset by the decreased number of patients of other dialysis providers serviced by the Company, during the third and fourth quarter of 1998, as competitors consolidate lab activity. Dialysis Services operating earnings for 1998 increased by 28% ($75 million) over the comparable period of 1997 primarily due to the increase in treatment volume, the beneficial impact of the extension of the MSP provision and higher EPO utilization. DIALYSIS PRODUCTS Dialysis Products net revenues for 1998 increased by 5% ($33 million) over the comparable period of 1997. This is due to increased sales of dialyzers ($26 million), machines ($13 million), concentrates ($5 million), partially offset by decreased sales of bloodlines ($3 million), peritoneal products ($3 million), and other products ($5 million). Dialysis Products operating earnings for 1998 increased by 60% ($40 million) over 1997. This is primarily due to revenue growth and improvements in gross margin resulting from manufacturing efficiencies from increased production volume. OTHER EXPENSES The Company's other expenses for 1998 increased by 27% ($69 million) over 1997. General corporate expenses increased by $38 million primarily due to foreign exchange gains ($28 million) realized in 1997, increased insurance and legal expenses ($6 million) and other cost increases ($4 million). Research and development expenses for 1998 were essentially the same as 1997. Interest expense for 1998 increased by $31 million over 1997 mainly due to an increase in debt to finance acquisitions. INCOME TAX RATE The effective tax rate from continuing operations for 1998 (58.9%) is higher than the rate for 1997 (57.4%), due primarily to a rate reduction in 1997 related to the loss carryover of FUSA offset by various other items. DISCONTINUED OPERATIONS On June 1, 1998, the Company classified its Non-Renal Diagnostic Services and Homecare businesses as discontinued operations. The Company sold both its Non-Renal Diagnostic Services business and its Homecare business on, June 26, 1998 and July 29, 1998 respectively. In connection with the sale of Homecare, the Company retained the assets and the operations associated with the delivery of IDPN and records, for accounting purposes, its activity as part of discontinued operations. A net after tax loss of $97 million has been recorded on the sale of these businesses. The discontinued operations revenues for its Non-Renal Diagnostic Services and Homecare divisions was $121 million for 1998 with a net after tax loss of $9 million. 55 56 1997 COMPARED TO 1996 Net revenues from continuing operations for 1997 increased by 26% ($449 million) over 1997. Net earnings from continuing operations for 1997 decreased 67% ($68 million) as compared to 1996 primarily as a result of increased amortization and interest expenses partially offset by increased operating earnings of dialysis products and dialysis services. DIALYSIS SERVICES Dialysis Services net revenues for 1997 increased by 14% ($210 million) over 1996, which included a favorable OBRA adjustment ($10 million), primarily as a result of a 15% increase in the number of treatments provided worldwide. This increase was partially offset by a decline in the ancillary revenue rate ($16 million). The treatment increase was largely due to an increase in the number of dialysis centers (715 at December 31, 1997 as compared to 623 at December 31, 1996). Laboratory testing revenues for 1997 increased by $10 million over 1996. This was primarily due to revenues of Spectra Laboratories ($29 million), acquired by FMCH in June 1997, partially offset by decreases in testing volume of LifeChem ($12 million) and Renal Diagnostics ($7 million). Dialysis Services operating earnings for 1997 increased by 3% ($7 million) over 1996. This was primarily due to the increase in treatment volume partially offset by the aforementioned OBRA 93 adjustment in 1996, decreases in volume of LifeChem laboratory and Renal Diagnostics testing and increases to personnel costs. Spectra Laboratories operating earnings for 1997 were $4 million. DIALYSIS PRODUCTS Dialysis Products net revenues for 1997 increased by 70% ($259 million) over 1996, primarily due to a $267 million increase in revenues for FUSA, which was contributed to the Company by FMC effective October 1, 1996. Included in the increased sales of FUSA, was a $30 million increase in product sales between FUSA and Dialysis Services, which has been eliminated for financial reporting. Dialysis Products operating earnings for 1997 increased by 68% ($27 million) over 1996, primarily due to increased operating earnings of FUSA ($22 million). NMC's Renal Product Division's operating earnings increased by approximately $5 million during 1997, primarily due to a reduction in operating expenses and distribution costs ($2 million) as well as one-time charges recorded during 1996 for legal expenses ($3 million). OTHER EXPENSES The Company's other expenses for 1997 increased by 108% ($131 million) over 1996. General corporate expense increased by 1% ($1 million) primarily due to increased amortization expenses associated with the revaluation of intangible assets at the time of the Merger ($56 million), almost entirely offset by reduced legal expenses ($12 million) favorable savings in foreign exchange ($27 million), and other cost reductions ($16 million). Research and development expenses for 1997 increased by $1 million over 1996. Interest expense for 1997 increased by $129 million over 1996 mainly due to the large amount of bank debt incurred to finance the merger and the increase in interest expense associated with FUSA ($7 million). INCOME TAX RATE The effective tax rate from continuing operations was 57.4% for 1997 as compared with 42.5% in 1996. The effective income tax rates for 1997 and 1996 were significantly higher than the combined statutory rates due primarily to the large amount of non-deductible goodwill incurred as a result of the Merger in 1996 and 1997, partially offset by a reduction in the FUSA valuation allowance. DISCONTINUED OPERATIONS On June 1, 1998, the Company classified its Non Renal Diagnostic Services and Homecare divisions as discontinued operations. The Company sold both its Non Renal Diagnostic Services division and its Homecare division on June 26, 1998 and July 29, 1998, respectively. For comparison purposes, 1997 and 1996 results for these businesses are shown as discontinued operations. The discontinued operations revenues were $283 million and $363 for 1997 and 1996, respectively, with a net after tax loss of $14 million and $3 million for 1997 and 1996, respectively. 56 57 The following table represents the unaudited proforma statements of operations for continuing operations of the Company for the fiscal year 1996, assuming the Merger occurred on January 1, 1996, and the actual statements of operations for continuing operations for the fiscal year 1996.
ACTUAL PROFORMA YEARS ENDED DECEMBER 31, 1996 1996 ------- -------- (DOLLARS IN MILLIONS) Net Revenues: Dialysis Services $ 1,560 $ 1,560 Dialysis Products 368 629 Intercompany Eliminations (211) (261) ------- ------- Total Net Revenues $ 1,717 $ 1,928 ======= ======= Operating Earnings: Dialysis Services $ 258 $ 258 Dialysis Products 40 37 ------- ------- 298 295 ------- ------- Other Expenses: General Corporate 69 111 Research and Development 3 5 Interest Expense, Net 49 138 ------- ------- Total Other Expenses 121 254 ------- ------- Earnings Before Income Taxes from Continuing Operations 177 41 Provision for Income Taxes 75 32 ------- ------- Net Earnings from Continuing Operations $ 102 $ 9 ======= =======
EFFECT OF MERGER ON RESULTS OF OPERATIONS In accordance with U.S. GAAP relating to purchase accounting rules, the Company has adjusted to fair value its assets and liabilities which, on a pro forma basis, would have resulted in increased amortization of approximately $41 million for 1996, in the pro forma Statement of Operations shown as part of general corporate expenses. In addition, as part of the Merger, the Company has incurred additional debt, which would have resulted in a net increase in interest expense, including amortization of debt issuance costs and other fees, in the amount of $89 million for 1996 on a pro forma basis. In connection with the Merger, the addition of FUSA for the entire year would have resulted in increased revenues for Renal Products of $211 million and decreased operating earnings for Renal Products of $3 million in 1996, on a pro forma basis. The addition of FUSA for the entire year would have also resulted in a $2 million increase in research and development expense, on a pro forma basis. The Merger would have resulted in a decrease in the Company's provision for income taxes of $43 million in 1996, on a pro forma basis. As a result of the above adjustments, on a pro forma basis, the Company would have reported a net income from continuing operations of $9 million in 1996, as compared to its actual net profit from continuing operations of $102 million in 1996. 57 58 LIQUIDITY AND CAPITAL RESOURCES The Company's cash requirements, including, to a limited extent, acquisitions, have historically been funded by cash generated from operations. Cash generated from continued operations was $212 million, $127 million, and $134 million the years 1998, 1997 and 1996, respectively. These increases are primarily due to the Company's improved profit levels as well as working capital improvements. The Company made acquisitions totaling $170 million, $476 million and $90 million in 1998, 1997 and 1996, respectively net of cash acquired. The Company made capital expenditures for internal expansion, improvements, new furnishings and equipment of $75 million, $134 million and $127 million in 1998, 1997 and 1996, respectively. The Company intends to capitalize on the continuing shift in the U.S. from physician-owned and hospital based dialysis clinics to multi-center providers by acquiring existing dialysis centers and the establishment of new or expanded centers and, accordingly, will require significant capital resources to pursue its growth strategy in the dialysis marketplace. The Company may also make other strategic acquisitions in the future. During 1998 and 1997, the Company funded its acquisitions and capital expenditures primarily through proceeds from external short and long-term debt and the proceeds from the receivable financing facility and proceeds from the sale of the Non Renal Diagnostics and Homecare divisions. In addition, acquisitions were also funded through the issuance of investment securities by Fresenius Medical Care Finance, S.A., a Luxembourg subsidiary of FMC ("FMC Finance"). In exchange for such financing, an intercompany account was established between FMC Finance and the Company with payables due to FMC Finance of $42 million and $67 million for 1998 and 1997, respectively. The Company received net cash advances from Fresenius AG of $513 million during 1996. Prior to the Merger, the Company funded its acquisitions and capital expenditures with cash advances from the Grace Consolidated Group and cash from operations supplemented by financing programs, including the accounts receivable securitization program. The Company received net cash advances from Grace of $279 million for 1996. Effective July 1, 1995, the Company ceased to recognize the incremental revenue provided under HCFA's initial instruction under OBRA 93, although it continued to bill private third-party payors for these amounts through December 31, 1995. The Company began billing Medicare as the primary payor for the dual eligible ESRD patients affected by OBRA 93 effective January 1, 1996. If HCFA's revised instruction under OBRA 93 is permanently enjoined on a prospective basis, or if such revised instruction is sustained but given an effective date of later than June 30, 1995, the Company may be able to rebill such services to third-party payors and, as a result, the Company's future results of operations and financial position would be favorably affected by the incremental revenue that the Company would recognize. For further discussion see Notes to Consolidated Financial Statements - Note 16, "Commitments and Contingencies -- Omnibus Budget Reconciliation Act of 1993". CONTINGENCIES The Company is the subject of investigations by several federal agencies and authorities, is a plaintiff in litigation against the federal government with respect to the implementation of OBRA 93 and coverage for IDPN therapy, and is seeking to change a proposed revision to IDPN coverage policies and is a defendant in significant commercial insurance litigation. An adverse outcome in any of these matters, could have a material adverse effect on the Company's business, financial condition and results of operations. Because of the significant complexities and uncertainties associated with the above referenced governmental investigations and proceedings, neither an estimate of the possible loss or range of loss the Company may incur in respect of such matters nor a reserve based on any such estimate can be reasonably made. See Item 3 - Legal Proceedings and Notes to Consoliated Financial Statement - Note 16 "Commitments and Contingencies." The Company believes that its existing credit facilities, cash generated from operations and other current sources of financing are sufficient to meet its foreseeable needs. If existing sources of funds are not sufficient to provide liquidity, the Company may need to sell assets or obtain debt or equity financing from external sources. There can be no assurance that the Company will be able to do so on satisfactory terms, if at all. DIVESTITURES The Company sold its Non Renal Diagnostic Services and Homecare divisions on June 26, 1998 and July 29, 1998, respectively. The combined proceeds of the sales were approximately $100 million in cash and notes. 58 59 IMPACT OF INFLATION A substantial portion of the Company's net revenue is subject to reimbursement rates which are regulated by the federal government and do not automatically adjust for inflation. Non-governmental payors also are exerting downward pressure on reimbursement levels. Increased operating costs that are subject to inflation, such as labor and supply costs, without a compensating increase in reimbursement rates, may adversely affect the Company's business and results of operations, possibly materially. RECENTLY ISSUED ACCOUNTING STANDARDS In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards ("SFAS") No. 133, Accounting for Derivative Instruments and Hedging Activities, which establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as "derivatives") and for hedging activities. This statement requires that an entity recognize all derivatives as either assets or liabilities in the balance sheet and measure those instruments at fair value. The statement also sets forth the criteria for determining whether a derivative may be specifically designated as a hedge of a particular exposure with the intent of measuring the effectiveness of that hedge in the statement of operations. SFAS No. 133 is effective for all fiscal quarters of fiscal years beginning after June 15, 1999. The Company does not believe the adoption of SFAS 133 will have a material impact on the consolidated financial statements. YEAR 2000 ISSUES The "Year 2000 problem" is the result of computer programs using two digits rather than four to define the applicable years. Such software may recognize a date using "00" as the year 1900 rather than the year 2000. These programs are present in software applications running on desktop computers and network servers. These programs are also present in microchips and microcontrollers incorporated into equipment. Certain of the Company's computer hardware and software, building infrastructure components (e.g., alarm systems, HVAC systems, etc.) and medical devices that are date sensitive may contain programs with the Year 2000 problem. If uncorrected, the problem could result in computer system and program failures or equipment and medical device malfunctions or miscalculations that could result in a disruption of business operations or affect patient treatment. If the Company, its significant customers, reimbursement sources or suppliers fail to make necessary modifications and conversions on a timely basis, the Year 2000 problem could have a material adverse effect on the Company's operations and financial results. The Company believes that its competitors face a similar risk. The Company has been working on identifying and addressing potential Year 2000 risks since March 1997. In an effort to more comprehensively monitor and assess its progress in addressing Year 2000 issues, the Company established a Year 2000 Steering Committee in August 1998. The committee is comprised of senior company executives who meet regularly and provide status updates to the Company's management committee on a regular basis. Regarding information technology ("IT") systems, the Company has inventoried substantially all IT systems (e.g., clinical, supply chain management, financial, etc.) and has assessed Year 2000 compliance for those systems. The Company has developed specific plans and timetables to remediate or replace critical non-compliant systems and is in the process of completing these changes. Based on continued progress in addressing Year 2000 compliance issues, the Company is on the course to resolve such issues for all critical systems by September 30, 1999. Regarding non-IT equipment that may be dependent upon embedded software (e.g., medical, manufacturing/distribution, etc.), the Company has inventoried and assessed Year 2000 compliance for substantially all of this equipment. The Company has developed specific plans to remediate or replace substantially all non-compliant non-IT equipment and is in the process of completing these changes. Based on continued progress addressing Year 2000 compliance issues, the Company is on course to resolve such issues for substantially all non-IT equipment by September 30, 1999. 59 60 Although there can be no assurance that the Company will successfully complete implementation of its remediation efforts for IT systems and non-IT equipment by the dates critical for Year 2000 compliance, the Company's Year 2000 program is currently progressing in accordance with the Company's completion timetables. The Company relies heavily on third parties in operating its business. In addition to its reliance on systems and non-IT equipment vendors to verify Year 2000 compliance of their products, the Company also depends on 1) fiscal intermediaries which process claims and make payments for their Medicare and Medicaid programs, 2) insurance companies, HMOs, and other private payors, 3) utilities which provide electricity, water, natural gas, and telephone services, and 4) vendors of medical supplies and pharmaceuticals used in patient care. In conjunction with the fiscal intermediaries which process many of the claims submitted to Medicare and Medicaid, the Company has successfully tested its systemic interfaces to ensure that it will be able to bill these intermediaries before and after January 1, 2000. The Company is also working with these intermediaries and significant private payors to ensure that these payors will be able to process and make remittances for billed services. The Company has contacted substantially all significant vendors and service providers to seek assurances from these third parties that the services and products they provide will not be interrupted or malfunction due to the Year 2000 problem. Although no method exists for achieving certainty that any third party's organization will be Year 2000 compliant, the Company's goal is to obtain as much detailed information as possible about its significant vendors and service providers and to identify those companies which appear to pose a significant risk of failure to perform their obligations to the Company as a result of the Year 2000 problem. Failure of significant third parties to resolve their Year 2000 issues could have a material adverse effect on the Company's results of operations and ability to provide health care services and manufacture products. Costs related to the Year 2000 issue are funded through operating cash flows. The Company expects to spend a total of approximately $5 million in remediation and replacement efforts, including new software and hardware, costs to modify existing software, and consultant fees. The Company does not separately track internal costs incurred for the Year 2000 remediation effort; such costs are principally related to compensation costs for certain members of the Company's IT Department. The Company estimates remaining costs to be approximately $4 million. IT expenditures for Year 2000 are covered as part of the normal IT budget (the Year 2000 efforts are taking priority over other discretionary IT projects). Non-IT expenditures for Year 2000 are similarly being covered as part of the normal non-IT budget. The Company presently believes that the incremental cost of achieving Year 2000 compliant systems and equipment will not be material to the Company's financial condition, liquidity, or results of operation. Time and cost estimates are based on currently available information. Developments that could affect estimates include, but are not limited to: 1) the availability and cost of trained personnel, 2) the ability to locate and correct all relevant computer code and systems, and 3) remediation success of the Company's customers and suppliers. Based on its assessments to date, the Company believes it will not experience any material disruption as a result of Year 2000 issues in its internally manufactured medical devices, its internal manufacturing and distribution processes, and its internal information processing. However, if certain critical third party vendors or service providers, such as those supplying electricity or water, experience difficulties resulting in disruption of service to the Company, a shutdown of the Company's operations at individual facilities could occur for the duration of the disruption. The Year 2000 Steering Committee is completing its review of the various risk areas which might require a contingency plan. The committee is considering the need to develop contingency plans for certain key risk areas. At this point in time, the committee has not identified any risk areas which appears to have a reasonable likelihood to cause a material disruption to the Company's operations. Contingency plans will be developed on a case-by-case basis in respect to their Year 2000 status. Despite these efforts, judgements regarding contingency plans such as to what extent they should be developed are themselves subject to many variables and uncertainties. There can be no assurance that the Company will correctly anticipate the level, impact or duration of noncompliance by third party vendors or suppliers that provide inadequate information. As a result, there can be no assurance that any contingency plan will be sufficient to mitigate the impact of non-compliance by third-party vendors and service providers, and some material adverse effect to the Company could result regardless of such contingency plans. 60 61 ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company is exposed to market risks due to changes in interest rates and foreign currency rates. The Company uses derivative financial instruments, including interest rate swaps and foreign exchange contracts, as part of its market risk management strategy. These instruments are used as a means of hedging exposure to interest rate and foreign currency fluctuations in connection with debt obligations and purchase commitments. The Company does not hold or issue derivative instruments for trading or speculative purposes. Hedge accounting is applied if the derivative reduces the risk of the underlying hedged item and is designated at inception as a hedge. Additionally, changes in the value of the derivative must result in payoffs that are highly correlated to the changes in value of the hedged item. Derivatives are measured for effectiveness both at inception and on an ongoing basis. The Company enters into foreign exchange contracts that are designated as and effective as hedges for firmly committed purchases. Also, since the Company carries a substantial amount of floating rate debt, the Company uses interest rate swaps to synthetically change certain variable-rate debt obligations to fixed-rate obligations, as well as options to mitigate the impact of interest rate fluctuations. Gains and losses on foreign exchange contracts accounted for as hedges are deferred in other current assets or liabilities. The deferred gains and losses are recognized as adjustments to the underlying hedged transaction when the future sales or purchases are recognized. Interest rate swap payments and receipts are recorded as part of interest expense. The fair value of the swap contracts is not recognized in the financial statements. Cash flows from derivatives are recognized in the consolidated statement of cash flows in the same category as the item being hedged. If a derivative instrument ceases to meet the criteria for deferral, any subsequent gains or losses are recognized in operations. If a firm commitment does not occur, the foreign exchange contract is terminated and any gain or loss is recognized in operations. If a hedging instrument is sold or terminated prior to maturity, gains or losses continue to be deferred until the hedged item is recognized. Should a swap be terminated while the underlying obligation remains outstanding, the gain or loss is capitalized as part of the underlying obligation and amortized into interest expense over the remaining term of the obligation. The Company's hedging strategy vis-a-vis the above-mentioned market risks has not changed significantly from 1997 to 1998. For additional information, see also "Notes to Consolidated Financial Statements - Note 2. Summary of Significant Accounting Policies - Derivative Financial Instruments" and "Notes to Consolidated Financial Statements Note 15. Financial Instruments". ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The information called for by this item is indexed in Item 14 of this Report and contained on the pages following the signature page hereof. 61 62 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Not applicable PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT ITEM 11. EXECUTIVE COMPENSATION ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS In accordance with General Instruction G. (3) to Form 10-K, the information required by Part III is incorporated by reference to the Company's definitive information statement to be filed by April 30, 1999. PART IV ITEM 14. EXHIBITS, CONSOLIDATED FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a) Index to Consolidated Financial Statements The following consolidated financial statements are filed with this report: Report of Independent Auditors. Consolidated Statements of Operations for the Years Ended December 31, 1998 and 1997 and the Three Months Ended December 31, 1996 (Successor) and for the Nine Months Ended September 30, 1996 (Predecessor). Consolidated Statements of Comprehensive Income for the Years Ended December 31, 1998 and 1997 and the Three Months Ended December 31, 1996 (Successor) and for the Nine Months Ended September 30, 1996 (Predecessor). Consolidated Balance Sheets as of December 31, 1998 and 1997 (Successor). Consolidated Statements of Cash Flows for the Years Ended December 31, 1998 and 1997 and the Three Months Ended December 31, 1996 (Successor) and for the Nine Months Ended September 30, 1996 (Predecessor). Consolidated Statements of Changes in Equity for the Years Ended December 31, 1998 and 1997 and the Three Months Ended December 31,1996 (Successor) and for the Nine Months Ended September 30, 1996 (Predecessor). Notes to Consolidated Financial Statements. The Company is a majority-owned subsidiary of Fresenius Medical Care AG. The operating results and other financial information of the Company included in this report are not necessarily indicative of the operating results and financial condition of Fresenius Medical Care AG at the dates or for the periods presented herein. Users of the Company's financial statements wishing to obtain financial and other information regarding Fresenius Medical Care AG should consult the Annual Report on Form 20-F of Fresenius Medical Care AG, which is expected to be filed with the Securities and Exchange Commission and the New York Stock Exchange on or about March 15, 1999. (b) Reports on Form 8-K. None. (c) Exhibits. Exhibits. The following exhibits are filed or incorporated by reference as required by Item 601 of Regulation S-K. 62 63 EXHIBIT NO. DESCRIPTION Exhibit 2.1 Agreement and Plan of Reorganization dated as of February 4, 1996 between W. R. Grace & Co. and Fresenius AG (incorporated herein by reference to Appendix A to the Joint Proxy Statement-Prospectus of Fresenius Medical Care AG, W. R. Grace & Co. and Fresenius USA, Inc. dated August 2, 1996 and filed with the Commission on August 5, 1996). Exhibit 2.2 Distribution Agreement by and among W. R. Grace & Co., W. R. Grace & Co.-Conn. and Fresenius AG dated as of February 4, 1996 (incorporated herein by reference to Exhibit A to Appendix A to the Joint Proxy Statement-Prospectus of Fresenius Medical Care AG, W. R. Grace & Co. and Fresenius USA, Inc. dated August 2, 1996 and filed with the Commission on August 5, 1996). Exhibit 2.3 Contribution Agreement by and among Fresenius AG, Sterilpharma GmbH and W. R. Grace & Co.-Conn. dated February 4, 1996 (incorporated herein by reference to Exhibit E to Appendix A to the Joint Proxy-Statement Prospectus of Fresenius Medical Care AG, W. R. Grace & Co. and Fresenius USA, Inc. dated August 2, 1996 and filed with the Commission on August 5, 1996). Exhibit 3.1 Certificate of Incorporation of Fresenius Medical Care Holdings, Inc. (f/k/a W. R. Grace & Co.) under Section 402 of the New York Business Corporation Law dated March 23, 1988 (incorporated herein by reference to the Form 8-K of the Company filed on May 9, 1988). Exhibit 3.2 Certificate of Amendment of the Certificate of Incorporation of Fresenius Medical Care Holdings, Inc. (f/k/a W. R. Grace & Co.) under Section 805 of the New York Business Corporation Law dated May 25, 1988 (changing the name to W. R. Grace & Co., incorporated herein by reference to the Form 8-K of the Company filed on May 9, 1988). Exhibit 3.3 Certificate of Amendment of the Certificate of Incorporation of Fresenius Medical Care Holdings, Inc. (f/k/a W. R. Grace & Co.) under Section 805 of the New York Business Corporation Law dated September 27, 1996 (incorporated herein by reference to the Form 8-K of the Company filed with the Commission on October 15, 1996). Exhibit 3.4 Certificate of Amendment of the Certificate of Incorporation of Fresenius Medical Care Holdings, Inc. (f/k/a W. R. Grace & Co.) under Section 805 of the New York Business Corporation Law dated September 27, 1996 (changing the name to Fresenius National Medical Care Holdings, Inc., incorporated herein by reference to the Form 8-K of the Company filed with the Commission on October 15, 1996). Exhibit 3.5 Certificate of Amendment of the Certificate of Incorporation of Fresenius Medical Care Holdings, Inc. under Section 805 of the New York Business Corporation Law dated June 12, 1997 (changing name to Fresenius Medical Care Holdings, Inc., incorporated herein by reference to the Form 10-Q of the Company filed with the Commission on August 14, 1997). Exhibit 3.6 Amended and Restated By-laws of Fresenius Medical Care Holdings, Inc. (incorporated herein by reference to the Form 10-Q of the Company filed with the Commission on August 14, 1997). Exhibit 4.1 Credit Agreement dated as of September 27, 1996 among National Medical Care, Inc. and Certain Subsidiaries and Affiliates, as Borrowers, Certain Subsidiaries and Affiliates, as Guarantors, the Lenders named therein, Nationsbank, N.A., as paying agent and the Bank of Nova Scotia, The Chase Manhattan Bank, Dresdner Bank AG and Nationsbank, N.A., as Managing Agents (incorporated herein by reference to the Form 6-K of Fresenius Medical Care AG filed with the Commission on October 15, 1996). Exhibit 4.2 Amendment dated as of November 26, 1996 (amendment to the Credit Agreement dated as of September 27, 1996, incorporated herein by reference to the Form 8-K of Registrant filed with the Commission on December 16, 1996). Exhibit 4.3 Amendment No. 2 dated December 12, 1996 (second amendment to the Credit Agreement dated as of September 27, 1996, incorporated herein by reference to the Form 10-K of Registrant filed with the Commission on March 31, 1997). 63 64 Exhibit 4.4 Amendment No. 3 dated June 13, 1997 to the Credit Agreement dated as of September 27, 1996 , among National Medical Care, Inc. and Certain Subsidiaries and Affiliates , as Borrowers, Certain Subsidiaries and Affiliates, as Guarantors, the Lenders named therein, NationsBank, N.A., as paying agent and the Bank of Nova Scotia, the Chase Manhattan Bank, N.A., Dresdner Bank AG and NationsBank, N.A. as Managing Agents, as previously amended (incorporated herein by reference to the Form 10-Q of the Registrant filed with the Commission on November 14, 1997). Exhibit 4.5 Amendment No. 4, dated August 26, 1997 to the Credit Agreement dated as of September 27, 1996, among National Medical Care, Inc. and Certain Subsidiaries and Affiliates, as Borrowers, Certain Subsidiaries and Affiliates, as Guarantors, the Lenders named therein, NationsBank, N.A., as paying agent and the Bank of Nova Scotia, the Chase Manhattan Bank, N.A., Dresdner Bank AG and NationsBank, N.A. as Managing Agents, as previously amended (incorporated herein by reference to the Form 10-Q of Registrant filed with Commission on November 14, 1997). Exhibit 4.6 Amendment No. 5 dated December 12, 1997 to the Credit Agreement dated as of September 27, 1996, among National Medical Care, Inc. and Certain Subsidiaries and Affiliates, as Borrowers, Certain Subsidiaries and Affiliates, as Guarantors, the Lenders named therein, NationsBank, N.A., as paying agent and the Bank of Nova Scotia, the Chase Manhattan Bank, N.A., Dresdner Bank AG and NationsBank, N.A. as Managing Agents, as previously amended (incorporated herein by reference to the Form 10-K of Registrant filed with Commission on March 23, 1998). Exhibit 4.7 Form of Consent to Modification of Amendment No. 5 dated December 12, 1997 to the Credit Agreement dated as of September 27, 1996 among National Medical Care, Inc. and Certain Subsidiaries and Affiliates, as Borrowers, Certain Subsidiaries and Affiliates, as Guarantors, the Lenders named therein, NationsBank, N.A., as paying agent and the Bank of Nova Scotia, the Chase Manhattan Bank, N.A., Dresdner Bank AG and NationsBank, N.A. as Managing Agents (incorporated herein by reference to the Form 10-K of Registrant filed with Commission on March 23, 1998). Exhibit 4.8 Amendment No. 6 dated effective June 30, 1998 to the Credit Agreement dated as of September 27, 1996, among National Medical Care, Inc. and Certain Subsidiaries and Affiliates, as Borrowers, Certain Subsidiaries and Affiliates, as Guarantors, the Lenders named therein, NationsBank, N.A., as paying agent and the Bank of Nova Scotia, the Chase Manhattan Bank, N.A., Dresdner Bank AG and NationsBank, N.A. as Managing Agents, as previously amended. (incorporated herein by reference to the Form 10-Q of Registrant filed with Commission on November 12, 1998) Exhibit 4.9 Amendment No. 7 dated as of December 31, 1998 to the Credit Agreement dated as of September 27, 1996 among National Medical Care, Inc. and Certain Subsidiaries and Affiliates, as Borrowers, Certain Subsidiaries and Affiliates Guarantors, the Lenders named therein, Nations Bank, N.A. as paying agent and the Bank of Nova Scotia, the Chase Manhattan Bank, Dresdner Bank A. G. and Nations Bank, N.A. as Managing Agents (filed herewith). Exhibit 4.10 Fresenius Medical Care AG 1998 Stock Incentive Plan as amended effective as of August 3, 1998 (incorporated herein by reference to the Form 10-Q of Registrant filed with Commission on May 14, 1998). Exhibit 4.11 Senior Subordinated Indenture dated November 27, 1996, among Fresenius Medical Care AG, State Street Bank and Trust Company, as successor to Fleet National Bank, as Trustee and the Subsidiary Guarantors named therein (incorporated herein by reference to the Form 10-K of Registrant filed with the Commission on March 31, 1997). Exhibit 4.12 Senior Subordinated Indenture dated as of February 19, 1998, among Fresenius Medical Care AG, State Street Bank and Trust Company as Trustee and Fresenius Medical Care Holdings, Inc., and Fresenius Medical Care AG, as Guarantors with respect to the issuance of 7 7/8% Senior Subordinated Notes due 2008 (incorporated herein by reference to the Form 10-K of Registrant filed with Commission on March 23, 1998). Exhibit 4.13 Senior Subordinated Indenture dated as of February 19, 1998 among FMC Trust Finance S.a.r.l. Luxembourg, as Insurer, State Street Bank and Trust Company as Trustee and Fresenius Medical Care Holdings, Inc., and Fresenius Medical Care AG, as Guarantors with respect to the issuance of 7 3/8% Senior Subordinated Notes 64 65 due 2008 (incorporated herein by reference to the Form 10-K of Registrant filed with Commission on March 23, 1998). Exhibit 10.1 Employee Benefits and Compensation Agreement dated September 27, 1996 by and among W. R. Grace & Co., National Medical Care, Inc., and W. R. Grace & Co.-- Conn. (incorporated herein by reference to the Registration Statement on Form F-1 of Fresenius Medical Care AG, as amended (Registration No. 333-05922), dated November 22, 1996 and the exhibits thereto). Exhibit 10.2 Purchase Agreement, effective January 1, 1995, between Baxter Health Care Corporation and National Medical Care, Inc., including the addendum thereto (incorporated by reference to the Form SE of Fresenius Medical Care dated July 29, 1996 and the exhibits thereto). Exhibit 10.3 Agreement, dated November 25, 1992 between Bergen Brunswig Drug Company and National Medical Care, Inc., including the addendum thereto (incorporated by reference to the Form SE of Fresenius Medical Care dated July 29, 1996 and the exhibits thereto). Exhibit 10.4 Product Purchase Agreement, effective January 1, 1996, between Amgen, Inc. and National Medical Care, Inc. (incorporated by reference to the Form SE of Fresenius Medical Care dated July 29, 1996 and the exhibits thereto). Exhibit 10.5 Primary Guarantee dated July 31, 1996 (incorporated by reference to the Registrant's Registration Statement on Form S-4 (Registration No. 333-09497) dated August 2, 1996 and the exhibits thereto). Exhibit 10.6 Secondary Guarantee dated July 31, 1996 (incorporated by reference to the Registrant's Registration Statement on Form S-4 (Registration No. 333-09497) dated August 2, 1996 and the exhibits thereto). Exhibit 10.7 Receivables Purchase Agreement dated August 28, 1997 between National Medical Care, Inc. and NMC Funding Corporation (incorporated herein by reference to the Form 10-Q of the Registrant filed with the Commission on November 14, 1997). Exhibit 10.8 Amendment dated as of September 28, 1998 to the Receivables Purchase Agreement dated as of August 28, 1997, by and between NMC Funding Corporation, as Purchaser and National Medical Care, Inc., as Seller. (incorporated herein by reference to the Form 10-Q of Registrant filed with Commission on November 12, 1998). Exhibit 10.9 Transfer and Administration Agreement dated August 28, 1997 among NMC Funding Corporation, National Medical Care, Inc., Enterprise Funding Corporation, the Bank Investors listed therein and NationsBank, N.A., as agent (incorporated herein by reference to the Form 10-Q of the Registrant filed with the Commission on November 14, 1997). Exhibit 10.10 Amendment No. 1 dated as of February 27, 1998 to Transfer and Administration Agreement dated as of August 28, 1997 among NMC Funding Corporation, National Medical Care, Inc., Enterprise Funding Corporation, the Bank Investors listed herein and NationsBank, N.A., as agent (incorporated herein by reference to the Form 10-K of Registrant filed with Commission on March 23, 1998). Exhibit 10.11 Amendment No. 2 dated as of August 25, 1998 to Transfer and Administration Agreement dated us of August 28, 1997 among NMC Funding Corporation as Transferor, National Medical Care, Inc., as Collection Agent, Enterprise Funding Corporation, and Nations Bank, N.A. as agent for Enterprise Funding Corporation and the Bank Investors. (incorporated herein by reference to the Form 10-Q of Registrant filed with Commission on November 12, 1998). Exhibit 10.12 Amendment No. 3 dated as of September 28, 1998 to Transfer and Administration Agreement dated as of August 28, 1997 among NMC Funding Corporation as Transferor, National Medical Care, Inc., as Collection Agent, Enterprise Funding Corporation, and Nations Bank, N.A. as agent for Enterprise Funding Corporation and the Bank Investors. (incorporated herein by reference to the Form 10-Q of Registrant filed with Commission on November 12, 1998). Exhibit 10.13 Employment agreement dated January 1, 1992 by and between Ben J. Lipps and Fresenius USA, Inc. (incorporated herein by reference to the Annual Report on Form 10-K of Fresenius USA, Inc., for the year ended December 31, 1992). 65 66 Exhibit 10.14 Modification to FUSA Employment Agreement effective as of January 1, 1998 by and between Ben J. Lipps and Fresenius Medical Care AG (incorporated herein by reference to the Form 10-Q of Registrant filed with Commission on May 14, 1998). Exhibit 10.15 Employment Agreement dated July 1, 1997 by and between Jerry A. Schneider and the Company (incorporated herein by reference to the Form 10-Q of Registrant filed with Commission on May 14, 1998). Exhibit 10.16 Addendum to Employment Agreement dated as of September 18, 1997 by and between Jerry A. Schneider and the Company (incorporated herein by reference to the Form 10-Q of Registrant filed with Commission on May 14, 1998). Exhibit 10.17 Separation Agreement dated as of July 21, 1998 by and between Geoffrey W. Swett and National Medical Care, Inc. (incorporated herein by reference to the Form 10-Q of Registrant filed with Commission on November 12, 1998.) Exhibit 10.18 Employment Agreement dated October 23, 1998 by and between Roger S. Stoll and National Medical Care, Inc. (filed herewith) Exhibit 10.19 Employment Agreement dated November 11, 1998 by and between William F. Grieco and National Medical Care, Inc. (filed herewith) Exhibit 11 Statement re: Computation of Per Share Earnings. Exhibit 27 Financial Data Schedule (d) Financial Statement Schedules. Schedule II - Valuation and Qualifying Accounts 66 67 SIGNATURES Pursuant to the requirements of Section 13 of 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. Date: March 9, 1999 FRESENIUS MEDICAL CARE HOLDINGS, INC. By: /s/ Ben J. Lipps Ben J. Lipps, President (Chief Executive Officer) Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. NAME TITLE DATE ---- ----- ---- /s/ Ben J. Lipps President and Director March 9, 1999 Ben J. Lipps (Chief Executive Officer) /s/ Jerry A. Schneider Chief Financial Officer and Treasurer March 9, 1999 Jerry A. Schneider (Chief Financial and Accounting Officer) /s/ Udo Werle Director March 9, 1999 Udo Werle /s/ Hans-Ulrich Sutter Director March 9, 1999 Hans-Ulrich Sutter 67 68 REPORT OF INDEPENDENT AUDITORS To the Board of Directors and Stockholders of Fresenius Medical Care Holdings, Inc. We have audited the accompanying consolidated balance sheets of Fresenius Medical Care Holdings, Inc. and its subsidiaries (the "Company") as of December 31, 1998 and 1997 and the related consolidated statements of operations, comprehensive income, changes in equity and cash flows for the years ended December 31, 1998 and 1997 and the period October 1, 1996 to December 31, 1996, the successor periods, and for the period January 1, 1996 to September 30, 1996, the predecessor period. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the consolidated financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion. The accompanying predecessor consolidated financial statements were prepared on the basis of presentation described in Note 1, and are not intended to be a complete presentation of the assets, liabilities, revenues and expenses of the Company. In our opinion, the accompanying consolidated financial statements present fairly, in all material respects, the consolidated financial position of the Company as of December 31, 1998 and 1997, and the consolidated results of their operations and their cash flows for the year ended December 31, 1998 and 1997 and for the period October 1, 1996 to December 31, 1996, the successor periods, in conformity with generally accepted accounting principles, and for the period January 1, 1996 to September 30, 1996, the predecessor period pursuant to the basis of presentation in Note 1, in conformity with generally accepted accounting principles. As more fully described in Note 1 to the consolidated financial statements, the Company was acquired as of September 30, 1996 in a business combination accounted for as a purchase. As a result of the acquisition, the consolidated financial statements for the successor periods are presented on a different basis of accounting than that of the predecessor period, and therefore are not directly comparable. As discussed in Note 2 to the consolidated financial statements, the Company changed its method of accounting for start-up costs. KPMG Peat Marwick LLP February 9, 1999 Boston, MA 68 69 FRESENIUS MEDICAL CARE HOLDINGS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
SUCCESSOR PREDECESSOR ------------------------------------------------ -------------- TWELVE MONTHS TWELVE MONTHS THREE MONTHS NINE MONTHS ENDED ENDED ENDED ENDED DEC. 31, 1998 DEC. 31, 1997 DEC. 31, 1996 SEPT. 30, 1996 ------------- ------------- ------------- -------------- NET REVENUES Health care services ....................... $2,100,422 $1,726,842 $352,421 $1,495,451 Medical supplies ........................... 470,984 439,037 152,950 119,209 ---------- ---------- -------- ---------- 2,571,406 2,165,879 505,371 1,614,660 ---------- ---------- -------- ---------- EXPENSES Cost of health care services ............... 1,390,321 1,138,575 270,662 888,441 Cost of medical supplies ................... 317,122 317,829 69,139 80,545 General and administrative expenses ........ 253,920 204,644 49,076 319,466 Provision for doubtful accounts ............ 54,709 43,301 7,526 80,475 Depreciation and amortization .............. 216,214 199,726 48,889 93,097 Research and development ................... 4,060 4,077 1,083 1,906 Allocation of Grace Chemicals expenses ..... -- -- -- 5,322 Interest expense, net, and related financing costs including $77,705, $36,158 and $1,138, of interest with affiliates 208,776 178,087 42,618 16,325 ---------- ---------- -------- ---------- 2,445,122 2,086,239 488,993 1,485,577 ---------- ---------- -------- ---------- INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES AND CUMULATIVE EFFECT OF 126,284 79,640 16,378 129,083 CHANGE IN ACCOUNTING FOR START UP COSTS PROVISION FOR INCOME TAXES ...................... 74,447 45,720 11,001 66,202 ---------- ---------- -------- ---------- INCOME FROM CONTINUING OPERATIONS BEFORE CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING FOR START UP COSTS ........................... $ 51,837 $ 33,920 $ 5,377 $ 62,881 ---------- ---------- -------- ---------- DISCONTINUED OPERATIONS (NOTE 8) Loss from discontinued operations, net of income taxes ............................. (8,669) (13,783) (1,787) -- Loss on disposal of discontinued operations, net of income tax benefit ................ (97,228) -- -- -- ---------- ---------- -------- ---------- Loss from discontinued operations .......... $ (105,897) $ (13,783) (1,787) -- ---------- ---------- -------- ---------- CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING FOR START UP COSTS, NET OF TAX BENEFIT ........... (4,890) -- -- -- ---------- ---------- -------- ---------- NET INCOME (LOSS) ............................... $ (58,950) $ 20,137 $ 3,590 $ 62,881 ========== ========== ======== ========== Basic and fully dilutive earnings per share Continuing operations ........................ $ 0.57 $ 0.37 $ 0.06 $ 0.66 Discontinued operations ...................... $ (1.18) $ (0.15) $ (0.02) $ -- Cumulative effect of accounting change ....... $ (0.05) $ -- $ -- $ -- Net Income (loss) ............................ $ (0.66) $ 0.22 $ 0.04 $ 0.66
See accompanying Notes to Consolidated Financial Statements 69 70 FRESENIUS MEDICAL CARE HOLDINGS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (DOLLARS IN THOUSANDS)
SUCCESSOR PREDECESSOR ---------------------------------------------- ------------- TWELVE MONTHS TWELVE MONTHS THREE MONTHS NINE MONTHS ENDED ENDED ENDED ENDED DEC. 31, 1998 DEC. 31, 1997 DEC. 31, 1996 DEC. 31, 1996 ------------- ------------- ------------- ------------- NET INCOME (LOSS) $(58,950) $20,137 $3,590 $62,881 Other comprehensive income Foreign currency translation adjustments 1,872 -- 801 (2,653) -------- ------- ------ ------- Total other comprehensive income 1,872 -- 801 (2,653) -------- ------- ------ ------- COMPREHENSIVE INCOME (LOSS) $(57,078) $20,137 $4,391 $60,228 ======== ======= ====== =======
See accompanying Notes to Consolidated Financial Statements. 70 71 FRESENIUS MEDICAL CARE HOLDINGS, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (DOLLARS IN THOUSANDS)
SUCCESSOR ---------------------------- DECEMBER 31, ---------------------------- 1998 1997 ---------- ---------- ASSETS - ------ Current Assets: Cash and cash equivalents .................... $ 6,579 $ 13,054 Accounts receivable, less allowances of and .. 254,783 252,023 $49,209 and $53,109 Inventories .................................. 169,789 137,470 Deferred income taxes ........................ 139,653 94,905 Other current assets ......................... 93,912 82,148 Income taxes receivable ...................... -- 9,425 Net assets of discontinued operations ........ 149,949 370,677 ---------- ---------- Total Current Assets .................... 814,665 959,702 ---------- ---------- Properties and equipment, net ..................... 429,639 505,929 ---------- ---------- Other Assets: Excess of cost over the fair value of net assets acquired and other intangible assets, net of accumulated amortization of $289,167 and $136,243 ............................... 3,317,424 3,265,260 Other assets and deferred charges ............ 51,675 40,295 ---------- ---------- Total Other Assets ...................... 3,369,099 3,305,555 ---------- ---------- Total Assets ...................................... $4,613,403 $4,771,186 ========== ========== LIABILITIES AND EQUITY - ---------------------- Current Liabilities: Current portion of long-term debt and capitalized lease obligations................ $ 43,348 $ 18,599 Current portion of borrowing from affiliates . 32,716 67,584 Accounts payable ............................. 107,482 119,027 Accrued liabilities .......................... 306,333 338,238 Net accounts payable to affiliates ........... 17,966 22,279 Accrued Income taxes ......................... 12,411 -- ---------- ---------- Total Current Liabilities ............... 520,256 565,727 Long-term debt .................................... 1,010,880 1,613,657 Non-current borrowings from affiliates ............ 956,284 441,524 Capitalized lease obligations ..................... 2,666 7,968 Deferred income taxes ............................. 144,605 129,942 Other liabilities ................................. 29,278 25,718 ---------- ---------- Total Liabilities ....................... 2,663,969 2,784,536 ---------- ---------- Equity: Preferred stock, $100 par value ................ 7,412 7,412 Preferred stock, $.10 par value ................ 8,906 8,906 Common stock, $1 par value; 300,000,000 shares authorized; outstanding 90,000,000 ............. 90,000 90,000 Paid in capital ................................ 1,942,235 1,921,853 Retained deficit ............................... (100,156) (40,686) Accumulated comprehensive income ............... 1,037 (835) ---------- ---------- Total Equity .............................. 1,949,434 1,986,650 ---------- ---------- Total Liabilities and Equity ...................... $4,613,403 $4,771,186 ========== ==========
See accompanying Notes to Consolidated Financial Statements. 71 72 FRESENIUS MEDICAL CARE HOLDINGS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (DOLLARS IN THOUSANDS)
SUCCESSOR PREDECESSOR ---------------------------------------------- --------------- Twelve Twelve Three Nine Months Months Ended Months Ended Months Ended Ended Dec. Dec. 31, 1997 Dec. 31, 1996 Sept. 30., 1996 31, 1998 ---------- ------------- ------------- --------------- Cash Flows from Operating Activities: Net income (loss) ..................................... $ (58,950) $ 20,137 $ 3,590 $ 62,881 Adjustments to reconcile net earnings to net cash from Operating activities: Depreciation and amortization .................... 216,212 199,726 48,889 93,097 Loss from discontinued operations ................ 8,669 13,783 1,787 -- Loss on disposition of businesses ................ 97,228 -- -- -- Cumulative effect of change in accounting ............ 4,890 -- -- -- Provision for doubtful accounts .................. 54,709 43,300 7,526 80,475 Deferred income taxes ............................ 16,734 6,262 2,070 (8,268) Loss on disposal of properties and equipment ..... 402 587 13,394 5,816 Changes in operating assets and liabilities, net of effects of purchase acquisitions and foreign exchange: Increase in accounts receivable ................. (159,228) (113,631) (53,810) (82,981) (Increase) decrease in inventories ............... (30,979) 1,085 (7,504) 2,570 Decrease (increase) in other current assets ..... 3,890 (28,967) (11,437) (20,569) (Increase) decrease in other assets and deferred charges ..................................... (19,554) 2,521 (34,336) 987 (Decrease) increase in accounts payable .......... (11,705) 11,934 (6,736) 12,454 Increase (decrease) in accrued income taxes ...... 74,395 (16,615) 9,281 11,013 Decrease in accrued liabilities .................. (31,040) (42,792) (17,385) (17,282) Increase (decrease) in other long-term liabilities ................................. 3,560 (6,095) (5,291) 5,320 Net changes due to/from affiliates ............... 22,777 17,935 11,530 -- Other, net ....................................... 19,616 17,569 24,396 2,812 --------- --------- --------- ----------- Net cash provided by (used in) operating activities of continued operations ............................. 211,626 126,739 (14,036) 148,325 --------- --------- --------- ----------- Net cash used in operating activities of discontinued operations ....................................... (11,947) (18,762) (10,536) -- --------- --------- --------- ----------- Net cash provided by (used in) operating activities ... 199,679 107,977 (24,572) 148,325 --------- --------- --------- ----------- Cash Flows from Investing Activities: Capital expenditures ............................. (74,653) (133,744) (34,016) (92,853) Payments for acquisitions, net of cash acquired .. (170,137) (473,954) (561) (89,090) Proceeds from disposition of businesses .......... 82,500 -- -- -- -------- --------- --------- ----------- Net cash used in investing activities of continued operations ....................................... (162,290) (607,698) (34,577) (181,943) --------- --------- --------- ----------- Net cash used in investing activities of discontinued operations ....................................... (8,925) (22,744) (3,518) -- --------- --------- --------- ----------- Net cash used in investing activities ................. (171,215) (630,442) (38,095) (181,943) --------- --------- --------- ----------- Cash Flows from Financing Activities: Advances from Grace Chemicals, net ............... -- -- (1,130) 279,819 Increase in borrowings from affiliates ........... 445,447 137,282 513,448 -- Cash dividends paid .............................. (520) (520) (8,930) (2,114,396) Proceeds from issuance of debt ................... 16,385 203,937 90,334 2,390,607 Proceeds from receivable financing facility ..... 105,600 52,000 0 -- Payments on debt and capitalized leases ......... (599,714) (60,978) (953,834) (338,793) Contributed Capital from FMC AG ................. -- 202,170 249,005 -- Other net ....................................... (2,027) 3,918 5,876 -- --------- --------- --------- ----------- Net cash provided by (used in) used by financing ...... (34,829) 537,809 (105,231) 217,237 --------- --------- --------- ----------- activities of continued operations Net cash used in financing activities of discontinued operations ....................................... (2,107) (4,462) (9,890) -- --------- --------- --------- ----------- Net cash provided by (used in) financing activities ... (36,936) 533,347 (115,121) 217,237 --------- --------- --------- ----------- Effects of changes in foreign exchange rates ............... 1,997 (18,799) 20,537 3,353 --------- --------- --------- ----------- Change in cash and cash equivalents ........................ (6,475) (7,917) (157,251) 186,972 Cash and cash equivalents at beginning of period ........... 13,054 20,971 179,140 33,530 --------- --------- --------- ----------- Cash and cash equivalents at end of period ................. $ 6,579 $ 13,054 $ 21,889 $ 220,502 ========= ========= ========= ===========
72 73 FRESENIUS MEDICAL CARE HOLDINGS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (DOLLARS IN THOUSANDS)
SUCCESSOR PREDECESSOR ----------------------------------------------- --------------- Twelve Twelve Three Nine Months Ended Months Ended Months Ended Months Ended Dec. 31, 1998 Dec. 31, 1997 Dec. 31, 1996 Sept. 30., 1996 ------------- ------------- ------------- --------------- Supplemental disclosures of cash flow information: Cash paid during the period for: Interest ................................. $133,679 $136,998 $24,250 $21,328 Income taxes (received)/paid, net ........ (19,149) 40,471 (465) 23,293 Details for Acquisitions: Assets acquired ............................... 172,511 508,594 6,408 90,928 Liabilities assumed ........................... (2,374) (32,830) (5,847) (1,820) -------- -------- ------- ------- Cash paid ..................................... 170,137 475,764 561 89,108 Less cash acquired ............................ -- 1,810 -- 18 -------- -------- ------- ------- Net cash paid for acquisitions ................ $170,137 $473,954 $ 561 $89,090 ======== ======== ======= =======
See accompanying Notes to Consolidated Financial Statements 73 74 FRESENIUS MEDICAL CARE HOLDINGS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CHANGES IN EQUITY FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996 (IN THOUSANDS, EXCEPT SHARE AMOUNTS)
Preferred Stocks Common Stock ------------------------ ------------------------ Shares Amount Shares Amount ---------- ------- ---------- ------- BALANCE, DECEMBER 31, 1995 (Predecessor) .................. -- -- 10,268,701 103 Net Income for 9 months ended 9/30/96 ..................... -- -- -- -- Cumulative foreign currency translation adjustments ....... -- -- -- -- Cash dividends to Grace Chemicals for Reorganization ...... -- -- -- -- Increases to advances from Grace Chemicals for 9 months ended 9/30/96 .............................. -- -- -- -- ---------- ------- ---------- ------- BALANCE, SEPTEMBER 30, 1996 (PREDECESSOR) ................. -- -- 10,268,701 103 Excess of purchase price over book value .................. -- -- -- -- Adjustment to establish successor basis for Reorganization 89,136,435 16,318 79,731,299 89,897 ---------- ------- ---------- ------- BALANCE, OCTOBER 1, 1996 (SUCCESSOR) ...................... 89,136,435 16,318 90,000,000 90,000 Cash dividends to Grace Chemicals for Reorganization ...... -- -- -- -- Net income for 3 months ended 12/31/96 .................... -- -- -- -- Cash dividends on preferred stocks ........................ -- -- -- -- Contributed capital from Fresenius USA at 10/1/96 ......... -- -- -- -- Contributed capital from Fresenius Medical Care, AG ....... -- -- -- -- Transfer of International operations ...................... -- -- -- -- Cumulative foreign currency translation adjustments ....... -- -- -- -- ---------- ------- ---------- ------- BALANCE, DECEMBER 31, 1996 (SUCCESSOR) .................... 89,136,435 $16,318 90,000,000 $90,000 Net Income ................................................ -- -- -- -- Cash dividends on preferred stocks ........................ -- -- -- -- Contributed capital from Fresenius Medical Care, AG ....... -- -- -- -- Tax benefit of dispositions of stock options .............. -- -- -- -- Cumulative foreign currency translation adjustments ....... -- -- -- -- Other adjustments ......................................... -- -- -- -- ---------- ------- ---------- ------- BALANCE, DECEMBER 31, 1997 (SUCCESSOR) .................... 89,136,435 $16,318 90,000,000 $90,000 Net Income ................................................ -- -- -- -- Cash dividends on preferred stock ......................... -- -- -- -- Contributed capital from Fresenius Medical Care, AG ....... -- -- -- -- Transfer of International operations ...................... -- -- -- -- Tax benefit on International transfer ..................... -- -- -- -- Tax benefit of dispositions of stock options .............. -- -- -- -- Other Comprehensive Income - Cumulative foreign currency adjustments ............................................. -- -- -- -- Other adjustments ......................................... -- -- -- -- ---------- ------- ---------- ------- BALANCE, DECEMBER 31, 1998 (SUCCESSOR) .................... 89,136,435 $16,318 90,000,000 $90,000 ========== ======= ========== =======
74 75
Accumulated Capital in Retained Other Advance from Excess of Par Earnings Comprehensive Grace Value (Deficit) Income Chemicals ------------- ----------- ------------- ------------ BALANCE, DECEMBER 31, 1995 (PREDECESSOR) ............. 15,560 516,912 (3,126) 833,326 Net Income for 9 months ended 9/30/96 ................ -- 62,881 -- -- Cumulative foreign currency translation adjustments ........................................ -- -- (2,653) -- Cash dividends to Grace Chemicals for Reorganization ..................................... -- 2,114,396) -- -- Increases to advances from Grace Chemicals for 9 months ended 9/30/96 ......................... -- -- -- 199,905 ----------- ----------- -------- ----------- BALANCE, SEPTEMBER 30, 1996 (PREDECESSOR) ............ 15,560 (1,534,603) (5,779) 1,033,231 Excess of purchase price over book value ............. 1,696,698 -- -- -- Adjustment to establish successor basis for Reorganization .................................... (613,366) 1,534,603 5,779 (1,033,231) ----------- ----------- -------- ----------- BALANCE, OCTOBER 1, 1996 (SUCCESSOR) ................. 1,098,892 -- -- -- Transfer of International operations ................. (3,662) -- -- -- Cash dividends to Grace Chemicals for Reorganization .................. (8,800) -- -- -- Net income for 3 months ended 12/31/96 ............... -- 6,046 -- -- Cash dividends on preferred stocks ................... -- (130) -- -- Contributed capital from Fresenius USA at 10/1/96 .... 384,248 (67,005) (34) -- Contributed capital from Fresenius Medical Care, AG .. 249,005 -- -- -- Cumulative foreign currency translation adjustments ........................................ -- -- (801) -- ----------- ----------- -------- ----------- BALANCE, DECEMBER 31, 1996 (SUCCESSOR) ............... $ 1,719,683 $ (61,089) $ (835) $ 0 Net Income ........................................... -- 20,923 -- -- Cash dividends on preferred stocks ................... -- (520) -- -- Contributed capital from Fresenius Medical Care, AG .. 199,425 -- -- -- Tax benefit of dispositions of stock options ......... 2,739 -- -- -- Cumulative foreign currency translation adjustments .. -- -- -- -- Other adjustments .................................... 6 -- -- -- ----------- ----------- -------- ----------- BALANCE, DECEMBER 31, 1997 (SUCCESSOR) ............... $ 1,921,853 $ (40,686) $ (835) $ 0 Net Loss ............................................. -- (58,950) -- -- Cash dividends on preferred stocks ................... -- (520) -- -- Contributed capital from Fresenius Medical Care, AG .. -- -- -- -- Tax benefit on International transfer ................ 20,382 -- -- -- Tax benefit of dispositions of stock options ......... -- -- -- -- Other Comprehensive income Cumulative foreign currency adjustments ............................... -- -- 1,872 -- Other adjustments .................................... -- -- -- -- ----------- ----------- -------- ----------- BALANCE, DECEMBER 31, 1998 ........................... $ 1,942,235 $ (100,156) $ 1,037 $ 0 =========== =========== ======== ===========
75 76
TOTAL EQUITY ------------ BALANCE, DECEMBER 31, 1995 (PREDECESSOR) $ 1,362,775 Net Income for 9 months ended 9/30/96 62,881 Cumulative foreign currency translation adjustments (2,653) Cash dividends to Grace Chemicals for Reorganization (2,114,396) Increases to advances from Grace Chemicals for 9 months ended 9/30/96 199,905 ----------- BALANCE, SEPTEMBER 30, 1996 (PREDECESSOR) $ (491,488) Excess of purchase price over book value 1,696,698 Adjustment to establish successor basis for Reorganization 0 ----------- BALANCE, OCTOBER 1, 1996 (SUCCESSOR) $ 1,205,210 Transfer of International operations (3,662) Cash dividends to Grace Chemicals for Reorganization (8,800) Net income for 3 months ended 12/31/96 6,046 Cash dividends on preferred stocks (130) Contributed capital from Fresenius USA at 10/1/96 317,209 Contributed capital from Fresenius Medical Care, AG 249,005 Cumulative foreign currency translation adjustments (801) ----------- BALANCE, DECEMBER 31, 1996 (SUCCESSOR) $ 1,764,077 Net Income 20,923 Cash dividends on preferred stocks (520) Contributed capital from Fresenius Medical Care, AG 199,425 Tax benefit of dispositions of stock options 2,739 Cumulative foreign currency translation adjustments -- Other adjustments 6 ----------- BALANCE, DECEMBER 31, 1997 (SUCCESSOR) $ 1,986,650 Net Loss (58,950) Cash dividends on preferred stocks (520) Contributed capital from Fresenius Medical Care, AG -- Tax benefit on International Operations 20,382 Tax benefit of dispositions of stock options -- Other comprehensive income 1,872 Other adjustments -- ----------- BALANCE, DECEMBER 31, 1998 (SUCCESSOR) $ 1,949,434 ===========
See accompanying Notes to Consolidated Financial Statements 76 77 FRESENIUS MEDICAL CARE HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (DOLLARS IN THOUSANDS) NOTE 1. THE COMPANY, REORGANIZATION AND BASIS OF PRESENTATION THE COMPANY Fresenius Medical Care Holdings, Inc., (the "Company"), formerly known as W. R. Grace & Co. ("Grace New York"), together with its wholly owned subsidiaries, National Medical Care, Inc. and its subsidiaries ("NMC") and Fresenius USA, Inc. and its subsidiaries ("FUSA"), was formed as a result of a series of transactions pursuant to the Agreement and Plan of Reorganization dated as of February 4, 1996 by and between Grace New York and Fresenius AG (the "Merger") formerly known as the Reorganization, which is more fully described hereunder. The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries, NMC and FUSA and those financial statements where the Company controls professional corporations in accordance with Emerging Issues Task Force Issue 97-2. The Company is primarily engaged in (i) providing kidney dialysis services, and clinical laboratory testing and renal diagnostic services, and (ii) manufacturing and distributing products and equipment for dialysis treatment. THE MERGER The Merger, which was effective September 30, 1996, resulted from the culmination of the following transactions: (1) NMC, which was a subsidiary of W. R. Grace & Co. -- Conn. ("Grace Chemicals"), a wholly-owned subsidiary of Grace New York, borrowed $2,300,000 and paid a cash dividend of approximately $2,100,000 to Grace Chemicals; (2) the stock of NMC was transferred to Grace New York, so that NMC and Grace Chemicals became sibling subsidiaries of Grace New York; (3) the stock of Grace Chemicals was transferred to a newly formed Delaware subsidiary of Grace New York ("New Grace") and the shares of New Grace were spun-off to the Grace New York shareholders in a pro rata distribution; (4) Grace New York was recapitalized such that each Grace New York shareholder received one share of Class D Preferred Stock of Grace New York (the "Class D Preferred Stock") for each share of Grace New York common stock held; and (5) Grace New York, with NMC as its sole business, merged with a wholly-owned subsidiary of Fresenius Medical Care AG ("FMC"), and Fresenius AG's worldwide dialysis business (including its controlling interest in FUSA) ("FWD") was contributed as separate subsidiaries of FMC with the result that 44.8% of the ordinary shares of FMC were exchanged for the common stock held by Grace New York common shareholders in the merger transaction and the balance of the ordinary shares of FMC were received by Fresenius AG and the shareholders of FUSA, in consideration of the contribution of FWD to FMC. All of the Grace New York (now the Company) common stock is held by FMC, while the Class D Preferred Stock (which entitles its shareholders to a contingent dividend based on the consolidated performance of FMC in the years 1997-2001) and other previously issued classes of the Company preferred stock remain outstanding. Effective October 1, 1996, FMC contributed all of the assets and liabilities of FUSA to the Company. The contribution of FUSA to the Company by FMC was accounted for on the cost basis since FUSA was a subsidiary under control of a common parent. These consolidated financial statements include the results of FUSA's operations and cash flows for the period October 1, 1996 through December 31, 1998. INTERNATIONAL OPERATIONS Effective January 1, 1998, the Company transferred legal ownership of substantially all of its international operations to FMC. This transfer was accounted for on the cost basis since the international subsidiaries remain under control of a common parent. The consolidated financial statements in this report at December 31, 1998 and 1997 and for the three months ended December 31, 1996 do not include operating results and cash flows of the International Operations. See Note 7 - "International Operations." 77 78 BASIS OF PRESENTATION BASIS OF CONSOLIDATION - PREDECESSOR BASIS The consolidated financial statements have been prepared as if the Company had operated as an independent, stand alone entity for all periods presented. Such financial statements have been prepared using the historical basis of accounting prior to the Merger ("Predecessor") and include all of the assets, liabilities, revenues, expenses and related taxes on income of the Grace New York health care business operated by NMC (the "NMC Business") previously included in the consolidated financial statements of Grace New York and its subsidiaries prior to the Merger (the "Grace Consolidated Group"). Consequently, these consolidated financial statements include balances for goodwill and other assets and liabilities related to the NMC Business that were previously included in the financial statements of the Grace Consolidated Group, except that there is no allocation to the NMC Business of Grace Chemicals' borrowings and related interest expense. These consolidated financial statements reflect only the borrowings and interest expense of NMC prior to the Merger and interest expense of the Company after the Merger. In accordance with Securities and Exchange Commission Staff Accounting Bulletin No. 55 ("SAB 55"), the financial statements have also been adjusted to include certain expenses incurred by Grace Chemicals on the NMC Business's behalf prior to the Merger. These consolidated financial statements do not necessarily indicate the financial position and results of operations that would have occurred if the NMC Business were a stand-alone entity on the dates, and for the periods, indicated. ACCOUNTING FOR THE MERGER - SUCCESSOR BASIS The issuance of FMC ordinary shares for all of the common stock of NMC has been recorded as an acquisition in accordance with the purchase method of accounting. Accordingly, purchase accounting adjustments recorded by FMC have been "pushed down" to NMC, thus establishing a new basis of accounting at NMC ("Successor"). The purchase price of the acquisition was determined as the average of the mid-points of the ranges of valuation of NMC and FMC, respectively, as assigned by independent financial advisors to Fresenius AG and was approximately $1,152,000. The valuation has been increased for direct costs incurred to consummate the transaction. The excess of the purchase price over the cost of the net identifiable assets acquired at September 30, 1996 of $1,696,698 has been allocated to the fair value of the assets acquired and liabilities assumed with the remaining portion recorded as goodwill. The Agreement and Plan for Reorganization also provides for the payment of additional purchase price to the holders of the Company Class D Preferred Stock in the form of a dividend, contingent upon the attainment of certain specific consolidated operating results by FMC. Such future dividends, if any, will be recorded as an increase in goodwill. In order to properly allocate purchase price to assets acquired, the Company obtained an independent appraisal to fair value all assets of NMC. Accordingly, the carrying values of specifically identified intangible assets and certain tangible assets were adjusted upward by $186,030 and $53,122, respectively, to approximate their fair values. The Company has also recorded adjustments to increase liabilities assumed by approximately $123,000 for pre-acquisition contingencies primarily related to legal settlements and the anticipated costs incurred in the defense of litigation. These adjustments resulted from discussions with the government in March 1997. The Company has provided an estimate of legal costs at the low end of an expected range, but the ultimate costs could be significantly higher. The Company is in discussions with the government regarding these matters. Any difference between the final settlement and the Company's estimate would be adjusted to goodwill, if determined within the allocation period, or charged to income if determined thereafter. In addition, the Company has accrued approximately $50,000 for certain costs related to the closing of certain renal products manufacturing and distribution operations as well as the closing of certain clinics of the Homecare Division. These restructuring costs primarily relate to severance payments and lease commitments. Through the period ended December 31, 1998 approximately $62,000 in payments and other charges have been applied against the pre-acquisition contingencies and $40,000 against the restructuring costs. All intercompany transactions and balances under the predecessor and successor basis have been eliminated in consolidation. 78 79 NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Use of Estimates The preparation of consolidated financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions affecting the reported amounts of assets and liabilities (including disclosed amounts of contingent assets and liabilities) at the dates of the consolidated financial statements and the reported revenues and expenses during the reporting periods. Actual amounts could differ from those estimates. Cash Equivalents Cash equivalents consist of highly liquid instruments with maturities of three months or less when purchased. Derivative Financial Instruments Foreign currency contracts -- Gains and losses on foreign currency contracts that are designated and effective as hedges of existing assets, liabilities (including borrowings) and firm commitments are deferred and recorded as an adjustment to general and administrative expenses in the period in which the related transaction is consummated. Gains and losses on other foreign currency contracts are recognized at each reporting period. Interest rate swaps -- Interest rate agreements that are designated and effective as a hedge of a debt or other long-term obligations are accounted for on an accrual basis. That is, the interest payable and interest receivable under the swaps terms are accrued and recorded as an adjustment to interest expense of the designated liabilities or obligations. Amounts due from and payable to the counterparties of interest rate swaps are recorded on an accrual basis at each reporting date on amounts computed by reference of the respective interest rate swap contract. Realized gains and losses that occur from the early termination or of foreign currency contracts and interest rate swaps are recorded in the consolidated statement of operations over the remaining period of the original agreement. Gains and losses arising from the interest differential on contracts that hedge specific borrowings are recorded as a component of interest expense over the life of the contract. The effectiveness of the hedge is measured by a historical and probable future high correlation of changes in the fair value of the hedging instruments with changes in the value of the hedged item. If correlation ceases to exist, hedge accounting will be terminated and gains on losses recorded in other income. To date, high correlation has always been achieved. Revenue Recognition Revenues are recognized on the date services and related products are provided/shipped and are recorded at amounts estimated to be received under reimbursement arrangements with a large number of third-party payors, including Medicare and Medicaid. The Company establishes appropriate allowances based upon factors surrounding credit risks of specific third party payors, historical trends and other information. Retroactive adjustments are accrued on an estimated basis in the period the related services are rendered and adjusted in future periods as final settlements are determined. Inventories Inventories are stated at the lower of cost (first-in, first-out method) or market. Properties and Equipment Properties and equipment are stated at cost. Significant improvements are capitalized; repairs and maintenance costs that do not extend the lives of the assets are charged to expense as incurred. The cost and accumulated depreciation of assets sold or otherwise disposed of are removed from the accounts, and any resulting gain or loss is included in income when the assets are disposed. The cost of properties and equipment is depreciated over estimated useful lives on a straight - line basis as follows: buildings - 20 to 40 years, equipment and furniture - 3 to 10 years, and leasehold improvements - the shorter of the lease term or useful life. For income tax purposes, depreciation is calculated using accelerated methods to the extent permitted. 79 80 Excess of Cost Over the Fair Value of Net Assets Acquired and Other Intangible Assets On a predecessor basis, the Company had adopted the following useful lives and methods to amortize intangible assets: goodwill - 40 years on a straight - line basis; patient relationships and other intangible assets - over the estimated period to be benefited, generally from 7 to 25 years; and certain contractual arrangements - over the life of the agreements on a straight-line basis. On a successor basis, the Company has adopted the following useful lives and methods to amortize intangible assets: trade name, acute care agreements 40 years; and goodwill--25 to 40 years on a straight-line basis; patient relationships and other intangible assets - over the estimated period to be benefited, generally from 5 to 6 years on a straight line basis. Debt Issuance Costs Costs related to the issuance of debt are amortized over the term of the related obligation using a straight line method. Self Insurance Programs The Company is self insured for professional, product and general liability, auto and worker's compensation claims up to predetermined amounts above which third party insurance applies. Estimates include ultimate costs for both reported claims and incurred but not reported. Impairment In accordance with Statement of Financial Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of", the Company reviews the carrying value of its investments for impairment whenever events or changes in circumstances indicate that the carrying amount of assets may not be recoverable. The Company considers various valuation factors including discounted cash flows, fair values and replacement costs to assess any impairment of goodwill and other long lived assets. Foreign Currency Translation The Company follows the provisions of Statement of Financial Accounting Standards No. 52, "Foreign Currency Translation". Substantially all assets and liabilities of the Company's foreign subsidiaries are translated at year end exchange rates, while revenue and expenses are translated at exchange rates prevailing during the year. Adjustments for foreign currency translation fluctuations are excluded from net earnings and are deferred in the cumulative translation adjustment component of equity. In addition, the translation of certain intercompany borrowings denominated in foreign currencies, which are considered foreign equity investments, is included in the cumulative translation adjustment. Gains and losses resulting from the translation of revenues and expenses and intercompany borrowings, which are not considered equity investments, are included in general and administrative expense. On a successor basis, translation gains amounted to $766, $27,732, and $2,142 for the twelve months ended December 31, 1998 and 1997 and for the three months ended December 31, 1996, respectively. On a predecessor basis, similar exchange losses amounted to $3,661 for the nine months ended September 30, 1996. Income Taxes Income tax expense and certain other tax-related information included in these consolidated financial statements have been calculated as if the Company were a stand-alone taxpayer for all periods presented. Deferred income taxes are provided for temporary differences between the reporting of income and expense for financial reporting and tax return purposes. Deferred tax liabilities or assets at the end of each period are determined using the tax rates then in effect for the periods when taxes are actually expected to be paid or recovered. Accordingly, income tax expense provisions will increase or decrease in the period in which a change in tax rates is enacted. 80 81 Research and Development Research and development costs are expensed as incurred. Earnings per Share The Company adopted the provisions of SFAS No. 128, Earnings per Share, effective for fiscal 1997. This statement requires the presentation of basic earnings per share and diluted earnings per share. Basic earnings per share are computed by dividing net income available to common shareholders by the weighted-average number of common shares outstanding during the year. Diluted earnings per share includes the effect of all dilutive potential common shares that were outstanding during the year. The number of shares used to compute basic and diluted earnings per share was (in thousands) 90,000 for the year ended December 31, 1998 and 1997, and the three months ended December 31, 1996, successor basis, as there were no potential common shares and no adjustments to net earnings to be considered for purposes of the diluted earnings per shares calculation. On a predecessor basis, primary earnings per share was computed on the basis of weighted average number of common shares outstanding. Comprehensive Income The Company adopted the provisions of SFAS No. 130, Reporting Comprehensive Income, effective January 1, 1998 This statement 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. This statement further requires that the Company classify items of other comprehensive income by their nature in a financial statement and display the accumulated balance of other comprehensive income separately from retained earnings and additional paid-in capital in the equity section of a statement of financial position. Pension and other Postretirement Benefits Effective December 31, 1998, the Company adopted SFAS No. 132, "Employers' Disclosures about Pensions and Other Postretirement Benefits". The provisions of SFAS No. 132 revise employers' disclosures about pension and other post retirement benefit plans. It does not change the measurement or recognition of these plans. It standardized the disclosure requirements for pensions and other post retirement benefits to the extent practicable. Accounting Changes In April 1998, Statement of Position No. 98-5, Reporting on the Costs of Start - up Activities ("SOP 98-5"), was issued by the Accounting Standards Executive Committee (AcSEC) of the AICPA and was adopted by the Company, effective January 1, 1998. SOP 98-5 requires that the costs of start-up activities, including organization costs, which have been previously capitalized, should be expensed as incurred. As a result of the adoption of SOP 98-5, all deferred start-up activities as of January 1, 1998, have been recognized as a cumulative effect of a change in accounting for start-up costs net of tax benefit, in the consolidated statements of operations for the twelve months ended December 31, 1998. During 1998, costs for start-up activities were expensed as incurred. 81 82 NOTE 3. ACQUISITIONS The Company acquired certain health care facilities and clinical laboratories for a total consideration of $170,137 and $ 475,764 for the twelve months ended December 31, 1998 and 1997, respectively, and $561 for the three months ended December 31, 1996, on a successor basis, and $91,737 for the nine months ended September 30, 1996, on a predecessor basis. These acquisitions have been accounted for as purchase transactions and, accordingly, are included in the results of operations from the dates of acquisition. The excess of the total acquisition costs over the fair value of tangible net assets acquired was $157,836 and $383,626 for the twelve months ended December 31, 1998 and 1997 and $0 for the three months ended December 31, 1996, on a successor basis, and $81,189 for the nine months ended September 30, 1996, on a predecessor basis. Had the acquisitions occurred during the twelve months ended December 31, 1998 been consummated on January 1, 1997, unaudited proforma net revenues for the twelve months ended December 31, 1998 and 1997 would have been $2,584,806 and $2,226,976, respectively. Unaudited proforma income from continuing operations before cumulative effect of change in accounting for start up costs would have been $50,806 and $27,657 for the twelve months ended December 31, 1998 and 1997 respectively. Had the acquisitions that occurred during the twelve months ended December 31, 1997 been consummated on October 1, 1996, unaudited proforma net revenues for the twelve months ended December 31, 1997 would have been $2,530,129 and $630,494 for the three months ended December 31, 1996 on a successor basis. Unaudited proforma net earnings would have been $15,573 for the twelve months ended December 31, 1997 and $928 for the three months ended December 31, 1996, on a successor basis. 82 83 NOTE 4. OTHER BALANCE SHEET ITEMS
Successor December 31, --------------------------- 1998 1997 ---------- ---------- Inventories Raw materials $ 35.199 $ 37,792 Manufactured goods in process 18,802 14,074 Manufactured and purchased inventory available for sale 86,615 53,511 ---------- ---------- 140,616 105,377 Health care supplies 29,173 32,093 ---------- ---------- Total $ 169,789 $ 137,470 ========== ========== Under the terms of certain unconditional purchase commitments, the Company is obligated to purchase raw materials during 1999 amounting to $61,785 Other Current Assets Miscellaneous accounts receivable $ 70,126 $ 67,612 Deposits and prepaid expenses 23,786 14,536 ---------- ---------- $ 93,912 $ 82,148 ========== ========== Excess of Cost Over the Fair Value of Net Assets Acquired and Other Intangible Assets: Goodwill, less accumulated amortization of $156,210 and $62,140 $2,710,236 $2,739,939 Patient relationships, less accumulated amortization of $57,650 and $28,398 115,954 138,329 Other intangible assets, less accumulated amortization of $75,307 and $45,705 491,234 386,992 ---------- ---------- Total $3,317,424 $3,265,260 ========== ========== Accrued Liabilities Accrued operating expenses $ 42,943 $ 52,913 Accrued insurance 66,513 65,813 Accrued legal and compliance costs 46,329 62,470 Accrued salaries and wages 38,740 41,836 Accrued receivable credit balances 42,804 38,589 Accrued interest 30,742 32,270 Accrued other 9,830 13,947 Accrued physician compensation 17,495 16,178 Accrued restructuring 4,526 6,899 Accrued bonus and incentive compensation 6,411 7,323 ---------- ---------- $ 306,333 $ 338,238 ========== ==========
Accounts receivable credit balances principally reflect overpayments from third party payors and are in the process of repayment. 83 84 NOTE 5. SALE OF ACCOUNTS RECEIVABLE On September 27, 1997, NMC established a new $204,000 receivable financing facility with NationsBank to replace its former facility with CitiCorp. The NationsBank facility was amended on February 27, 1998 to increase the commitment amount to $331,500. The current agreement has an effective interest rate of 5.30% and matures on September 27, 1999. At December 31, 1998 and 1997, $305,600 and $200,000 had been received pursuant to such sales; these amounts are reflected as reductions to accounts receivable. Under the terms of the agreement, new interests in accounts receivable are sold as collections reduce previously sold accounts receivable. The costs related to such sales are expensed as incurred and recorded as interest expense and related financing costs. There were no gains or losses on these transactions. NOTE 6. DEBT Long-term debt to outside parties consists of:
DECEMBER 31, --------------------------- 1998 1997 ---------- ---------- NMC Credit Facility $1,032,700 $1,613,300 Third-party debt, primarily bank borrowings at variable interest rates (3% -14%) with various maturities 16,215 12,475 ---------- ---------- 1,048,915 1,625,775 Less amounts classified as current 38, 035 12,118 ========== ========== $1,010,880 $1,613,657 ========== ==========
NMC entered into a credit agreement with a group of banks (collectively, the "Lenders"), pursuant to which the Lenders made available to NMC and certain specified subsidiaries and affiliates an aggregate of $2,000,000 through two credit facilities (collectively, the "NMC Credit Facility"). The NMC Credit Facility, as amended, includes: (i) a revolving credit facility of up to $1,000,000 for up to seven years (of which up to $250,000 is available for letters of credit, up to $450,000 is available for borrowings in certain non-U.S. currencies, up to $50,000 is available as swing lines in U.S. dollars and up to $20,000 is available as swing lines in certain non-U.S. currencies) ("Facility 1") and (ii) a term loan facility of $1,000,000 for up to seven years ("Facility 2"). Loans under the NMC Credit Facility bear interest at one of the following rates, at either (i) LIBOR plus an applicable margin or (ii) a base rate equal to the sum of (1) the higher from time to time of (A) the prime rate of NationsBank, N.A. or (B) the federal funds rate plus 0.50% and (2) an applicable margin. A commitment fee is payable to the Lenders equal to a percentage per annum applied against the unused portion of the NMC Credit Facility. In addition to scheduled principal payments, the NMC Credit Facility will be reduced by certain portions of the net cash proceeds from certain sales of assets, sales of accounts receivable and the issuance of subordinated debt and equity securities. All payments outstanding under Facility 1 are due and payable at the end of the seventh year. Prepayments are permitted at any time without penalty, except in certain defined periods. The NMC Credit Agreement contains certain affirmative and negative covenants with respect to the Company, NMC and its subsidiaries, customary for this type of agreement. In February 1998, $250 million of Facility 2 was repaid, primarily using borrowings from affiliates. The voluntary prepayment reduces the available financing under the agreement to $1,750,000. At December 31, 1998 and 1997 the Company had available $508 million and $168 million, respectively, of additional borrowing capacity under the NMC Credit Facility including $33 million and $40 million respectively, available for additional letters of credit. In connection with the purchase of certain assets, FUSA entered into a term loan agreement with a commercial bank to borrow $25 million at an interest rate of 5.68% per annum. The loan was repaid in February 1998. In consideration of proprietary technology acquired, FUSA issued a note payable due in annual installments of $2,500 through 1998. The obligation was fully repaid in 1998. 84 85 Non current borrowings from affiliates consists of:
DECEMBER 31, DECEMBER 31, 1998 1997 ----------- ------------ Fresenius Medical Care AG non-current borrowings primarily at interest rates approximating 6 - 9.25% . $ 94,471 $351,549 Fresenius AG non-current borrowing at interest rates approximating 6 - 7% ............................ 60,000 -- Fresenius Medical Care AG deutsche mark denominated at variable interest rate approximately 5% ............. -- 72,601 Fresenius Medical Care Finance SA borrowings primarily at interest rates approximating 6.5% ....... 47,665 67,584 approximately 5% (deutsche mark denominated) ......... -- 17,099 Fresenius Medical Care-Deutschland-at interest rates Fresenius Medical Care Trust Finance S.a.r.l at interest rate of 8.43% and 9.25% .................. 786,524 -- Other ................................................ 340 275 -------- -------- 989,000 509,108 Less amounts classified as current ................... 32,716 67,584 -------- -------- Total ................................................ $956,284 $441,524 ======== ========
Scheduled maturities of long-term debt and non-current borrowings from affiliates are as follows: 1999 $ 70,751 2000 300,379 2001 300,000 2002 300,000 2003 300,000 2004 and beyond 766,785 ---------- Total $2,037,915 ========== 85 86 NOTE 7. INTERNATIONAL OPERATIONS Effective January 1, 1998, the Company transferred legal ownership of substantially all of its international operations to FMC. This transfer was accounted for on the cost basis since the international subsidiaries remain under control of a common parent. The consolidated financial statements in this report at December 31, 1998 and 1997 and for the three months ended December 31, 1996 do not include the operating results and cash flows of the international operations which were transferred. The consolidated financial statements at December 31, 1997 and for the three months ended December 31, 1996 have been restated to exclude operating results and cash flows of the international operations and to conform to the current period presentation. Total international assets of $208,669 and liabilities of $249,733, which included $187,525 of intercompany obligations were transferred at December 31, 1997. The following table shows the restatement to net revenues and net earnings for continuing operations and earnings per share for the prior periods:
TWELVE MONTHS THREE MONTHS ENDED ENDED DECEMBER 31, 1997 DECEMBER 31, 1996 ----------------- ----------------- Net Revenues:................................... Previously reported........................ $2,338,294 $549,211 Less International Transfer................ 172,415 43,840 ---------- -------- Restated FMCH.............................. $2,165,879 $505,371 ========== ======== Net earnings from continuing operations before cumulative effect of change in accounting for start up cost................................... Previously reported........................ $ 34,706 $ 7,833 Less International Transfer................ 786 2,456 ---------- -------- Restated FMCH.............................. $ 33,920 $ 5,377 ========== ======== Restated basic and fully diluted earnings per share $ 0.23 $ 0.22
The following table shows the restatement to the previously reported October 1, 1996 stockholders equity:
CONSOLIDATED INTERNATIONAL RESTATED FMCH TRANSFER FMCH ------------- ------------- ---------- Net Equity...................................... $1,205,210 $(3,662) $1,201,548
86 87 NOTE 8. DISCONTINUED OPERATIONS Effective June 1, 1998, the Company classified its non renal diagnostic Services business ("Non Renal Diagnostic Services") and homecare business ("Homecare") as discontinued operations. The Company disposed of its Non Renal Diagnostic Services division and its Homecare division on respectively, June 26, 1998 and July 29, 1998. In connection with the sale of Homecare, the Company retained the assets and the operations associated with the delivery of IDPN and records, for accounting purporses, its activity as part of discontinued operations. The Company has recorded a net after tax loss of $97 million on the sale of these businesses. The net loss on the disposal of these businesses and their results of operations have been accounted for as discontinued operations, and accordingly, prior year results have been restated. The remaining assets and liabilities of these discontinued operations at the balance sheet date have been classified in the consolidated balance sheet as Net Assets of Discontinued Operations. Included in net assets of discontinued operations is approximately $150 million of IDPN receivables. These assets have not been sold and will remain classified as discontinued operations until they have been settled. See Note 16 - "Commitments and Contingencies - Legal Proceedings." Operating results and net assets of discontinued operations are presented below: Discontinued Operations - Results of Operations The revenues and results of operations of the discontinued operations of Non Renal Diagnostic Services and Homecare divisions were as follows:
TWELVE MONTHS ENDED THREE MONTHS ENDED DECEMBER 31, DECEMBER 31, ------------------------- ------------------ 1998 1997 1996 --------- -------- ------- NET REVENUES ................................. $ 120,940 $283,006 $81,355 --------- -------- ------- Loss from operations before income tax benefit (14,212) (21,001) (3,030) Income tax benefit ........................... (5,543) (7,218) (1,243) --------- -------- ------- Loss from operations ......................... (8,669) (13,783) (1,787) --------- -------- ------- Loss on disposal before income tax benefit ... (140,000) -- -- Income tax benefit ........................... (42,772) -- -- --------- -------- ------- Loss on disposal ............................. (97,228) -- -- --------- -------- ------- Loss from discontinued operations ............ (105,897) (13,783) (1,787) ========= ======== =======
Discontinued Operations - Consolidated Balance Sheet The net assets, excluding intercompany assets, of the discontinued operations of the Non Renal Diagnostic Services and Homecare divisions, included in the consolidated balance sheet at December 31, 1998 are as follows: Total Current assets........................... $168,005 Properties & equipment, net.............. 219 Other assets............................. 594 -------- Total Assets.......................... $168,818 ======== Current liabilities...................... 18,622 Other liabilities........................ 247 -------- Total Liabilities..................... 18,869 ======== Net assets............................ $149,949 ======== 87 88 NOTE 9. INCOME TAXES Income from continuing operations before income taxes and cumulative effect of change in accounting for start-up costs are as follows:
SUCCESSOR PREDECESSOR --------------------------------------------- -------------- TWELVE MONTHS TWELVE MONTHS THREE MONTHS NINE MONTHS ENDED ENDED ENDED ENDED DEC. 31, 1998 DEC. 31, 1997 DEC. 31, 1996 SEPT. 30, 1996 ------------- ------------- ------------- -------------- Domestic $ 125,347 $ 80,461 $ 18,415 $ 154,878 Foreign (63) (821) (2,037) (25,795) ========= ======== ======== ========= Total $ 126,284 $ 79,640 $ 16,378 $ 129,083 ========= ======== ======== =========
The provision for income taxes was as follows:
SUCCESSOR PREDECESSOR --------------------------------------------- -------------- TWELVE MONTHS TWELVE MONTHS THREE MONTHS NINE MONTHS ENDED ENDED ENDED ENDED DEC. 31, 1998 DEC. 31, 1997 DEC. 31, 1996 SEPT. 30, 1996 ------------- ------------- ------------- -------------- Current tax expense Federal $44,777 $25,040 $ 7,098 $ 56,100 State 12,406 13,354 1,596 15,183 Foreign 530 1,064 237 3,187 ------- ------- ------- -------- Total Current 57,713 39,458 8,931 74,470 Deferred tax (benefit) expense Federal 14,642 5,137 1,783 (7,235) State 2,092 1,125 287 (1,033) ------- ------- ------- -------- Total deferred 16,734 6,262 2,070 (8,268) ------- ------- ------- -------- Total provision $74,447 $45,720 $11,001 $ 66,202 ======= ======= ======= ========
The income tax expense (benefit) for the year ended December 31, 1998 was allocated as follows: Income from continuing operations $ 74,447 Discontinued operations (48,315) Change in accounting method (3,260) -------- Total tax expense $ 22,872 ======== 88 89 Deferred tax liabilities (assets) are comprised of the following:
SUCCESSOR -------------------------- DECEMBER 31, 1998 1997 --------- --------- Allowance for doubtful accounts $ (28,965) $ (16,960) Insurance liability (23,550) (24,780) Legal liability (28,972) (37,666) Restructuring reserves -- (2,978) Deferred and incentive compensation (9,335) (17,028) Pension and benefit accruals (16,153) (14,230) Accrued interest (9,990) (3,460) Inventory reserves (4,155) (2,450) General reserves (14,684) (4,354) Discontinued operations -- (5,861) Other temporary differences (8,791) (3,557) Loss carry forwards (18,405) (7,231) --------- --------- Gross deferred tax assets (162,998) (140,555) Deferred tax assets valuation 5,340 3,368 --------- --------- Deferred tax assets (157,658) (137,187) --------- --------- Depreciation and amortization 162,148 182,974 Other temporary differences 462 2,007 --------- --------- Gross deferred tax liabilities 162,610 184,981 --------- --------- Net deferred tax liabilities $ 4,952 $ 47,794 ========= =========
The provision for income taxes for continuing operations before the cumulative effect of change in accounting for start-up costs for the twelve months ended December 31, 1998, December 31, 1997 and the three months ended December 31, 1996 and for the periods prior to the Merger of the Company as described in Note 1 differed from the amount of income taxes determined by applying the applicable statutory Federal income tax rate to pretax earnings as a result of the following differences:
SUCCESSOR PREDECESSOR --------------------------------------------- -------------- TWELVE MONTHS TWELVE MONTHS THREE MONTHS NINE MONTHS ENDED ENDED ENDED ENDED DEC. 31, 1998 DEC. 31, 1997 DEC. 31, 1996 SEPT. 30, 1996 ------------- ------------- ------------- -------------- Statutory federal tax rate 35.0% 35.0% 35.0% 35.0% State income taxes, net of Federal tax benefit 7.5 11.8 7.5 7.1 Amortization of goodwill 16.6 25.2 22.2 0.9 Foreign losses and taxes 0.4 1.7 5.8 7.7 Decrease in valuation allowance 0.0 (16.5) 0.0 0.0 Other (0.6) 0.2 (3.3) 0.6 ==== ==== ==== ==== Effective tax rate 58.9% 57.4% 67.2% 51.3% ==== ==== ==== ====
The net changes in the valuation allowance for deferred tax assets were $1,972, ($11,042), ($5,090), and $0, for the twelve months ended December 31, 1998, and 1997, for the three months ended December 31, 1996, and for the nine months ended September 30, 1996, respectively. The increase for 1998 relates to losses incurred by foreign subsidiaries. The decrease for 1997 relates mainly to the utilization of the FUSA loss carryforward. The decrease for the three months ended December 31, 1996 relates mainly to the transfer of a portion of the Company's international operations to FMC. There were no tax provision implications regarding the transfer of the valuation allowance. At December 31, 1997, there were approximately $13,454 of foreign (net) operating losses, the majority of which expire in varying amounts over the next seven years. The Company also has $37,329 of domestic U.S. net operating losses that will expire in the year 2018. Provision has not been made for additional federal, state, or foreign taxes on $3,418 of undistributed earnings of foreign subsidiaries. Those earnings have been, and will continue to be, reinvested. The earnings could become subject to additional tax if they were remitted as dividends, if foreign earnings were loaned to the Company or a U.S. affiliate, or if the Company should 89 90 sell its stock in the subsidiaries. The Company estimates that the distribution of these earnings would result in $1,386 of additional foreign withholding and federal income taxes. 90 91 NOTE 10. PROPERTIES AND EQUIPMENT
SUCCESSOR -------------------------- 1998 1997 --------- --------- Land and improvements $ 5,219 $ 6,190 Buildings 68,384 48,594 Capitalized lease property 9,398 9,950 Leasehold improvements 176,099 144,361 Equipment and furniture 327,643 376,199 Construction in progress 16,932 31,477 --------- --------- 603,675 616,771 Accumulated depreciation and amortization (174,035) (110,842) --------- --------- Properties and equipment, net $ 429,639 $ 505,929 ========= =========
Depreciation expense relating to properties and equipment amounted to $81,683 and $76.912 for the years ended December 31,1998 and 1997 respectively and $21,847 for the three months ended December 31, 1996 on a successor basis, and $53,509, for the nine months ended September 30, 1996, on a predecessor basis. Included in properties and equipment as of December 31, 1998, and 1997 were $24,428 and $16,313, respectively, of peritoneal dialysis cycler machines which the Company leases to customers with end-stage renal disease on a month-to-month basis.. Rental income for the peritoneal dialysis cycler machines was $7,679 and $6,230 for the twelve months ended December 31, 1998 and 1997, respectively and $467, for the three months ended December 31, 1996. Leases In September 1997, FUSA entered into an amended operating lease arrangement with a bank that covers approximately $40,100 of certain new equipment of FUSA's dialyzer manufacturing facility at its Ogden, Utah plant. The agreement has a basic term expiration date of January 1, 2010, renewal options and a purchase option at the greater of 20% of the original cost or the fair market value. If FUSA elects not to purchase the equipment or renew the lease at the end of the lease term, FUSA will be obligated to pay a remarketing fee of up to $1,350. Machine sales for 1998 and 1997 include $32.6 million and $1.6 million, respectively, of net revenues for machines sold to a third party leasing company which are utilized by the dialysis services division to provide services to the Company's customers. 91 92 Future minimum payments under noncancelable leases (principally for clinics and offices) as of December 31, 1998 are as follows:
OPERATING CAPITAL LEASES LEASES TOTAL --------- ------- -------- 1999 $ 76,521 $5,992 $ 82,513 2000 67,154 1,647 68,801 2001 59,456 342 59,798 2002 41,607 300 41,907 2003 35,392 284 35,676 2004 and beyond 107,944 522 108,466 -------- ------ -------- Total minimum payments $388,074 $9,087 $397,161 ======== ======== Less interest and operating costs 1,108 ------ Present value of minimum lease Payments ($5,313 payable in 1999). $7,979 ======
Rental expense for operating leases was $103,838 and $81,740 for the years ended December 31, 1998 and 1997 respectively, $19,826 for the three months ended December 31, 1996 on a successor basis and $66,864, for nine months ended September 30, 1996, on a predecessor basis. Amortization of properties under capital leases amounted to $968 and $3,445 for the years ended December 31, 1998 and 1997 and $465 for the three months ended December 31, 1996 on a successor basis and $629 for the nine months ended September 30, 1996, on a predecessor basis. Lease agreements frequently include renewal options and require that the Company pay for utilities, taxes, insurance and maintenance expenses. Options to purchase are also included in some lease agreements, particularly capital leases. 92 93 NOTE 11. EMPLOYEE INCENTIVES PREDECESSOR BASIS Compensation Arrangements On a predecessor basis, Grace New York and NMC had established long term incentive and annual incentive compensation plans under which certain key executives were eligible to receive payments and bonuses if certain corporate objectives were attained. These programs were terminated as of the effective date of the Merger. The earnings for the nine months ended September 31, 1996 included charges of $5,084 for costs associated with these programs. SUCCESSOR BASIS Annual Incentive Compensation Plan The Company has an annual incentive compensation plan under which key employees of the Company are eligible to receive bonuses based upon the achievement of EBIT results and other key objectives. Target awards range from 10% to 40% of employee's salary. Awards under these plans were accrued in 1998 for payment in 1999. No awards were paid in 1997. 93 94 NOTE 12. PENSION AND OTHER POST RETIREMENT BENEFITS Defined Benefit Pension Plans Substantially all domestic employees are covered by NMC's non-contributory, defined benefit pension plan. Each year NMC contributes at least the minimum required by the Employee Retirement Income Security Act of 1974, as amended. Plan assets consist primarily of publicly traded common stock, fixed income securities and cash equivalents. The following provides a reconciliation of benefit obligations, plan assets, and funded status of the plans.
SUCCESSOR PREDECESSOR --------------------------------------------- -------------- TWELVE MONTHS TWELVE MONTHS THREE MONTHS NINE MONTHS ENDED ENDED ENDED ENDED DEC. 31, 1998 DEC. 31, 1997 DEC. 31, 1996 SEPT. 30, 1996 ------------- ------------- ------------- -------------- CHANGE IN BENEFIT OBLIGATION Benefit obligation at beginning of year 72,025 63,260 Service Cost 7,416 7,100 Interest Cost 5,217 4,561 Amendments -- -- Actuarial (Gain)/Loss 5,810 (1,972) Divestures (1,717) -- Benefits Paid (1,287) (924) -------- -------- Benefit obligation at end of year 87,464 72,025 -------- -------- CHANGE ON PLAN ASSETS Fair value of plan assets at beginning of year 65,088 54,218 Actual return on plan assets 13,218 11,794 Employee contribution 0 0 Benefits paid (1,287) (924) -------- -------- Fair value of plan assets at end of year 77,019 65,088 -------- -------- Funded Status (10,444) (6,937) Unrecognized net (gain)/loss (15,239) (15,152) Recognition of U.A -- -- Adjustment for sale -- -- -------- -------- Accrued benefit costs (25,683) (22,089) -------- -------- WEIGHTED - AVERAGE ASSUMPTIONS AS OF DECEMBER 31, Discount rate 6.75% 7.50% 7.25% 7.25% Expected return of plan assets 9.70 9.00 9.00 9.00 Rate of compensation increase 4.50 4.50 4.50 4.50 COMPONENTS OF NET PERIOD BENEFIT COST Service Cost $ 7,416 7,100 1,678 5,036 Interest Cost 5,217 4,561 1,021 3,063 Expected return on plan assets (6,430) (4,758) (1,103) (3,310) Amortization of transition asset -- -- (128) (384) Amortization of prior service cost -- -- (11) (35) Recognized net (gain)/loss (891) (139) 76 223 Curtailment net (gain) (1,717) -- -- -- -------- -------- -------- -------- Net periodic benefit costs $ 3,595 $ 6,764 $ 1,533 $ 4,593 -------- -------- -------- --------
NMC also sponsors a supplemental executive retirement plan to provide certain key executives with benefits in excess of normal pension benefits. The projected benefit obligation was $3,100 at December 31, 1998 and 1997 respectively. Pension expense for this plan, for the twelve months ended December 31, 1998 and 1997 and the three months ended December 31, 1996 was $374 and $360, and $149, respectively on a successor basis, and $319 for the nine months ended September 30, 1996, on a predecessor basis. NMC does not provide any postretirement benefits to its employees other than those provided under its pension plan and supplemental executive retirement plan. 94 95 Defined Contribution Plans The Company's employees are eligible to join NMC's 401 (k) Savings Plan once they have achieved a minimum of one year of service and if they have more than 900 hours of service before their one year anniversary date. Under the provisions of the 401 (k) plan, employees are allowed to contribute up to 16% of their salaries. The Company contributes 50% of their savings up to 6% of saved pay. The Company's total contributions for the year ended December 31, 1998 and 1997 was $7,195 and $6,385 respectively and for the three months ended December 31, 1996 and nine months ended September 30, 1996 amounted to $1,204 and $3,428, respectively. FUSA employees are eligible to join FUSA's 401 (k) Savings Plan once they have achieved a minimum of one year of service, 1000 hours of service and attained the age of 18. Under the provisions of FUSA's 401 (k) Savings Plan, FUSA contributes 2% of eligible employee base salary to the FUSA 401 (k) Plan. FUSA's obligation to the FUSA 401 (k) Savings Plan was approximately $422, $780, and $217 for the twelve months ended December 31, 1998 and 1997 and for the three months ended December 31, 1996, respectively. NOTE 13. EQUITY PREFERRED STOCK-SUCCESSOR BASIS At December 31, 1998, the components of the Company's preferred stocks as presented in the Consolidated Balance Sheet and the Consolidated Statement of Changes in Equity are as follows: PREFERRED STOCKS, $100 PAR VALUE - - 6% Cumulative (1); 40,000 shares authorized; 36,460 outstanding $ 3,646 - - 8% Cumulative Class A (2); 50,000 shares authorized; 16,176 outstanding 1,618 - - 8% Noncumulative Class B (2); 40,000 shares authorized; 21,483 outstanding 2,148 ------- $ 7,412 ------- PREFERRED STOCKS, $.10 PAR VALUE - - Noncumulative Class D (3); 100,000,000 shares authorized; 89,062,316 outstanding 8,906 ------- Total Preferred $16,318 =======
(1) 160 votes per share (2) 16 votes per share (3) 1/10 vote per share Stock Options - Predecessor Basis On a predecessor basis, stock options were granted under the stock incentive plans of companies within the Grace Consolidated Group. At September 30, 1996, options for 6,740,450 shares were outstanding with an average exercise price of $30.12 (of which 4,726,562 were exercisable) and 7,000,000 shares were available for additional grants. As of the date of the Merger, all outstanding Grace New York stock options were, in the case of NMC employees, converted to FMC stock options and, for non-NMC personnel, converted into Grace Chemical stock options. Accordingly, there are no outstanding stock options on the Company's common stock. Stock Options - Successor Basis Immediately prior to the Merger, FMC adopted a stock incentive plan (the "FMC Plan") under which the Company's key management and executive employees are eligible. Under the FMC Plan, eligible employees will have the right to acquire Preference Shares of FMC. Options granted under the FMC Plan will be evidenced by a non-transferable convertible bond and corresponding non-recourse loan to the employee, secured solely by the bond with which it was made. Each convertible bond, which will be DM denominated, will entitle the holder thereof to convert the bond in Preference Shares equal to the face amount 95 96 of the bond divided by the Preference Share's nominal value. During 1997, FMC granted 2,697,438 options (of which 216,663 were forfeited) to the Company, under the FMC Plan. At December 31, 1997 no options were exercisable. During 1998, 2,169,273 options were cancelled or forfeited leaving 311,502 options outstanding under the plan. If these awards are exercised, a total of 103,800 non-voting preference shares would be issued at December 31, 1998. No options were exercisable under the FMC Plan. During 1998, the Company adopted a new stock incentive plan ("FMC 98 Plan") under which the Company's key management and executive employees are eligible. Under the FMC 98 Plan, eligible employees will have the right to acquire Preference Shares of FMC. Options granted under the FMC 98 Plan will be evidenced by a non-transferable convertible bond and a corresponding non-recourse loan to the employee, secured solely by the bond with which it was made. Each convertible bond, which will be DM denominated, will entitle the holder thereof to convert the bond in Preference Shares equal to the face amount of the bond divided by the Preference Share's nominal value. During 1998, FMC awarded 1,024,083 options and exercisable upon vesting for 1,024,083 Preference. At December 31, 1998 no options were exercisable under the FMC 98 Plan. 96 97 NOTE 14. FINANCIAL INSTRUMENTS Market Risk The Company is exposed to market risks due to changes in interest rates and foreign currency rates. The Company uses derivative financial instruments, including interest rate swaps and foreign exchange contracts, as part of its risk management strategy. These instruments are used as a means of hedging exposure to interest rate and foreign currency fluctuations in connection with firm commitments and debt obligations. The Company does not hold or issue derivative instruments for trading or speculative purposes. The mark-to-market valuations of the financial instruments and of associated underlying exposures are closely monitored at all times. The Company uses portfolio sensitivities and stress tests to monitor risk. Overall financial strategies and the effects of using derivatives are reviewed periodically. Foreign Currency Contracts The Company uses foreign exchange contracts as a hedge against foreign exchange risks associated with the settlement of foreign currency denominated payables and firm commitments. At December 31, 1998 and 1997, the Company had outstanding foreign currency contracts for the purchase of Deutsche Marks ("DEM") totaling of $33,280 and $135,000, respectively. The contracts outstanding at December 31, 1998 include forward contracts for delivery of DEM between January and June 1999, at rates ranging from 1.7528 to 1.804 DEM per U.S. Dollar ("USD"), plus option contracts to provide downside protection at 1.6500 DEM per USD and upside potential up to 1.7640 DEM per USD on $12,000 with a maturity date in September 1999. The fair value of forward currency contracts are the estimated amounts that the Company would receive or pay to terminate the agreement at the reporting date, taking into account the current exchange rates and the current credit worthiness of the counterparties. At December 31, 1998 and 1997, the Company would have received $1,658 and paid $2,985, respectively to terminate the contracts. Interest Rate Agreements At December 31, 1998 and 1997, the Company had interest rate swaps and option agreements outstanding with various commercial banks for notional amounts totaling $1,600,000 and $1,950,000 respectively. Of the amount outstanding at December 31, 1998, $1,350,000 relate to agreements that became effective prior to December 31, 1998. Three other agreements totaling $250,000 become effective on January 4, 2000. All of these agreements were entered into for other than trading purposes and expire at various dates between January 4, 2000 and January 5, 2004. The interest rate swaps totaling $1,450,000 effectively change the Company's interest rate exposure on its variable-rate revolving loans under the Credit Facility (drawn as of December 31, 1998: $1,032,700), the drawdowns under the receivables financing facility (drawn as of December 31, 1998: $305,600), and certain operating lease payments to fixed rates of interest ranging between 6.05% and 6.6025%. For a notional amount of $150,000, the option agreements give protection against an increase of interest rates above 6.76% whereas the Company has to pay the difference between the current interest rates and 5.55% when the current rates are below that level. These option contracts will be effective between January 4, 2000 and January 4, 2005. Under the NMC Credit facility, the Company agreed to maintain at least $500,000 of interest rate protection. The fair value of the interest rate swaps and options is the estimated amount that the Company would receive or pay to terminate the agreements. The fair value of these agreements at December 31, 1998 and 1997 would require the Company to pay approximately $51,500 and $23,000, respectively. These estimates are subjective in nature and involves uncertainties and matters of significant judgement and therefore cannot be determined with precision. Changes in assumptions significantly affect the estimates. 97 98 Credit Risk The Company is exposed to credit risk to the extent of potential nonperformance by counterparties on financial instruments. As of December 31, 1998, the Company's credit exposure was insignificant and limited to the fair value stated above; the Company believes the risk of incurring losses due to credit risk is remote. Fair Value of Other Financial Instruments At December 31, 1998 and 1997, the carrying value of cash, cash equivalents, accounts receivable, prepaid expenses, accounts payable, accrued expenses, short-term borrowings, short-term borrowing from related parties and current liabilities approximated their fair values, based on the short-term maturities of these instruments. At December 31, 1998, the fair value of the mandatorily redeemable trust preferred securities exceeded their carrying value by $13,486. At December 31, 1997, the fair value of this debt outstanding at that time exceeded its carrying value by $16,200. Fair value was determined based upon market quotes. 98 99 NOTE 15. RELATED PARTY TRANSACTIONS AND ALLOCATIONS PREDECESSOR BASIS Corporate Services In accordance with SAB 55, Grace Chemicals allocated a portion of its domestic corporate expenses to its business units, including NMC. These expenses have included management and corporate overhead; benefit administration; risk management/insurance administration; tax and treasury/cash management services; environmental services; litigation administration services; and other support and executive functions. Allocations and charges were based on either a direct cost pass through or a percentage allocation for such services provided based on factors such as net sales, management time, or headcount. Such allocations and charges totaled $5,322, for the nine months ended September 30, 1996. Domestic research and development expenses of Grace Chemicals related to NMC's business and allocated to NMC in accordance with SAB 55 totaled $0, for the nine months ended September 30, 1996. Management believes that the basis used for allocating corporate services was reasonable and that the terms of these transactions would not materially differ from those that would result from transactions among unrelated parties. Grace Chemicals also charged NMC for its share of domestic workers' compensation, employee life, medical and dental, and other general business liability insurance premiums and claims which were handled by Grace Chemicals on a corporate basis. These charges have been based on NMC's actual and expected future experience, including actual payroll expense, and totaled $13,314, for the nine months ended September 30, 1996, and have been included in either cost of health care services or general and administrative expenses, depending upon the nature of the employee's or insured asset's function. NOTE 16. COMMITMENTS AND CONTINGENCIES Contingent Non-NMC Liabilities of Grace New York (Now Known as Fresenius Medical Care Holdings, Inc.) In connection with the Merger, Grace Chemicals has agreed to indemnify the Company and NMC against all liabilities of the Company and its successors, whether relating to events occurring before or after the Merger, other than liabilities arising from or relating to NMC operations. After the Merger the Company will remain contingently liable for certain liabilities with respect to pre-Merger matters that are not related to NMC operations. The Company believes that in view of the nature of the non-NMC liabilities and the expected impact of the Merger on Grace Chemicals' financial position, the risk of significant loss from non-NMC liabilities is remote. Were events to violate the tax-free nature of the Merger, the resulting tax liability would be the obligation of the Company. Subject to representations by Grace Chemicals, the Company, and Fresenius AG, Grace Chemicals has agreed to indemnify the Company for such a tax liability. If the Company was not able to collect on the indemnity, the tax liability would have a material adverse effect on the Company's business, the financial condition of the Company and the results of operations. 99 100 NOTE 16. COMMITMENTS AND CONTINGENCIES Contingent Non-NMC Liabilities of Grace New York (Now Known as Fresenius Medical Care Holdings, Inc.) The Company, formerly known as W. R. Grace & Co. ("Grace New York"), together with its wholly owned subsidiaries, National Medical Care, Inc. and its subsidiaries ("NMC") and Fresenius USA, Inc. and its subsidiaries ("FUSA"), was formed as a result of a series of transactions pursuant to the Agreement and Plan of Reorganization dated as of February 4, 1996 by and between Grace New York and Fresenius AG (the "Merger"). In connection with the Merger, W. R. Grace & Co. - Conn. ("Grace Chemicals") has agreed to indemnify the Company and NMC against all liabilities of the Company and its successors, whether relating to events occurring before or after the Merger, other than liabilities arising from or relating to NMC operations. After the Merger the Company will remain contingently liable for certain liabilities with respect to pre-Merger matters that are not related to NMC operations. The Company believes that in view of the nature of the non-NMC liabilities and the expected impact of the Merger on Grace Chemicals' financial position, the risk of significant loss from non-NMC liabilities is remote. Were events to violate the tax-free nature of the Merger, the resulting tax liability would be the obligation of the Company. Subject to representations by Grace Chemicals, the Company, and Fresenius AG, Grace Chemicals has agreed to indemnify the Company for such a tax liability. If the Company was not able to collect on the indemnity, the tax liability would have a material adverse effect on the Company's business, the financial condition of the Company and the results of operations. LEGAL PROCEEDINGS Government Investigations OIG INVESTIGATIVE SUBPOENAS In October 1995, NMC received five investigative subpoenas from the Office of the Inspector General ("OIG") of the Department of Health and Human Services. The subpoenas were issued in connection with an investigation being conducted by the OIG, the U.S. Attorney for the District of Massachusetts and others concerning possible violations of federal laws, including the anti-kickback statutes and the False Claims Act (the "OIG Investigation"). The subpoenas call for extensive document production relating to various aspects of NMC's business. In connection with the OIG Investigation, the Company continues to receive additional subpoenas directed to NMC or the Company to obtain supplemental information and documents regarding the above-noted issues, or to clarify the scope of the original subpoenas. The Company is cooperating with the OIG Investigation. The Company believes that the government continues to review and evaluate the voluminous information the Company has provided. As indicated above, the government continues, from time to time, to seek supplementing and/or clarifying information from the Company. The Company understands that the government has utilized a grand jury to investigate these matters. The Company expects that this process will continue while the government completes its evaluation of the issues. The OIG Investigation covers the following areas: (a) NMC's dialysis services business ("DSD"), principally relating to its Medical Director contracts and compensation; (b) NMC's treatment of credit balances resulting from overpayments received under the Medicare, Medicaid, CHAMPUS and other government and commercial payors, its billing for home dialysis services, and its payment of supplemental 100 101 medical insurance premiums on behalf of indigent patients; (c) NMC's LifeChem laboratory subsidiary's ("LifeChem") business, including testing procedures, marketing, customer relationships, competition, overpayments totaling approximately $4.9 million that were received by LifeChem from the Medicare program with respect to laboratory services rendered between 1989 and 1993, a 1997 review of dialysis facilities' standing orders, and the provision of discounts on products from NMC's products division, grants, equipment and entertainment to customers; and (d) NMC's homecare division ("Homecare") and, in particular, information concerning intradialytic parenteral nutrition ("IDPN") utilization, documentation of claims and billing practices including various services, equipment and supplies and payments made to third parties as compensation for administering IDPN therapy. The government has indicated that the areas identified above are not exclusive, and that it may pursue additional areas. As noted, the penalties applicable under the anti-kickback statutes, the U.S. Federal False Claims Act (the "False Claims Act") and other federal and state statutes and regulations applicable to NMC's business can be substantial. While NMC asserts that it is able to offer legal and/or factual defenses with respect to many of the areas the government has identified, it is expected that the government will assert that NMC has violated multiple statutory and regulatory provisions. Additionally, nine and possibly other qui tam actions alleging that NMC submitted false claims to the government have been filed under seal by former or current NMC employees or other individuals who may have familiarity with one or more of the issues under investigation. As noted, under the False Claims Act, any such private plaintiff could pursue an action against NMC in the name of the U.S. at his or her own expense if the government declines to do so. During the approximately three and one-half years since the initial subpoenas were served NMC and the government have met periodically to discuss issues in connection with the OIG Investigation, including theories of liability. Recently, NMC and the government have begun to explore the possibility of settling the matters which are encompassed by the OIG Investigation and, as referenced below, have reached an agreement in principal in connection with the diagnostics investigation matter. There can be no assurance that any of the other matters subject to the OIG Investigation will be settled. If however, one or more of the matters encompassed by the OIG Investigation is settled, it may result in NMC acknowledging that its past practices violated federal statutes, as well as NMC incurring substantial civil and criminal financial penalties which could have a material adverse effect on the Company. If one or more of these matters is not settled, the government may be expected to initiate litigation in which it would seek substantial civil and criminal financial penalties and other sanctions that could result in the exclusion of NMC and its subsidiaries from the Medicare program, Medicaid program and other federal health care programs. See "Management's Discussion and Analysis of Financial Condition and Results of Operations Contingencies." DIAGNOSTICS SUBPOENA In October 1996, Biotrax International, Inc. ("Biotrax") and NMC Diagnostics, Inc., ("DSI") both of which are subsidiaries of NMC, received an investigative subpoena from the OIG. The subpoena calls for the production of extensive documents and was issued in connection with an investigation being conducted by the OIG in conjunction with the U.S. Attorney for the Eastern District of Pennsylvania concerning the possible submission of false or improper claims to, and their payment by, the Medicare program. The subpoena calls for the production of documents on corporate organization, business plans, document retention, personnel files, sales and marketing and Medicare billing issues relating to certain procedures offered by the prior owner of the Biotrax business before its assets were acquired by NMC in March 1994 and by DSI following the acquisition. The Company has reviewed the subpoena with its legal counsel and has made extensive document production in response to the subpoena. The Company and the government have been negotiating a resolution to this matter, and negotiations have progressed to the point of a possible settlement. The Company and the government have reached an agreement in principle in which, among other things, the government has agreed to release the Company from liability in this matter in exchange for a payment of approximately $16.5 million from the Company. The Company and the government are currently negotiating the terms of a settlement agreement. The agreement is not final. For this reason, the eventual outcome of this matter, its duration, and its effect, if any, on NMC or the Company cannot be predicted at this time. The Company divested Non-Renal Diagnostic services on June 26, 1998. See Note 8 - "Discontinued Operations." 101 102 MEDICAL DIRECTOR COMPENSATION The government is investigating whether Dialysis Services' compensation arrangements with its Medical Directors constitute payments to induce referrals, which would be illegal under the anti-kickback statutes, rather than payment for services rendered. Dialysis Services compensated the substantial majority of its Medical Directors on the basis of a percentage of the earnings of the dialysis center for which the Medical Director was responsible from the inception of NMC's predecessor in 1972 until January 1, 1995, the effective date of Stark II. Under the arrangements in effect prior to January 1, 1995, the compensation paid to Medical Directors was adjusted to include "add backs," which represented a portion of the profit earned by NMC's Medical Products Group ("MPG") on products purchased by the Medical Director's facility from MPG and (until January 1, 1992) a portion of the profit earned by LifeChem on laboratory services provided to patients at the Medical Director's facility. These adjustments were designed to allocate a profit factor to each dialysis center relating to the profits that could have been realized by the center if it had provided the items and services directly rather than through a subsidiary of NMC. The percentage of profits paid to any specific Medical Director was reached through negotiation, and was typically a provision of a multi-year consulting agreement. To comply with provisions of OBRA 93 (as hereafter defined) known as "Stark II" if Designated Health Services (as defined in Stark II) are involved, Medical Director compensation must not exceed fair market value and may not take into account the volume or value of referrals or other business generated between the parties. Since January 1, 1995, Dialysis Services has compensated its Medical Directors on a fixed compensation arrangement intended to comply with the requirements of Stark II. In renegotiating its Medical Director compensation arrangements in connection with Stark II, Dialysis Services took and continues to take account of the compensation levels paid to its Medical Directors in prior years. Certain government representatives have expressed the view in meetings with counsel for NMC that arrangements where the Medical Director was or is paid amounts in excess of the "fair market value" of the services rendered may evidence illegal payments to induce referrals, and that hourly compensation is a relevant measure for evaluating the "fair market value" of the services. Dialysis Services does not compensate its Medical Directors on an hourly basis and has asserted to the government that hourly compensation is not a determinative measure of fair market value. Although the Company believes that the compensation paid to its Medical Directors is generally reflective of fair market value, there can be no assurances that the government will agree with this position or that the Company ultimately will be able to defend its position successfully. Because of the wide variation in local market factors and in the profit percentage contractually negotiated between Dialysis Services and its Medical Directors prior to January 1, 1995, there is a wide variation in the amounts that have been paid to Medical Directors. As a result, the compensation that Dialysis Services has paid and is continuing to pay to a material number of its Medical Directors could be viewed by the government as being in excess of "fair market value," both in absolute terms and in terms of hourly compensation. NMC has asserted to the government that its compensation arrangements do not constitute illegal payments to induce referrals. NMC has also asserted to the government that OIG auditors repeatedly reviewed NMC's compensation arrangements with its Medical Directors in connection with their audits of the costs claimed by Dialysis Services; that the OIG stated in its audit reports that, with the exception of certain technical issues, NMC had complied with applicable Medicare laws and regulations pertaining to the ESRD program; and that NMC reasonably relied on these audit reports in concluding that its program for compensating Medical Directors was lawful. There has been no indication that the government will accept NMC's assertions concerning the legality of its arrangements generally or NMC's assertion that it reasonably relied on OIG audits, or that the government will not focus on specific arrangements that DSD has made with one or more Medical Directors and assert that those specific arrangements were or are unlawful. The government is also investigating whether Dialysis Services' profit sharing arrangements with its Medical Directors influenced them to order unnecessary ancillary services and items. NMC has asserted to the government that the rate of utilization of ancillary services and items by its Medical Directors is reasonable and that it did not provide illegal inducements to Medical Directors to order ancillary services and items. 102 103 CREDIT BALANCES In the ordinary course of business, medical service providers like Dialysis Services receive overpayments from Medicare intermediaries and other payors for services that they provide to patients. Medicare intermediaries commonly direct such providers to notify them of the overpayment and not remit such amounts to the intermediary by check or otherwise unless specifically requested to do so. In 1992, the Health Care Financing Administration ("HCFA") adopted a regulation requiring certain Medicare providers, including dialysis centers, to file a quarterly form listing unrecouped overpayments with the Medicare intermediary responsible for reimbursing the provider. The first such filing was required to be made as of June 30, 1992 for the period beginning with the initial date that the provider participated in the Medicare program and ending on June 30, 1992. The government is investigating whether Dialysis Services intentionally understated the Medicare credit balance reflected on its books and records for the period ending June 30, 1992 by reversing entries out of its credit balance account and taking overpayments into income in anticipation of the institution of the new filing requirement. Dialysis Services' policy was to notify Medicare intermediaries in writing of overpayments upon receipt and to maintain unrecouped Medicare overpayments as credit balances on the books and records of Dialysis Services for four years; overpayments not recouped by Medicare within four years would be reversed from the credit balance account and would be available to be taken into income. NMC asserts that Medicare overpayments that have not been recouped by Medicare within four years are not subject to recovery under applicable regulations and that its initial filing with the intermediaries disclosed the credit balance on the books and records of Dialysis Services as shown in accordance with its policy, but there can be no assurance that the government will accept NMC's views. The government has inquired whether other divisions including Homecare, LifeChem and DSI have appropriately treated Medicare credit balances as well as credit balances of other payors. The government is also investigating whether Dialysis Services failed to disclose Medicare overpayments that resulted from Dialysis Services' obligation to rebill commercial payors for amounts originally billed to Medicare under HCFA's initial implementation of the Omnibus Budget Reconciliation Act of 1993 ("OBRA 93") amendments to the secondary payor provisions of the Medicare Act. Dialysis Services experienced delays in reporting a material amount of overpayments after the implementation of the OBRA 93 amendments. NMC asserts that most of these delays were the result of the substantial administrative burdens placed on Dialysis Services as a consequence of the changing and inconsistent instructions issued by HCFA with respect to the OBRA 93 amendments and were not intentional. Substantially all overpayments resulting from the rebilling effort associated with the OBRA 93 amendments have now been reported. Procedures are in place that are designed to ensure that subsequent overpayments resulting from the OBRA 93 amendments will be reported on a timely basis. SUPPLEMENTAL MEDICAL INSURANCE Dialysis Services provided grants or loans for the payment of premiums for supplemental medical insurance (under which Medicare Part B coverage is provided) on behalf of a small percentage of its patients who are financially needy. The practice of providing loans or grants for the payment of supplemental medical insurance premiums by NMC was one of the subjects of review by the government as part of the OIG Investigation. The Government, however, advised the Company orally that it is no longer pursuing this issue. Furthermore, as a result of the passage of HIPAA, the Company terminated making such payments on behalf of its patients. Instead, the Company, together with other representatives of the industry, obtained an advisory opinion from the OIG, whereby, consistent with specified conditions, the Company and other similarly situated providers may make contributions to a non-profit organization that has volunteered to make these payments on behalf of indigent ESRD patients, including patients of the Company. In addition, the government has indicated that it is investigating the method by which NMC made Medigap payments on behalf of its indigent patients. 103 104 OVERPAYMENTS FOR HOME DIALYSIS SERVICES NMC acquired Home Intensive Care, Inc. ("HIC"), an in-center and home dialysis service provider, in 1993. At the time of the acquisition, HIC was the subject of a claim by HCFA that HIC had received payments for home dialysis services in excess of the Medicare reasonable charge for services rendered prior to February 1, 1990. NMC settled the HCFA claim against HIC in 1994. The government is investigating whether the settlement concerning the alleged overpayments made to HIC resolved all issues relating to such alleged overpayments. The government is also investigating whether an NMC subsidiary, Home Dialysis Services, Inc. ("HDS"), received payments similar to the payments that HIC received, and whether HDS improperly billed for home dialysis services in excess of the monthly cost cap for services rendered on or after February 1, 1990. The government is investigating whether NMC was overpaid for services rendered. NMC asserts that the billings by HDS were proper, but there can be no assurance that the government will accept NMC's view. LIFECHEM Overpayments. On September 22, 1995, LifeChem voluntarily disclosed certain billing problems to the government that had resulted in LifeChem's receipt of approximately $4.9 million in overpayments from the Medicare program for laboratory services rendered between 1989 and 1993. LifeChem asserts that most of these overpayments relate to errors caused by a change in LifeChem's computer systems and that the remainder of the overpayments were the result of the incorrect practice of billing for a complete blood count with differential when only a complete blood count was ordered and performed, and of the incorrect practice of billing for a complete blood count when only a hemoglobin or hematocrit test was ordered. LifeChem asserts that the overpayments it received were not caused by fraudulent activity, but there can be no assurance that the government will accept LifeChem's view. LifeChem made these disclosures to the government as part of an application to be admitted to a voluntary disclosure program begun by the government in mid-1995. At the time of the disclosures, LifeChem tendered repayment to the government of the $4.9 million in overpayments. After the OIG Investigation was announced, the government indicated that LifeChem had not been accepted into its voluntary disclosure program. The government has deposited the $4.9 million check with NMC's approval. The matters disclosed in LifeChem's September 22, 1995 voluntary disclosure are a subject of the OIG Investigation. On June 7, 1996, LifeChem voluntarily disclosed an additional billing problem to the government that had resulted in LifeChem's receipt of between $40,000 and $160,000 in overpayments for laboratory services rendered in 1991. LifeChem advised the government that this overpayment resulted from the submission for payment of a computer billing tape that had not been subjected to a "billing rules" program designed to eliminate requests for payments for laboratory tests that are included in the Composite Rate and that were not eligible for separate reimbursement. LifeChem also advised the government that there may have been additional instances during the period from 1990 to 1992 when other overpayments were received as a result of the submission of computer billing tapes containing similar errors and that it was in the process of determining whether such additional overpayments were received. On June 21, 1996, LifeChem advised the government that the 1991 billing problem disclosed on June 7, 1996 resulted in an overpayment of approximately $112,000. LifeChem also advised the government that certain records suggested instances in July 1990 and August 31 through September 11, 1990, when billing tapes may have been processed without rules processing. LifeChem continued its effort to determine whether any other overpayments occurred relating to the "billing rules" problem and, in March 1997, advised the government that an additional overpayment of approximately $260,000 was made by Medicare. Capitation for routine tests and panel design. In October 1994, the OIG issued a special fraud alert in which it stated its view that the industry practice of offering to perform or performing the routine tests covered by the composite rate payment method (the "Composite Rate") at a price below fair market value, coupled with an agreement by a dialysis center to refer all or most of its non-Composite Rate tests to the laboratory, violates the anti-kickback statutes. In response to this alert, LifeChem changed its practices with respect to testing covered by the Composite Rate to increase the amount charged to both Dialysis Services and third- 104 105 party dialysis centers and reduce the number of tests provided for the fixed rate. The government is investigating LifeChem's practices with respect to these tests. Benefits provided to dialysis centers and persons associated with dialysis centers. The government is investigating whether Dialysis Services or any third-party dialysis center or any person associated with any such center was provided with benefits in order to induce them to use LifeChem services. Such benefits could include, for example, discounts on products or supplies, the provision of computer equipment, the provision of money for the purchase of computer equipment, the provision of research grants and the provision of entertainment to customers. NMC has identified certain instances in which benefits were provided to customers who purchased medical products from NMC Medical Products, Inc., NMC's products company, and used LifeChem's laboratory services. The government may assert that the provision of such benefits violates, among other things, the anti-kickback statutes. In December 1998, the former Vice President of Sales responsible for NMC's laboratory and products divisions plead guilty to the payment of illegal kickbacks to obtain laboratory business for NMC. In February 1999, the former President of NMC Medical Products, Inc. was indicted by the government for the payment of these same and/or similar kickbacks. Business and testing practices. As noted above, the government has identified a number of specific categories of documents that it is requiring NMC to produce in connection with LifeChem business and testing practices. In addition to documents relating to the areas discussed above, the government has also required LifeChem to produce documents relating to the equipment and systems used by LifeChem in performing and billing for clinical laboratory blood tests, the design of the test panels offered and requisition forms used by LifeChem, the utilization rate for certain tests performed by LifeChem, recommendations concerning diagnostic codes to be used in ordering tests for patients with given illnesses or conditions, internal and external audits and investigations relating to LifeChem's billing and testing. Subsequently, the government served an investigative subpoena for documents concerning the Company's 1997 review of dialysis facilities' standing orders, and responsive documents were provided. Recently the government served investigative subpoenas requiring NMC to update its production on the above issues and to produce contract files for twenty-three identified dialysis clinic customers. The government is investigating each of these areas, and asserts that LifeChem and/or NMC have violated the False Claims Act and/or the Anti-Kickback Statute through the test ordering, paneling, requisitioning, utilization, coding, billing and auditing practices described above. INTRADIALYTIC PARENTERAL NUTRITION Administration kits. One of the activities of SRM is to provide IDPN therapy to dialysis patients at both NMC-owned facilities and at facilities owned by other providers. IDPN therapy was provided by Homcare prior to its divestiture IDPN therapy is typically provided to the patient 12-13 times per month during dialysis treatment. Bills are submitted to Medicare on a monthly basis and include separate claims for reimbursement for supplies, including, among other things, nutritional solutions, administration kits and infusion pumps. In February 1991, the Medicare carrier responsible for processing Homecare's IDPN claims issued a Medicare advisory to all parenteral and enteral nutrition suppliers announcing a coding change for reimbursement of administration kits provided in connection with IDPN therapy for claims filed for items provided on or after April 1, 1991. The Medicare allowance for administration kits during this period was approximately $625 per month per patient. The advisory stated that IDPN providers were to indicate the "total number of actual days" when administration kits were "used," instead of indicating that a one-month supply of administration kits had been provided. In response, Homecare billed for administration kits on the basis of the number of days that the patient was on an IDPN treatment program during the billing period, which typically represented the entire month, as opposed to the number of days the treatment was actually administered. During the period from April 1991 to June 1992, Homecare had an average of approximately 1,200 IDPN patients on service. In May 1992, the carrier issued another Medicare advisory to all PEN suppliers in which it stated that it had come to the carrier's attention that some IDPN suppliers had not been prorating their billing for administration kits used by IDPN patients and that providers should not bill for administration kits on the basis of the number of days that the patient was on an IDPN treatment program during the billing period. The advisory stated further that the carrier would be conducting "a special study to determine whether or not overpayments have occurred as a result of incorrect billing" and that "if overpayments have resulted, 105 106 providers that have incorrectly billed" would "be contacted so that refunds can be recovered." Homecare revised its billing practices in response to this advisory for claims filed for items provided on or after July 1, 1992. Homecare was not asked to refund any amounts relating to its billings for administration kits following the issuance of the second advisory. The government asserts that NMC submitted false claims for administration kits during the period from 1988 to June 30, 1996, and that Homecare's billing for administration kits during this period violated, among other things, the False Claims Act. Infusion Pumps and IV Poles. During the time period covered by the subpoenas, Medicare regulations permitted IDPN providers to bill Medicare for the infusion pumps and, until 1992, for IV poles provided to IDPN patients in connection with the administration of IDPN treatments. These regulations do not expressly specify that a particular pump and IV pole be dedicated to a specific patient, and NMC asserts that these regulations permitted Homecare to bill Medicare for an infusion pump and IV pole so long as the patient was infused using a pump and IV pole. Despite the absence of an express regulatory specification, Homecare developed a policy to deliver to a dialysis center a dedicated infusion pump and IV pole for each patient, although the Company cannot represent that Homecare followed this policy in every instance. The government is investigating the propriety of Homecare's billings for infusion pumps and IV poles and asserts that Homecare's billings violate the False Claims Act. As noted above, under the new policies published by HCFA with respect to IDPN therapy, the Company has not been able to bill for infusion pumps after July 1, 1996. The government discontinued reimbursement for IV poles in 1992. "Hang fees" and other payments. IDPN therapy is typically provided to the patient during dialysis by personnel employed by the dialysis center treating the patient with supplies provided and billed to Medicare by Homecare in accordance with the Medicare parenteral nutrition supplier rules. In order to compensate dialysis centers for the costs incurred in administering IDPN therapy and monitoring the patient during therapy, Homecare followed the practice common in the industry of paying a "hang fee" to the center. Dialysis centers are responsible for reporting such fees to HCFA on their cost reports. For Dialysis Services dialysis centers, the fee was $30 per administration, based upon internal Dialysis Services cost calculations. For third-party dialysis centers, the fee was negotiated with each center, typically pursuant to a written contract, and ranged from $15 to $65 per administration. The Company has identified instances in which other payments and amounts beyond that reflected in a contract were paid to these third-party centers. The Company has stopped paying "hang fees" to both Dialysis Services and third-party facilities. In July 1993, the OIG issued a management advisory alert to HCFA in which it stated that "hang fees" and other payments made by suppliers of IDPN to dialysis centers "appear to be illegal as well as unreasonably high." The government is investigating the nature and extent of the "hang fees" and other payments made by Homecare as well as payments by Homecare to physicians whose patients have received IDPN therapy. The government may assert that the payments by Homecare to dialysis centers violate, among other things, the anti-kickback statutes. Utilization of IDPN. Since 1984, when HCFA determined that Medicare should cover IDPN and other parenteral nutrition therapies, the Company has been an industry leader in identifying situations in which IDPN therapy is beneficial to end-stage renal disease ("ESRD") patients. It is the policy of the Company to seek Medicare reimbursement for IDPN therapy only when it is prescribed by a patient's treating physician and when it believes that the circumstances satisfy the requirements published by HCFA and its carrier agents. Prior to 1994, HCFA and its carriers approved for payment more than 90% of the IDPN claims submitted by Homecare. After 1993, the rate of approval for Medicare reimbursement for IDPN claims submitted by Homecare for new patients and by the infusion industry in general, fell to approximately 9%. The Company contends that the reduction in rates of approval occurred because HCFA and its carriers implemented an unauthorized change in coverage policy without giving notice to providers. While NMC continued to offer IDPN to patients pursuant to the prescription of the patients' treating physicians and to submit claims for Medicare reimbursement when it believed the requirements stated in HCFA's published regulations were satisfied, other providers responded to the drop in the approval rate for new Medicare IDPN patients by 106 107 abandoning the Medicare IDPN business, cutting back on the number of Medicare patients to whom they provide IDPN, or declining to add new Medicare patients. Beginning in 1994 the number of patients to whom NMC provided IDPN increased as a result. The government is investigating the utilization rate of IDPN therapy among NMC patients, whether NMC submitted IDPN claims to Medicare for patients who were not eligible for coverage, and whether documentation of eligibility was adequate. NMC asserts that the utilization rate of IDPN therapy among its dialysis patients, which, in 1995, averaged less than 3.5%, is the result of the factors discussed above and that it is the policy of Homecare to seek Medicare reimbursement for IDPN therapy prescribed by the patients' treating physician in accordance with the requirements published by HCFA and its carrier agents. There can be no assurance that the government will accept NMC's view. The government asserts that Homecare submitted IDPN claims for individuals who were not eligible for coverage and/or with inadequate documentation of eligibility. The Company believes that it has presented to the government substantial defenses which support NMC's interpretation of coverage rules of IDPN as HCFA and its carriers published and explained them, and which demonstrated that HCFA and its carriers improperly implemented unpublished, more restrictive criteria after 1993. Nevertheless, the government is expected to assert in the OIG Investigation that, on a widespread basis, NMC submitted and received payments on claims for IDPN to Medicare for patients who were not eligible for coverage, and for whom the documentation of eligibility was inadequate. In addition, the government asserts that, in a substantial number of cases, documentation of eligibility was false or inaccurate. With respect to some claims, the Company has determined that false or inaccurate documentation was submitted, deliberately or otherwise. The government continues to investigate the IDPN claims. QUI TAM ACTIONS The Company and NMC have become aware that nine qui tam actions have been filed in various jurisdictions. Each of these actions is under seal and in each action, pursuant to court order the seal has been modified to permit the Company, NMC and other affiliated defendants to disclose the complaint to any relevant investors, financial institutions and/or underwriters, their successors and assigns and their respective counsel and to disclose the allegations in the complaints in their respective U.S. Securities and Exchange Commission (the "SEC" or the "Commission") and New York Stock Exchange ("NYSE") periodically required filings. The first qui tam action was filed in the United States District Court for the Southern District of Florida in 1996, amended on July 8, 1996 and disclosed to the Company on July 10, 1996. It alleges, among other things, that Grace Chemicals and NMC violated the False Claims Act in connection with certain billing practices regarding IDPN and the administration of EPO and that as a result of this allegedly wrongful conduct, the United States suffered actual damages in excess of $200 million. The Amended Complaint also seeks the imposition of a constructive trust on the proceeds of the NMC dividend to Grace Chemicals for the benefit of the United States on the ground that the Merger constitutes a fraudulent conveyance that will render NMC unable to satisfy the claims asserted in the Amended Complaint. The second qui tam action was filed in the United States District Court for the Middle District of Florida in 1995 and disclosed to the Company on or before November 7, 1996. It alleges, among other things, that NMC and certain NMC subsidiaries violated the False Claims Act in connection with the alleged retention of over-payments made under the Medicare program, the alleged submission of claims in violation of applicable cost caps and the payment of supplemental Medicare insurance premiums as an alleged inducement to patients to obtain dialysis products and services from NMC. The complaint alleges that as a result of this allegedly wrongful conduct, the United States suffered damages in excess of $10 million including applicable fines. The third qui tam action was filed in the United States District Court for the Eastern District of Pennsylvania in February 1996 and was disclosed to the Company in November 1996. It alleges, among 107 108 other things, that a pharmaceutical manufacturer, an unaffiliated dialysis provider and NMC violated the False Claims Act in connection with the submission of claims to the Medicare program for a nonsterile intravenous drug and for intravenous drugs which were allegedly billed in excess of permissible Medicare reimbursement rates. The complaint also asserts that the defendants violated the Medicare and Medicaid anti-kickback statutes in connection with the receipt of discounts and other in kind payments as alleged inducements to purchase intravenous drugs. The complaint is focused on the business relationship between the pharmaceutical manufacturer and several providers, one of which is NMC. The complaint asserts that as a result of this allegedly wrongful conduct, the United States suffered damages. On June 28, 1997, in response to relator's motion to dismiss and the United States' declination to intervene, the District Court ordered the complaint dismissed without prejudice. The fourth qui tam action was filed in the United States District Court for the Eastern District of Pennsylvania in May 1995 and was disclosed to the Company in August 1997. It alleges, among other things, that Biotrax violated the False Claims Act in connection with its submission of claims to the Medicare program for diagnostic tests and induced overutilization of such tests in the medical community through improper marketing practices also in violation of the False Claims Act. The fifth qui tam action was filed in the United States District Court for the Eastern District of Pennsylvania in August 1996 and was disclosed to the Company in August 1997. It alleges, among other things, that Biotrax and NMC Diagnostic Services induced overutilization of diagnostic tests by several named and unnamed physician defendants in the local medical community, through improper marketing practices and fee arrangements, in violation of the False Claims Act. The sixth qui tam action was filed in the United States District Court for the Eastern District of Pennsylvania in November 1996 and was disclosed to the Company in August 1997. It alleges, among other things, that NMC, DSI and Biotrax violated the False Claims Act in connection with the submission of claims to the Medicare program by improperly upcoding and otherwise billing for various diagnostic tests. The seventh qui tam action was filed in the United States District Court for the District of Delaware in January 1997 and was disclosed to the Company in September 1997. It alleges, among other things, that NMC and Biotrax violated the False Claims Act in connection with the submission of claims to the Medicare program for diagnostic tests, and induced overutilization of such tests through improper marketing practices which provided impermissible incentives to health care providers to order these tests. The eighth qui tam action was filed in the United States District Court for the District of New Jersey in February 1997 and was disclosed to the Company in September 1997. It alleges, among other things, that DSI and NMC violated the False Claims Act in connection with the submission of claims to the Medicare program for reimbursement for diagnostic tests, by causing unnamed physicians to overutilize these tests though a variety of fee arrangements and other impermissible inducements. The ninth qui tam was filed in the United States District Court for the District of Massachusetts in 1994 and was disclosed to the Company in February 1999. It alleges among other things that NMC violated the False Claims Act and the Anti-Kickback Statute in connection with certain billing and documentation practices regarding IDPN therapy, home oxygen therapy and certain medical billings in NMC's Chicago office. Each of the qui tam complaints asserts that as a result of the allegedly wrongful conduct, the United States suffered damages and that the defendants are liable to the United States for three times the amount of the alleged damages plus civil penalties of up to $10,000 per false claim. An adverse result in any of the qui tam actions could have a material adverse affect on the Company's business, financial condition or results of operations. 108 109 OIG AGREEMENTS As a result of discussions with representatives of the United States in connection with the OIG Investigation, certain agreements (the "OIG Agreements") have been entered into to guarantee the payment of any obligations of NMC to the United States (an "Obligation") relating to or arising out of the OIG Investigation and the qui tam action filed in the Southern District of Florida (the "Government Claims"). For the purposes of the OIG Agreements, an Obligation is (a) a liability or obligation of NMC to the United States in respect of a Government Claim pursuant to a court order (i) which is final and nonappealable or (ii) the enforcement of which has not been stayed pending appeal or (b) a liability or obligation agreed to be an Obligation in a settlement agreement executed by Fresenius Medical Care, the Company or NMC, on the one hand, and the United States, on the other hand. As stated elsewhere herein, the outcome of the OIG Investigation cannot be predicted. Pursuant to the OIG Agreements, upon consummation of the Merger, Fresenius Medical Care, the Company and NMC provided the United States with a joint and several unconditional guarantee of payment when due of all Obligations (the "Primary Guarantee"). As credit support for this guarantee, NMC delivered an irrevocable standby letter of credit in the amount of $150 million. The United States will return such letter of credit (or any renewal or replacement) for cancellation when all Obligations have been paid in full or it is determined that NMC has no liability in respect of the Government Claims. Under the terms of the Merger, any potential resulting monetary liability has been retained by NMC, and the Company has indemnified Grace Chemicals against all potential liability arising from or relating to the OIG Investigation. Fresenius Medical Care and the United States state in the OIG Agreements that they will negotiate in good faith to attempt to arrive at a consensual resolution of the Government Claims and, in the context of such negotiations, will negotiate in good faith as to the need for any restructuring of the payment of any Obligations arising under such resolution, taking into account the ability of Fresenius Medical Care to pay the Obligations. The OIG Agreements state that the foregoing statements shall not be construed to obligate any person to enter into any settlement of the Government Claims or to agree to a structured settlement. Moreover, the OIG Agreements state that the statements described in the first sentence of this paragraph are precatory and statements of intent only and that (a) compliance by the United States with such provisions is not a condition or defense to the obligations of Fresenius Medical Care under the OIG Agreements and (b) breach of such provisions by the United States cannot and will not be raised by Fresenius Medical Care to excuse performance under the OIG Agreements. Neither the entering into of the OIG Agreements nor the providing of the Primary Guarantee and the $150 million letter of credit is an admission of liability by any party with respect to the OIG Investigation, nor does it indicate the liability, which may result therefrom. The foregoing describes the material terms of the OIG Agreements, copies of which were previously filed with the Commission and copies of which may be examined without charge at the public reference facilities maintained by the Commission at Room 1024, 450 Fifth Street, N.W. Washington, D.C. 20549, and at the Regional Offices of the Commission located at Suite 1400, Citicorp Center, 500 West Madison Street, Chicago, Illinois 60661-2551 and Room 1300, 7 World Trade Center, New York, New York 10048. Copies of such material will also be made available by mail from the Public Reference Branch of the Commission at 450 Fifth Street, N.W. Washington, D.C. 20549, at prescribed rates. The foregoing description does not purport to be complete and is qualified in its entirety by reference to such agreements. An adverse determination with respect to any of the issues addressed by the subpoenas, or any of the other issues that have been or may be identified by the government, could result in the payment of substantial fines, penalties and forfeitures, the suspension of payments or exclusion of the Company or one or more of its subsidiaries from the Medicare program and other federal programs, and changes in billing and other practices that could adversely affect the Company's revenues. Any such result could have a material adverse effect on the Company's business, financial condition and results of operations. OMNIBUS BUDGET RECONCILIATION ACT OF 1993 OBRA 93 affected the payment of benefits under Medicare and employer health plans for certain eligible ESRD patients. In July 1994, HCFA issued an instruction to Medicare claims processors to the 109 110 effect that Medicare benefits for the patients affected by OBRA 93 would be subject to a new 18-month "coordination of benefits" period. This instruction had a positive impact on NMC's dialysis revenues because, during the 18-month coordination of benefits period, patients' employer health plans were responsible for payment, which was generally at rates higher than that provided under Medicare. In April 1995, HCFA issued a new instruction, reversing its original instruction in a manner that would substantially diminish the positive effect of the original instruction on NMC's dialysis business. HCFA further proposed that its new instruction be effective retroactive to August 1993, the effective date of OBRA 93. NMC ceased to recognize the incremental revenue realized under the original Program Memorandum as of July 1, 1995, but it continued to bill employer health plans as primary payors for patients affected by OBRA 93 through December 31, 1995. As of January 1, 1996, NMC commenced billing Medicare as primary payor for dual eligible ESRD patients affected by OBRA 93, and then began to rebill in compliance with the revised policy for services rendered between April 24 and December 31, 1995. On May 5, 1995, NMC filed a complaint in the U.S. District Court for the District of Columbia (National Medical Care, Inc. and Bio-Medical Applications of Colorado, Inc. d/b/a Northern Colorado Kidney Center v. Shalala, C.A. No. 95-0860 (WBB)) seeking to preclude HCFA from retroactively enforcing its April 24, 1995 implementation of the OBRA 93 provisions relating to the coordination of benefits for dual eligible ESRD patients. On May 9, 1995, NMC moved for a preliminary injunction to preclude HCFA from enforcing its new policy retroactively, that is, to billings for services provided between August 10, 1993 and April 23, 1995. On June 6, 1995, the court granted NMC's request for a preliminary injunction and in December of 1996, NMC moved for partial summary judgment seeking a declaration from the Court that HCFA's retroactive application of the April 1995 rule was legally invalid. HCFA cross-moved for summary judgment on the grounds that the April 1995 rule was validly applied prospectively. In January 1998, the court granted NMC's motion for partial summary judgment and entered a declaratory judgment in favor of NMC, holding HCFA's retroactive application of the April 1995 rule legally invalid, and based on its finding, the Court also permanently enjoined HCFA from enforcing and applying the April 1995 rule retroactively against NMC. The Court took no action on HCFA's motion for summary judgment pending completion of outstanding discovery. On October 5, 1998 NMC filed it's own motion for summary judgment requesting that the Court declare HCFA's prospective application of the April 1995 rule invalid and permanently enjoin HCFA from prospectively enforcing and applying the April 1995 rule. The Court has not yet ruled on the parties' motions. The Company believes that the Court's favorable rulings to date provide a stronger legal basis for NMC to collect outstanding amounts from commercial payors on the retroactive portion of the case during the first half of 1998. HCFA elected not to appeal from the Court's June 1995 and January 1998 orders. HCFA may, however, appeal all rulings at the conclusion of the litigation. If HCFA should successfully appeal so that the revised interpretation would be applied retroactively Dialysis Services may be required to refund the payments received from employer health plans for services provided after August 10, 1993 under HCFA's original implementation, and to re-bill Medicare for the same services, which would result in a net loss to Dialysis Services of approximately $120 million attributable to all periods prior to December 31, 1995. Also, in such event, the Company's business, financial position and results of operations would be materially adversely affected. INTRADIALYTIC PARENTERAL NUTRITION COVERAGE ISSUES SRM administers IDPN therapy to chronic dialysis patients who suffer from severe gastrointestinal malfunctions. IDPN therapy was provided by Homecare prior to its divestiture After 1993, Medicare claims processors sharply reduced the number of IDPN claims approved for payment as compared to prior periods. NMC believes that the reduction in IDPN claims represented an unauthorized policy coverage change. Accordingly, NMC and other IDPN providers pursued various administrative and legal remedies, including administrative appeals, to address this reduction. In November 1995, NMC filed a complaint in the U.S. District Court for the Middle District of Pennsylvania seeking a declaratory judgment and injunctive relief to prevent the implementation of this policy coverage change. (National Medical Care, Inc. v. Shalala, 3:CV-95-1922 (RPC)). Subsequently, the 110 111 District Court affirmed a prior report of the magistrate judge dismissing NMC's complaint, without considering any substantive claims, on the grounds that the underlying cause of action should be submitted fully to the administrative review processes available under the Medicare Act. NMC decided not to appeal the Court's decision, but rather, to pursue the claims through the available administrative processes. NMC was successful in pursuing these claims through the administrative process, receiving favorable decisions from Administrative Law Judges in more than 80% of its cases. In early 1998, a group of claims which had been ruled on favorably were remanded by the Medical Appeals Council to a single Administrative Law Judge (the "ALJ") with extensive instructions concerning the review of these decisions. A hearing was scheduled on the remanded claims to take place in July, but later postponed until October 1998. Prior to the July hearing date, the United States Attorney for the District of Massachusetts requested that the hearing be stayed pending resolution of the OIG Investigation, on the basis that proceeding could adversely effect the government's investigation as well as the government's efforts to confirm its belief that these claims are false. Prior to the ALJ issuing a decision on the stay request, the U.S. Attorney's Office requested that NMC agree to a stay in the proceedings in order to achieve a potential resolution of the IDPN claims subject to the OIG Investigation as well as those which are subject to the administrative appeals process. NMC has agreed to this request, and together with the U.S. Attorney's Office has requested a stay. The ALJ has agreed to this request in order to allow the parties the opportunity to resolve both the IDPN claims which are the subject of the OIG Investigation and the IDPN claims which are the subject of the administrative proceedings. At this time, it is not possible to determine whether NMC and the government will be able to resolve issues surrounding the IDPN claims. Further proceedings on all other government appeals from the Administrative Law Judges' decisions favorable to the Company have also been stayed by agreement of the parties. Although NMC management believes that those IDPN claims were consistent with published Medicare coverage guidelines and ultimately will be approved for payment, there can be no assurance that the claims on appeal will be approved for payment. Such claims represent substantial accounts receivable of NMC, amounting to approximately $150 million as of December 31, 1998. If NMC is unable to collect its IDPN receivable, either through the administrative appeal process or through negotiation, or if IDPN coverage is reduced or eliminated, depending on the amount of the receivable that is not collected and/or the nature of the coverage change, the Company's business, financial condition and results of operations could be materially adversely affected. NMC's IDPN receivables are included in the net assets of the Company's discontinued operations. However, these receivables have not been sold and will remain classified as discontinued operations until they have been settled. See Notes to Consoliated Financial Statements Note 8 -"Discontinued Operations." OTHER LEGAL PROCEEDINGS DISTRICT OF NEW JERSEY INVESTIGATION NMC has received multiple subpoenas from a federal grand jury in the District of New Jersey investigating, among other things, whether NMC sold defective products, the manner in which NMC handled customer complaints and certain matters relating to the development of a new dialyzer product line. NMC is cooperating with this investigation and has provided the grand jury with extensive documents. In February, 1996, NMC received a letter from the U.S. Attorney for the District of New Jersey indicating that it is the target of a federal grand jury investigation into possible violations of criminal law in connection with its efforts to persuade the FDA to lift a January 1991 import hold issued with respect to NMC's Dublin, Ireland manufacturing facility. In June 1996, NMC received a letter from the U.S. Attorney for the District of New Jersey indicating that the U.S. Attorney had declined to prosecute NMC with respect to a submission related to NMC's effort to lift the import hold. The letter added that NMC remains a subject of a federal grand jury's investigation into other matters. NMC has produced documents in response to a June 1996 subpoena from the federal grand jury requesting certain documents in connection with NMC's imports of the FOCUS(R) dialyzer from January 1991 to November 1995. The 111 112 government investigators and the Company have narrowed the issues with respect to which the government has previously expressed concerns and recently have conducted discussions in order to resolve this investigation. However, the outcome and impact, if any, of these discussions and potential resolution on the Company's business, financial condition or results of operations cannot be predicted at this time. COMMERCIAL INSURER LITIGATION In 1997, the Company, NMC and certain named NMC subsidiaries were served with a civil complaint filed by Aetna Life Insurance Company in the U.S. District Court for the Southern District of New York (Aetna Life Insurance Company v. National Medical Care, Inc. et al, 97-Civ-9310). Based in large part on information contained in prior securities filings, the lawsuit alleges inappropriate billing practices for nutritional therapy, diagnostic and clinical laboratory tests and misrepresentations. The complaint seeks unspecified damages and costs. This matter is at a relatively early stage in the litigation process, with substantial discovery just beginning and its outcome and impact on the Company cannot be predicted at this time. However, the Company, NMC and its subsidiaries believe that they have substantial defenses to the claims asserted, and intend to continue to vigorously defend the lawsuit. It is also possible that one or more other private payors may assert that NMC received excess payments and similarly, may seek reimbursement and other damages from NMC. An adverse result could have a material adverse effect on the Company's business, financial condition or results of operations. ADMINISTRATIVE APPEALS The Company regularly pursues various administrative appeals relating to reimbursement issues in connection with its dialysis facilities. One such appeal consists of a challenge to the Medicare regulation which capped reimbursement for the bad debts incurred by dialysis facilities. In 1998, the United States Court of Appeals for the District of Columbia ruled in favor of the Company in connection with the bad debt issue, holding that the Secretary of Health & Human Services had not adequately justified the bad debt regulation, and ruling that the government's order adopting the rule was arbitrary and capricious. The Court of Appeals remanded the matter to the Secretary to provide a more adequate explanation of the bad debt cap or to abandon it. Subsequently, the Court modified its holding to continue the bad debt regulation in effect pending remand. The Company has recently begun settlement discussions with the government in an attempt to recover reimbursement for disallowed bad debt expenses. The Company cannot predict the outcome of these discussions. 112 113 NOTE 17. SIGNIFICANT RELATIONS For the periods presented, approximately 60% of the Company's health care services net revenues are paid by and subject to regulations under governmental programs, primarily Medicare and Medicaid. The Company maintains reserves for losses related to these programs, including uncollectible accounts receivable, and such losses have been within management's expectations. Revenues from EPO accounted for approximately 26% of the Dialysis Services net revenues for the twelve months ended December 31, 1998 and materially contribute to Dialysis Services' operating earnings. EPO is produced by a single source manufacturer, Amgen, Inc., and any interruption of supply could materially adversely affect the Company's business and results of operations. 113 114 NOTE 18. INDUSTRY SEGMENTS AND INFORMATION ABOUT FOREIGN OPERATIONS The Company adopted SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information during the fourth quarter of 1998. SFAS No. 131 established the standards for reporting information about operating statements in annual financial statements and requires selected information about operating segments in interim financial reports issued to stockholders. The Company's reportable segments are Dialysis Services and Dialysis Products. For purposes of segment reporting, the Dialysis Services division and Spectra Renal Management are combined and reported as Dialysis Services. These divisions are aggregated because of their similar economic classifications. These include the fact that they are both health care service providers whose services are provided to a common patient population, and both receive a significant portion of their net revenue from Medicare and other government and non government third party payors. The Dialysis Products segment reflects the activity of the Dialysis Products Division only. The accounting policies of the operating segments are the same as those described in the summary of significant accounting policies. The Company generally evaluates division operating performance based on Earnings Before Interest and Taxes (EBIT) but does use Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA) in some cases. The table below provides information for the years ended December 31, 1998 and 1997 and the three months ended December 31, 1996 on a successor basis and for the nine months ended September 30, 1996 on a predecessor basis pertaining to the Company's operations by geographic area.
UNITED STATES EUROPE OTHER TOTAL ------------- ------ ----- ----- NET REVENUES Twelve Months Ended 1998 $2,564,785 -- $ 6,621 $2,571,406 Twelve Months Ended 1997 2,156,622 -- 9,257 2,165,879 Three Months Ended 12/31/96 502,811 -- 2,560 505,371 Nine Months Ended 9/30/96 1,480,500 103,576 30,584 1,614,660 OPERATING EARNINGS Twelve Months Ended 1998 446,725 -- 1,013 447,738 Twelve Months Ended 1997 332,166 -- (123) 332,043 Three Months Ended 12/31/96 76,374 -- 380 76,754 Nine Months Ended 9/30/96 219,289 (12,277) (4,099) 202,913 Assets 1998 2,452,279 -- 9,584 2,461,863 1997 2,233,932 -- 12,239 2,240,171 1996 1,740,211 -- 16,260 1,756,471
The table below provides information for the years ended December 31, 1998 and 1997 and three months ended December 31, 1996 on a successor basis and the nine months ended September 30, 1996 on a predecessor basis pertaining to the Company's two industry segments. The predecossor basis has not been restated and includes results of operations of discontinued operations and international operations which were discontinued and transferred, respectively, on a successor basis.
LESS DIALYSIS DIALYSIS INTERSEGMENT SERVICES PRODUCTS SALES TOTAL -------- -------- ------------ ----- NET REVENUES Twelve Months Ended 1998 $2,133,314 $660,458 $222,366 $2,571,406 Twelve Months Ended 1997 1,770,212 626,397 230,730 2,165,879 Three Months Ended 12/31/96 406,680 165,674 66,983 505,371 Nine Months Ended 9/30/96 1,523,458 240,175 148,973 1,614,660 OPERATING EARNINGS Twelve Months Ended 1998 340,618 107,120 -- 447,738 Twelve Months Ended 1997 264,643 67,400 -- 332,043 Three Months Ended 12/31/96 67,318 9,436 -- 76,754 Nine Months Ended 9/30/96 169,715 33,198 -- 202,913 Assets Successor 1998 1,817,751 644,112 -- 2,461,863 1997 1,621,037 625,134 -- 2,246,171 1996 1,141,515 614,956 -- 1,756,471 CAPITAL EXPENDITURES Twelve Months Ended 1998 55,972 11,996 -- 67,968 Twelve Months Ended 1997 80,278 49,574 -- 129,852 Three Months Ended 12/31/96 27,472 5,486 -- 32,958 Nine Months Ended 9/30/96 89,684 2,198 -- 91,882 DEPRECIATION AND AMORTIZATION OF PROPERTIES AND EQUIPMENT Twelve Months Ended 1998 114,471 21,944 -- 136,415 Twelve Months Ended 1997 94,737 26,574 -- 121,311 Three Months Ended 12/31/96 21,305 8,444 -- 29,749 Nine Months Ended 9/30/96 82,217 5,303 -- 87,520
114 115 The table below provides the reconciliations of reportable segment operating earnings, assets, capital expenditures, and depreciation and amortization to the Company's consolidated totals.
TWELVE MONTHS TWELVE MONTHS THREE MONTHS NINE MONTHS SEGMENT RECONCILIATION ENDED 12/31/98 ENDED 12/31/97 ENDED 12/31/96 ENDED 9/30/96 ---------------------- -------------- -------------- -------------- ------------- INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES AND CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING FOR START UP COSTS: Total operating earnings for reportable segments $ 447,738 $ 332,043 $ 76,754 $202,913 Corporate G&A (including foreign exchange) (108,618) (70,240) (16,416) (55,598) Research and development expense (4,060) (4,077) (1,083) (1,906) Net interest expense (208,776) (178,086) (42,877) (16,326) ---------- ---------- ---------- -------- Income Before Income Taxes and cumulative effect of change in accounting for start up costs $ 126,284 $ 79,640 $ 16,378 $129,083 ========== ========== ========== ======== ASSETS: Total assets for reportable segments $2,461,863 $2,246,171 $1,756,471 Intangible assets not allocated to segments 2,067,648 2,002,656 1,891,079 Accounts receivable financing agreement (305,600) (200,000) (148,000) Net assets of discontinued operations 149,949 370,677 345,709 Other unallocated assets 239,543 351,682 525,228 ---------- ---------- ---------- Total Assets $4,613,403 $4,771,186 $4,370,487 ========== ========== ========== Capital Expenditures Total capital expenditures for reportable segments $ 67,968 $ 129,852 $ 32,958 $ 91,882 Corporate capital expenditures 6,685 3,892 1,058 971 ---------- ---------- ---------- -------- Total Capital Expenditures $ 74,653 $ 133,744 $ 34,016 $ 92,853 ========== ========== ========== ======== DEPRECIATION AND AMORTIZATION: Total depreciation and amortization for reportable segments $ 136,415 $ 121,311 $ 29,749 $ 87,520 Corporate depreciation and amortization 79,799 78,415 19,140 5,577 ---------- ---------- ---------- -------- Total Depreciation and Amortization $ 216,214 $ 199,726 $ 48,889 $ 93,097 ========== ========== ========== ========
115 116 NOTE 19. QUARTERLY SUMMARY (UNAUDITED)
SUCCESSOR -------------------------------------------------------------- 1ST QUARTER 2ND QUARTER 3RD QUARTER 4TH QUARTER ----------- ----------- ----------- ----------- 1998 Net revenues $610,046 $638,282 $655,652 $667,426 Cost of health care services and medical supplies 406,438 422,167 432,126 446,712 Operating expenses 136,824 132,626 135,609 123,844 Interest expense, net 47,099 53,080 54,880 53,717 -------- -------- -------- -------- Total expenses 590,361 607,873 622,615 624,273 -------- -------- -------- -------- Earnings from continuing operations before Income Taxes and cumulative effect of accounting policy change 19,685 30,409 33,037 43,153 Provision for Income Taxes 9,962 17,582 18,872 28,031 -------- -------- -------- -------- Net earnings from continuing operations before cumulative effect of accounting change $ 9,723 $ 12,827 $ 14,165 $ 15,122 ======== ======== ======== ======== SUCCESSOR -------------------------------------------------------------- 1ST QUARTER 2ND QUARTER 3RD QUARTER 4TH QUARTER ----------- ----------- ----------- ----------- 1997 Net revenues $503,059 $529,320 $547,678 $585,822 Cost of health care services and medical supplies 344,635 342,065 368,122 401,582 Operating expenses 105,033 117,991 112,427 116,297 Interest expense, net 38,758 43,428 47,547 48,354 -------- -------- -------- -------- Total expenses 488,426 503,484 528,096 566,233 -------- -------- -------- -------- Earnings from continuing operations before Income Taxes 14,633 25,836 19,582 19,589 Provision for Income Taxes 7,749 14,940 9,775 13,256 -------- -------- -------- -------- Net earnings $ 6,884 $ 10,896 $ 9,807 $ 6,333 ======== ======== ======== ========
116 117 To the Board of Directors and Stockholders of Fresenius Medical Care Holdings, Inc. Under the date of February 11, 1999, we reported on the consolidated balance sheets of Fresenius Medical Care Holdings, Inc. and its subsidiaries (the "Company") as of December 31, 1998 and 1997 and the related consolidated statements of operations, comprehensive income, changes in equity and cash flows for the years ended December 31, 1998 and 1997 and the period October 1, 1996 to December 31, 1996, the successor periods and the period January 1, 1996 to September 30, 1996, the predecessor period, as included in the annual report on Form 10-K for the year 1998. In connection with our audits of the aforementioned consolidated financial statements, we also audited the related consolidated financial statement schedules. These consolidated financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statement schedules based on our audits. In our opinion, such consolidated financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein. The audit report on the consolidated financial statements of the Company referred to above contains an explanatory paragraph that states that the Company was acquired as of September 30, 1996 in a business combination accounted for as a purchase. As a result of the acquisition, the consolidated financial statements for the successor period are presented on a different basis of accounting than that of the predecessor period, and therefore are not directly comparable. It is further explained that the predecessor period consolidated financial statements were prepared on the basis of presentation described in the notes to the consolidated financial statement and are not intended to be a complete presentation of the assets, liabilities, revenues and expenses of the Company. KPMG PEAT MARWICK LLP February 11, 1999 Boston, MA 117 118 SCHEDULE II FRESENIUS MEDICAL CARE HOLDINGS, INC. AND SUBSIDIARIES VALUATION AND QUALIFYING ACCOUNTS (DOLLARS IN THOUSANDS)
SUCCESSOR - FOR THE TWELVE MONTHS ENDED DECEMBER 31, 1998 ADDITIONS (DEDUCTIONS) ---------------------------- CHARGED BALANCE AT (CREDITED) TO BEGINNING OF COSTS AND BALANCE AT YEAR EXPENSES OTHER NET END OF PERIOD ------------ ------------- --------- ------------- DESCRIPTION Valuation and qualifying accounts deducted from assets: Allowances for notes and accounts receivable 53,109 54,709 (58,609) 49,209 Valuation allowance for deferred tax assets 3,368 1,972 -- 5,340 SUCCESSOR - FOR THE TWELVE MONTHS ENDED DECEMBER 31, 1997 ADDITIONS (DEDUCTIONS) ---------------------------- CHARGED BALANCE AT (CREDITED) TO BEGINNING OF COSTS AND BALANCE AT YEAR EXPENSES OTHER NET END OF PERIOD ------------ ------------- --------- ------------- DESCRIPTION Valuation and qualifying accounts deducted from assets: Allowances for notes and accounts receivable $ 56,491 $ 43,300 $(46,682) $ 53,109 Valuation allowance for deferred tax assets 14,140 (11,042) -- 3,368 SUCCESSOR - FOR THE THREE MONTHS ENDED DECEMBER 31, 1996 ADDITIONS (DEDUCTIONS) ---------------------------- CHARGED BALANCE AT (CREDITED) TO BEGINNING OF COSTS AND BALANCE AT YEAR EXPENSES OTHER NET END OF PERIOD ------------ ------------- --------- ------------- DESCRIPTION Valuation and qualifying accounts deducted from assets: Allowances for notes and accounts receivable $ 55,242 $ 7,526 $ (6,277) $ 56,491 Valuation allowance for deferred tax assets 19,500 12,219 (17,309) 14,410 PREDECESSOR - FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1996 ADDITIONS (DEDUCTIONS) ---------------------------- CHARGED BALANCE AT (CREDITED) TO BEGINNING OF COSTS AND BALANCE AT YEAR EXPENSES OTHER NET END OF PERIOD ------------ ------------- --------- ------------- DESCRIPTION Valuation and qualifying accounts deducted from assets: Allowances for notes and accounts receivable $119,914 $ 80,475 $(59,870) $140,519 Valuation allowance for deferred tax assets 19,500 -- -- 19,500
118 119 EXHIBIT INDEX EXHIBIT NO. DESCRIPTION - ----------- ----------- Exhibit 2.1 Agreement and Plan of Reorganization dated as of February 4, 1996 between W. R. Grace & Co. and Fresenius AG (incorporated herein by reference to Appendix A to the Joint Proxy Statement-Prospectus of Fresenius Medical Care AG, W. R. Grace & Co. and Fresenius USA, Inc. dated August 2, 1996 and filed with the Commission on August 5, 1996). Exhibit 2.2 Distribution Agreement by and among W. R. Grace & Co., W. R. Grace & Co.-Conn. and Fresenius AG dated as of February 4, 1996 (incorporated herein by reference to Exhibit A to Appendix A to the Joint Proxy Statement-Prospectus of Fresenius Medical Care AG, W. R. Grace & Co. and Fresenius USA, Inc. dated August 2, 1996 and filed with the Commission on August 5, 1996). Exhibit 2.3 Contribution Agreement by and among Fresenius AG, Sterilpharma GmbH and W. R. Grace & Co.-Conn. dated February 4, 1996 (incorporated herein by reference to Exhibit E to Appendix A to the Joint Proxy-Statement Prospectus of Fresenius Medical Care AG, W. R. Grace & Co. and Fresenius USA, Inc. dated August 2, 1996 and filed with the Commission on August 5, 1996). Exhibit 3.1 Certificate of Incorporation of Fresenius Medical Care Holdings, Inc. (f/k/a W. R. Grace & Co.) under Section 402 of the New York Business Corporation Law dated March 23, 1988 (incorporated herein by reference to the Form 8-K of the Company filed on May 9, 1988). Exhibit 3.2 Certificate of Amendment of the Certificate of Incorporation of Fresenius Medical Care Holdings, Inc. (f/k/a W. R. Grace & Co.) under Section 805 of the New York Business Corporation Law dated May 25, 1988 (changing the name to W. R. Grace & Co., incorporated herein by reference to the Form 8-K of the Company filed on May 9, 1988). Exhibit 3.3 Certificate of Amendment of the Certificate of Incorporation of Fresenius Medical Care Holdings, Inc. (f/k/a W. R. Grace & Co.) under Section 805 of the New York Business Corporation Law dated September 27, 1996 (incorporated herein by reference to the Form 8-K of the Company filed with the Commission on October 15, 1996). Exhibit 3.4 Certificate of Amendment of the Certificate of Incorporation of Fresenius Medical Care Holdings, Inc. (f/k/a W. R. Grace & Co.) under Section 805 of the New York Business Corporation Law dated September 27, 1996 (changing the name to Fresenius National Medical Care Holdings, Inc., incorporated herein by reference to the Form 8-K of the Company filed with the Commission on October 15, 1996). Exhibit 3.5 Certificate of Amendment of the Certificate of Incorporation of Fresenius Medical Care Holdings, Inc. under Section 805 of the New York Business Corporation Law dated June 12, 1997 (changing name to Fresenius Medical Care Holdings, Inc., incorporated herein by reference to the Form 10-Q of the Company filed with the Commission on August 14, 1997). Exhibit 3.6 Amended and Restated By-laws of Fresenius Medical Care Holdings, Inc. (incorporated herein by reference to the Form 10-Q of the Company filed with the Commission on August 14, 1997). Exhibit 4.1 Credit Agreement dated as of September 27, 1996 among National Medical Care, Inc. and Certain Subsidiaries and Affiliates, as Borrowers, Certain Subsidiaries and Affiliates, as Guarantors, the Lenders named therein, Nationsbank, N.A., as paying agent and the Bank of Nova Scotia, The Chase Manhattan Bank, Dresdner Bank AG and Nationsbank, N.A., as Managing Agents (incorporated herein by reference to the Form 6-K of Fresenius Medical Care AG filed with the Commission on October 15, 1996). Exhibit 4.2 Amendment dated as of November 26, 1996 (amendment to the Credit Agreement dated as of September 27, 1996, incorporated herein by reference to the Form 8-K of Registrant filed with the Commission on December 16, 1996). 119 120 Exhibit 4.3 Amendment No. 2 dated December 12, 1996 (second amendment to the Credit Agreement dated as of September 27, 1996, incorporated herein by reference to the Form 10-K of Registrant filed with the Commission on March 31, 1997). Exhibit 4.4 Amendment No. 3 dated June 13, 1997 to the Credit Agreement dated as of September 27, 1996 , among National Medical Care, Inc. and Certain Subsidiaries and Affiliates , as Borrowers, Certain Subsidiaries and Affiliates, as Guarantors, the Lenders named therein, NationsBank, N.A., as paying agent and the Bank of Nova Scotia, the Chase Manhattan Bank, N.A., Dresdner Bank AG and NationsBank, N.A. as Managing Agents, as previously amended (incorporated herein by reference to the Form 10-Q of the Registrant filed with the Commission on November 14, 1997). Exhibit 4.5 Amendment No. 4, dated August 26, 1997 to the Credit Agreement dated as of September 27, 1996, among National Medical Care, Inc. and Certain Subsidiaries and Affiliates, as Borrowers, Certain Subsidiaries and Affiliates, as Guarantors, the Lenders named therein, NationsBank, N.A., as paying agent and the Bank of Nova Scotia, the Chase Manhattan Bank, N.A., Dresdner Bank AG and NationsBank, N.A. as Managing Agents, as previously amended (incorporated herein by reference to the Form 10-Q of Registrant filed with Commission on November 14, 1997). Exhibit 4.6 Amendment No. 5 dated December 12, 1997 to the Credit Agreement dated as of September 27, 1996, among National Medical Care, Inc. and Certain Subsidiaries and Affiliates, as Borrowers, Certain Subsidiaries and Affiliates, as Guarantors, the Lenders named therein, NationsBank, N.A., as paying agent and the Bank of Nova Scotia, the Chase Manhattan Bank, N.A., Dresdner Bank AG and NationsBank, N.A. as Managing Agents, as previously amended (incorporated herein by reference to the Form 10-K of Registrant filed with Commission on March 23, 1998). Exhibit 4.7 Form of Consent to Modification of Amendment No. 5 dated December 12, 1997 to the Credit Agreement dated as of September 27, 1996 among National Medical Care, Inc. and Certain Subsidiaries and Affiliates, as Borrowers, Certain Subsidiaries and Affiliates, as Guarantors, the Lenders named therein, NationsBank, N.A., as paying agent and the Bank of Nova Scotia, the Chase Manhattan Bank, N.A., Dresdner Bank AG and NationsBank, N.A. as Managing Agents (incorporated herein by reference to the Form 10-K of Registrant filed with Commission on March 23, 1998). Exhibit 4.8 Amendment No. 6 dated effective June 30, 1998 to the Credit Agreement dated as of September 27, 1996, among National Medical Care, Inc. and Certain Subsidiaries and Affiliates, as Borrowers, Certain Subsidiaries and Affiliates, as Guarantors, the Lenders named therein, NationsBank, N.A., as paying agent and the Bank of Nova Scotia, the Chase Manhattan Bank, N.A., Dresdner Bank AG and NationsBank, N.A. as Managing Agents, as previously amended. (incorporated herein by reference to the Form 10-Q of Registrant filed with Commission on November 12, 1998) Exhibit 4.9 Amendment No. 7 dated effective December 31, 1998 to the Credit Agreement dated as of September 27, 1996 among National Medical Care, Inc. and Certain Subsidiaries and Affiliates, as Borrowers, Certain Subsidiaries and Affiliates as Guarantors, the Lendors named therein, Nations Bank, N.A. as paying agent and the Bank of Nova Scotia, the Chase Manhattan Bank, N. A., as Dresdner Bank AG and Nations Bank, N.A. as Managing Agents (filed herewith). Exhibit 4.10 Fresenius Medical Care AG 1998 Stock Incentive Plan as amended effective as of August 3, 1998 (incorporated herein by reference to the Form 10-Q of Registrant filed with Commission on May 14, 1998). Exhibit 4.11 Senior Subordinated Indenture dated November 27, 1996, among Fresenius Medical Care AG, State Street Bank and Trust Company, as successor to Fleet National Bank, as Trustee and the Subsidiary Guarantors named therein (incorporated herein by reference to the Form 10-K of Registrant filed with the Commission on March 31, 1997). Exhibit 4.12 Senior Subordinated Indenture dated as of February 19, 1998, among Fresenius Medical Care AG, State Street Bank and Trust Company as Trustee and Fresenius Medical Care Holdings, Inc., and Fresenius Medical Care AG, as Guarantors with respect to the issuance of 7 7/8% Senior Subordinated Notes due 2008 (incorporated herein by reference to the Form 10-K of Registrant filed with Commission on March 23, 1998). 120 121 Exhibit 4.13 Senior Subordinated Indenture dated as of February 19, 1998 among FMC Trust Finance S.a.r.l. Luxemborg, as Insurer, State Street Bank and Trust Company as Trustee and Fresenius Medical Care Holdings, Inc., and Fresenius Medical Care AG, as Guarantors with respect to the issuance of 7 3/8% Senior Subordinated Notes due 2008 (incorporated herein by reference to the Form 10-K of Registrant filed with Commission on March 23, 1998). Exhibit 10.1 Employee Benefits and Compensation Agreement dated September 27, 1996 by and among W. R. Grace & Co., National Medical Care, Inc., and W. R. Grace & Co.-- Conn. (incorporated herein by reference to the Registration Statement on Form F-1 of Fresenius Medical Care AG, as amended (Registration No. 333-05922), dated November 22, 1996 and the exhibits thereto). Exhibit 10.2 Purchase Agreement, effective January 1, 1995, between Baxter Health Care Corporation and National Medical Care, Inc., including the addendum thereto (incorporated by reference to the Form SE of Fresenius Medical Care dated July 29, 1996 and the exhibits thereto). Exhibit 10.3 Agreement, dated November 25, 1992 between Bergen Brunswig Drug Company and National Medical Care, Inc., including the addendum thereto (incorporated by reference to the Form SE of Fresenius Medical Care dated July 29, 1996 and the exhibits thereto). Exhibit 10.4 Product Purchase Agreement, effective January 1, 1996, between Amgen, Inc. and National Medical Care, Inc. (incorporated by reference to the Form SE of Fresenius Medical Care dated July 29, 1996 and the exhibits thereto). Exhibit 10.5 Primary Guarantee dated July 31, 1996 (incorporated by reference to the Registrant's Registration Statement on Form S-4 (Registration No. 333-09497) dated August 2, 1996 and the exhibits thereto). Exhibit 10.6 Secondary Guarantee dated July 31, 1996 (incorporated by reference to the Registrant's Registration Statement on Form S-4 (Registration No. 333-09497) dated August 2, 1996 and the exhibits thereto). Exhibit 10.7 Receivables Purchase Agreement dated August 28, 1997 between National Medical Care, Inc. and NMC Funding Corporation (incorporated herein by reference to the Form 10-Q of the Registrant filed with the Commission on November 14, 1997). Exhibit 10.8 Amendment dated as of September 28, 1998 to the Receivables Purchase Agreement dated as of August 28, 1997, by and between NMC Funding Corporation, as Purchaser and National Medical Care, Inc., as Seller. (incorporated herein by reference to the Form 10-Q of Registrant filed with Commission on November 12, 1998) Exhibit 10.9 Transfer and Administration Agreement dated August 28, 1997 among NMC Funding Corporation, National Medical Care, Inc., Enterprise Funding Corporation, the Bank Investors listed therein and NationsBank, N.A., as agent (incorporated herein by reference to the Form 10-Q of the Registrant filed with the Commission on November 14, 1997). Exhibit 10.10 Amendment No. 1 dated as of February 27, 1998 to Transfer and Administration Agreement dated as of August 28, 1997 among NMC Funding Corporation, National Medical Care, Inc., Enterprise Funding Corporation, the Bank Investors listed herein and NationsBank, N.A., as agent (incorporated herein by reference to the Form 10-K of Registrant filed with Commission on March 23, 1998). Exhibit 10.11 Amendment No. 2 dated as of August 25, 1998 to Transfer and Administration Agreement dated us of August 28, 1997 among NMC Funding Corporation as Transferor, National Medical Care, Inc., as Collection Agent, Enterprise Funding Corporation, and Nations Bank, N.A. as agent for Enterprise Funding Corporation and the Bank Investors. (incorporated herein by reference to the Form 10-Q of Registrant filed with Commission on November 12, 1998) Exhibit 10.12 Amendment No. 3 dated as of September 28, 1998 to Transfer and Administration Agreement dated as of August 28, 1997 among NMC Funding Corporation as Transferor, National Medical Care, Inc., as Collection Agent, Enterprise Funding Corporation, and Nations Bank, N.A. as agent for Enterprise Funding Corporation and the Bank Investors. (incorporated herein by reference to the Form 10-Q of Registrant filed with Commission on November 12, 1998) 121 122 Exhibit 10.13 Employment agreement dated January 1, 1992 by and between Ben J. Lipps and Fresenius USA, Inc. (incorporated herein by reference to the Annual Report on Form 10-K of Fresenius USA, Inc., for the year ended December 31, 1992). Exhibit 10.14 Modification to FUSA Employment Agreement effective as of January 1, 1998 by and between Ben J. Lipps and Fresenius Medical Care AG (incorporated herein by reference to the Form 10-Q of Registrant filed with Commission on May 14, 1998). Exhibit 10.15 Employment Agreement dated July 1, 1997 by and between Jerry A. Schneider and the Company (incorporated herein by reference to the Form 10-Q of Registrant filed with Commission on May 14, 1998). Exhibit 10.16 Addendum to Employment Agreement dated as of September 18, 1997 by and between Jerry A. Schneider and the Company (incorporated herein by reference to the Form 10-Q of Registrant filed with Commission on May 14, 1998). Exhibit 10.17 Separation Agreement dated as of July 21, 1998 by and between Geoffrey W. Swett and National Medical Care, Inc. (incorporated herein by reference to the Form 10-Q of Registrant filed with Commission on November 12, 1998) Exhibit 10.18 Employment Agreement dated October 23, 1998 by and between Roger G. Stoll and National Medical Care, Inc. (filed herewith). Exhibit 10.19 Employment Agreement dated November 11, 1998 by and between William F. Grieco and National Medical Care, Inc. (filed herewith) Exhibit 11 Statement re: Computation of Per Share Earnings. Exhibit 27 Financial Data Schedule (b) Reports on Form 8-K On July 16, 1998, the Company filed a report on Form 8-K with respect to the Company's divestiture of its Non Renal Diagnostic Services and Homecare divisions. On August 5, 1998, the Company filed a report on Form 8-K showing certain restated financial data of FMC, the parent corporation of the registrant, on a quarterly basis for 1996 and 1997 and the first quarter of 1998. These quarterly statements detailed results of operations between FMC's core and divested non - core businesses. Schedule II - Valuation and Qualifying Accounts Portions of this Exhibit have been granted confidential treatment by the Commission. 122 EX-4.9 2 AMENDMENT TO CREDIT AGREEMENT 1 EXHIBIT 4.9 AMENDMENT NO. 7 THIS AMENDMENT NO. 7, dated as of December __, 1998 (the "AMENDMENT") relating to the Credit Agreement referenced below, by and among NATIONAL MEDICAL CARE, INC., a Delaware corporation, certain subsidiaries and affiliates party to the Credit Agreement and identified on the signature pages hereto, and NATIONSBANK, N.A., as Paying Agent for and on behalf of the Lenders. Terms used but not otherwise defined shall have the meanings provided in the Credit Agreement. W I T N E S S E T H WHEREAS, a $2.5 billion credit facility has been extended to National Medical Care, Inc. and certain subsidiaries and affiliates pursuant to the terms of that Credit Agreement dated as of September 27, 1996 (as amended and modified, the "CREDIT AGREEMENT") among National Medical Care, Inc., the other Borrowers, Guarantors and Lenders identified therein, and NationsBank, N.A., as Paying Agent; WHEREAS, the Company has requested the consent of the Paying Agent and the Lenders to amend the provisions of the Credit Agreement to provide for the obligations of certain of the Borrowers thereunder to be joint and several; WHEREAS, the required consents and modifications described herein require the consent of the Required Lenders; and WHEREAS, the Required Lenders have consented to the requested modifications on the terms and conditions set forth herein and have authorized the Paying Agent to enter into this Amendment on their behalf to give effect to this Amendment; NOW, THEREFORE, IN CONSIDERATION of these premises and other good and valuable consideration, the receipt and sufficiency of which is hereby acknowledged, the parties hereto agree as follows: 1. The Credit Agreement is amended and modified in the following respects: 1.1. In Section 1.1, the following definitions are hereby amended or added to read as follows: "CO-BORROWERS" means NMC and each of the Designated Borrowers which has been designated as a "Co-Borrower" in a Borrower Joinder Agreement executed pursuant to Section 3.16 in which it has agreed that its liability hereunder shall be joint and several with the other Co-Borrowers. "PRIMARY BORROWERS" means (i) those Borrowers identified as such on SCHEDULE 2.1(A)-2, (ii) any Borrower designated as a Primary Borrower in a Borrower Joinder Agreement executed pursuant to Section 3.16, and (iii) any Co-Borrower. 1.2 Section 2.1 (Revolving Loans) is hereby amended as follows: (i) by deleting the words "on behalf of a Primary Borrower" in the first sentence of clause (b)(i) thereof and inserting the words, "on behalf of the Co-Borrowers or any other Primary Borrower" in place thereof; (ii) by deleting clause (B) from the second sentence of clause (b)(i) thereof and inserting the following clause in its place "(B) the applicable Borrower or the Co-Borrowers,"; (iii) by deleting the words "for the account of each such Primary Borrower" from the first sentence of clause (b)(iii) thereof and inserting in place thereof the words "for the account of the Co-Borrowers or of each such Primary Borrower, as applicable, in each case"; and 2 (iv) by inserting the words "(but each Loan to the Co-Borrowers will count as one Loan)" in subsection (f) at the end of clause (i) of the last sentence thereof. 1.3 Section 2.5 (Domestic Swingline Loan Subfacility) is hereby amended as follows: (i) by deleting the words "on behalf of a Primary Borrower" in the first sentence of clause (b)(i) thereof and inserting the words, "on behalf of the Co-Borrowers or any other Primary Borrower" in place thereof; (ii) by deleting clause (B) from the second sentence of clause (b)(i) thereof and inserting the following clause in its place "(B) the applicable Borrower or the Co-Borrowers,"; (iii) by inserting the words "on behalf of the Co-Borrowers" immediately after the words "the Company shall be deemed to have requested" in the second sentence of clause (iii) thereof; and (iv) by inserting the words "the Co-Borrowers or" immediately before the words "the applicable Primary Borrower" in the third sentence of clause (iii) thereof. 1.4 Section 2.7(e) is hereby amended by deleting the words "on behalf of a Primary Borrower" from the first sentence thereof and inserting the words "on behalf of the Co-Borrowers or any other Primary Borrower" in place thereof. 1.5 Section 3.16 is hereby amended as follows: (i) by inserting the following at the end of the first sentence of clause (a) thereof: "and, if applicable, requesting that the Applicant Borrower be a Co-Borrower hereunder. The Designated Borrower Limit for any Co-Borrower shall be the same as the Designated Borrower Limit in effect for the Company." (ii) by inserting the following proviso at the end of clause (b) thereof: "PROVIDED, that a Co-Borrower (other than NMC) shall cease to be a Borrower on the date that the Paying Agent receives such request." 1.6 Section 3.17 is hereby deleted in its entirety and the following substituted therefor: "3.17 SEVERAL LIABILITY OF BORROWERS; JOINT AND SEVERAL LIABILITY OF CO-BORROWERS. The obligations of the Borrowers, as Borrowers, are several, and not joint, obligations of each of the Borrowers; PROVIDED, that the obligations of the Company and the other Co-Borrowers shall be joint and several." 1.7 A new Section 6.16 is added to read as follows: "6.16 YEAR 2000 COMPLIANCE. Holdings and the Company have each (i) initiated a review and assessment of all material areas within its and each of its Subsidiaries' business and operations (including those affected by major suppliers, vendors and account debtors) that could be adversely affected by the "Year 2000 Problem" (that is, the risk that computer applications used by Holdings or any of its Subsidiaries (or such suppliers, vendors and account debtors) may be unable to recognize and perform properly date-sensitive functions involving any date after December 31, 1999), (ii) developed a plan and timeline for addressing the Year 2000 Problem on a timely basis, and (iii) to date, implemented that plan, to the extent that the timetable is controlled by Holdings and its Subsidiaries and not by third parties, on a timetable consistent with addressing the Year 2000 Problem on a timely basis. Based on the foregoing, Holdings currently believes that all computer applications used by Holdings or any of its Subsidiaries that are material to its or 2 3 any of its Subsidiaries' business and operations are reasonably expected to be able to perform properly date-sensitive functions for all dates after January 1, 2000 (that is, be "Year 2000 compliant"), except to the extent that a failure to do so could not reasonably be expected to have Material Adverse Effect." 1.8 The following shall be inserted at the end of clause (iv) of Section 7.1(b): ; PROVIDED, that, in the case of the Co-Borrowers, the requirements of this clause (iv) shall be satisfied by the delivery of a company-prepared consolidated balance sheet of the Company, the Co-Borrowers and their respective Subsidiaries and related company-prepared consolidated statements of income and retained earnings; 1.9 A new Section 7.16 is added to read as follows: "7.16 YEAR 2000 COMPLIANCE. Holdings and the Company will promptly notify the Paying Agent in the event either discovers or determines that any computer application (including those of its suppliers, vendors and customers) that is material to Holdings' or any of its Subsidiaries' (including the Company's and its Subsidiaries') business and operations will not be Year 2000 compliant, except to the extent that such failure could not reasonably be expected to have a Material Adverse Effect." 1.10 SCHEDULE 3.16-1 to the Credit Agreement is hereby amended by deleting said SCHEDULE 3.16-1 in its entirety and substituting in place thereof a new SCHEDULE 3.16-1 in the form of ANNEX A to this Amendment. 2. Pursuant to Section 3.16, the Company requests that each of the Subsidiaries identified on ANNEX B hereto (collectively, the "DESIGNATED CO-BORROWERS") be designated as Co-Borrowers hereunder and confirms that it has delivered, or will deliver, a Borrower Joinder Agreement in the form specified by Section 3.16 to the Paying Agent on behalf of each of the Designated Co-Borrowers. The Required Lenders hereby consent to the joinder of each of the Designated Co-Borrowers as a Designated Borrower under the Credit Agreement as amended hereby, subject to and effective upon the delivery to the Paying Agent of executed promissory notes, if any, required in connection therewith, and supporting resolutions, articles of incorporation, bylaws, incumbency certificates, opinions of counsel and such other items as the Paying Agent may request, and hereby waive the provision contained in Section 3.16 that such joinder become effective ten days after such consent and delivery. 3. The Company hereby agrees that its obligations under the Credit Agreement as a Borrower are joint and several with the obligations of the other Co-Borrowers thereunder. 4. This Amendment shall be effective upon receipt by the Paying Agent of (i) copies of this Amendment executed by the Company and the other members of the Consolidated Group identified on the signature pages hereto, and (ii) the consent of the Required Lenders to this Amendment. 5. Except as modified hereby, all of the terms and provisions of the Credit Agreement (and Exhibits and Schedules) remain in full force and effect. 6. The Company agrees to pay all reasonable costs and expenses of the Paying Agent in connection with the preparation, execution and delivery of this Amendment, including without limitation the reasonable fees and expenses of Moore & Van Allen, PLLC. 7. This Amendment may be executed in any number of counterparts, each of which when so executed and delivered shall be deemed an original and its shall not be necessary in making proof of this Amendment to produce or account for more than one such counterpart. 8. This Amendment, and the Credit Agreement as amended hereby, shall be governed by and construed and interpreted in accordance with the laws of the State of New York. 3 4 IN WITNESS WHEREOF, each of the parties hereto has caused a counterpart of this Amendment to be duly executed and delivered as of the date first above written. BORROWERS: NATIONAL MEDICAL CARE, INC., a Delaware corporation By /s/ Ben J. Lipps ----------------------------------------- Name: Ben J. Lipps Title: President FRESENIUS MEDICAL CARE AG By /s/ Dr. K.-D. Schwab ----------------------------------------- Name: Dr. K.-D. Schwab Title: SVP Finance By /s/ Dr. D. Blumenhagen ----------------------------------------- Name: Dr. D. Blumenhagen Title: Treasurer NMC DO BRASIL LTDA., a Brazil corporation By /s/ Joao Padrinsui ----------------------------------------- Name: Joao Padrinsui Title: Manager NATIONAL MEDICAL CARE OF SPAIN, S.A., a Spanish corporation By /s/ Dr. E. Gatti and J. Allen ----------------------------------------- Name: Dr. E. Gatti and J. Allen Title: Board Members NATIONAL MEDICAL CARE OF TAIWAN, INC., a Delaware corporation By /s/ Marc Lieberman ----------------------------------------- Name: Marc Lieberman Title: Assistant Treasurer NMC CENTRO MEDICO NACIONAL, LDA., a Portuguese corporation By /s/ J. Allen ----------------------------------------- Name: J. Allen Title: Board Member FRESENIUS MEDICAL CARE ARGENTINA, S.A., as successor by merger to NMC DE ARGENTINA, S.A., an Argentine corporation By /s/ Guido Yagupsky ----------------------------------------- Name: Guido Yagupsky Title: Board Member 4 5 FRESENIUS USA, INC., a Massachusetts corporation By /s/ Ben J. Lipps ----------------------------------------- Name: Ben J. Lipps Title: President FRESENIUS MEDICAL CARE DEUTSCHLAND GmbH, a German corporation By /s/ Dr. K.-D. Schwab ----------------------------------------- Name: Dr. K.-D. Schwab Title: SVP Finance By /s/ Dr. D. Blumenhagen ----------------------------------------- Name: Dr. D. Blumenhagen Title: Treasurer FRESENIUS MEDICAL CARE GROUPE FRANCE (formerly known as Fresenius Groupe France S.A.), a French corporation By /s/ Dr. A. Stopper and Dr. E. Gatti ----------------------------------------- Name: Dr. A. Stopper and Dr. E. Gatti Title: Board Members FRESENIUS MEDICAL CARE HOLDING, S.p.A., an Italian corporation By /s/ Dr. A. Stopper and Dr. E. Gatti ----------------------------------------- Name: Dr. A. Stopper and Dr. E. Gatti Title: Board Members FRESENIUS MEDICAL CARE ESPANA S.A., a Spanish corporation By /s/ Dr. E. Gatti ----------------------------------------- Name: Dr. E. Gatti Title: Board Member 5 6 FRESENIUS MEDICAL CARE MAGYAROSZA KfG, a Hungarian corporation By /s/ Norman Erhard ----------------------------------------- Name: Norman Erhard Title: General Manager GUARANTORS: FRESENIUS MEDICAL CARE HOLDINGS, INC., a New York corporation formerly known as WRG-NY By /s/ Ben J. Lipps ----------------------------------------- Name: Ben J. Lipps Title: President NATIONAL MEDICAL CARE, INC., a Delaware corporation By /s/ Ben J. Lipps ----------------------------------------- Name: Ben J. Lipps Title: President BIO-MEDICAL APPLICATIONS MANAGEMENT CO., INC., a Delaware corporation By /s/ Patrick Moriarty ----------------------------------------- Name: Patrick Moriarty Title: Vice President LIFECHEM, INC., a Delaware corporation By /s/ Patrick Moriarty ----------------------------------------- Name: Patrick Moriarty Title: Assistant Treasurer FRESENIUS MEDICAL CARE AG, a German corporation By /s/ Dr. K.-D. Schwab ----------------------------------------- Name: Dr. K.-D. Schwab Title: SVP Finance By /s/ Dr. D. Blumenhagen ----------------------------------------- Name: Dr. D. Blumenhagen Title: Treasurer 6 7 FRESENIUS USA, INC., a Massachusetts corporation By /s/ Ben J. Lipps ----------------------------------------- Name: Ben J. Lipps Title: President FRESENIUS MEDICAL CARE DEUTSCHLAND GmbH, a German corporation By /s/ Dr. K.-D. Schwab ----------------------------------------- Name: Dr. K.-D. Schwab Title: SVP Finance By /s/ Dr. D. Blumenhagen ----------------------------------------- Name: Dr. D. Blumenhagen Title: Treasurer FRESENIUS MEDICAL CARE GROUPE FRANCE, a French corporation (formerly known as Fresenius Groupe France S.A.) By /s/ Dr. A. Stopper and Dr. E.Gatti ----------------------------------------- Name: Dr. A. Stopper and Dr. E. Gatti Title: Board Members FRESENIUS SECURITIES, INC., a California corporation By /s/ Ben J. Lipps ----------------------------------------- Name: Ben J. Lipps Title: President NEOMEDICA, INC., a Delaware corporation By /s/ Patrick Moriarty ----------------------------------------- Name: Patrick Moriarty Title: Treasurer FMC FINANCE S.A., a Luxembourg corporation By /s/ J. Allen ----------------------------------------- Name: J. Allen Title: Board Member 7 8 FMC TRUST FINANCE S.a.r.l. LUXEMBOURG, a Luxembourg corporation By /s/ Dr. A. Stopper ----------------------------------------- Name: Dr. A. Stopper Title: General Manager PAYING AGENT: NATIONSBANK, N.A., as Paying Agent for and on behalf of the Lenders By /s/ Ashley M. Crabtree ----------------------------------------- Ashley M. Crabtree Senior Vice President 8 9 CONSENT TO AMENDMENT NO. 7 NationsBank, N.A., as Paying Agent 101 N. Tryon Street, 15th Floor NC1-001-15-04 Charlotte, North Carolina 28255 Attn: Cindy Harmon, Agency Services Re: Credit Agreement dated as of September 27, 1996 (as amended and modified, the "CREDIT AGREEMENT") among National Medical Care, Inc., the other Borrowers, Guarantors and Lenders identified therein and NationsBank, N.A., as Paying Agent. Terms used but not otherwise defined shall have the meanings provided in the Credit Agreement. Amendment No. 7 dated December __, 1998 (the "SUBJECT AMENDMENT") relating to the Credit Agreement Ladies and Gentlemen: This should serve to confirm our receipt of, and consent to, the Subject Amendment. We hereby authorize and direct you, as Paying Agent for the Lenders, to enter into the Subject Amendment on our behalf in accordance with the terms of the Credit Agreement upon your receipt of such consent and direction from the Required Lenders, and agree that Company and the other Credit Parties may rely on such authorization. Sincerely, -------------------------------------- [Name of Lender] By: ---------------------------------- Name: Title: 9 10 ANNEX A to Amendment No. 7 SCHEDULE 3.16-1 Form of Borrower Joinder Agreement THIS BORROWER JOINDER AGREEMENT (the "AGREEMENT"), dated as of ________________, 19__, is by and between ______________________, a ________________ (the "APPLICANT BORROWER"), and NATIONSBANK, N.A., in its capacity as Paying Agent under that certain Credit Agreement (as amended and modified, the "CREDIT AGREEMENT"), dated as of September 27, 1996, by and among NATIONAL MEDICAL CARE, INC., a Delaware corporation, and certain subsidiaries and affiliates (the "BORROWERS"), the Guarantors identified therein, the Lenders and NationsBank, N.A., as Paying Agent. All of the defined terms in the Credit Agreement are incorporated hereby by reference. The Applicant Borrower has indicated its desire to become a Designated Borrower pursuant to Section 3.16 of the Credit Agreement. Accordingly, the Applicant Borrower hereby agrees as follows with the Paying Agent, for the benefit of the Lenders: 1. The Applicant Borrower hereby acknowledges, agrees and confirms that, by its execution of this Agreement, the Applicant Borrower will be deemed to be a party to the Credit Agreement and a Designated Borrower for all purposes of the Credit Agreement and the other Credit Documents, and shall have all of the obligations of a Borrower thereunder as if it has executed the Credit Agreement and the other Credit Documents. The Applicant Borrower hereby ratifies, as of the date hereof, and agrees to be bound by, all of the terms, provisions and conditions contained in the Credit Documents, including without limitation (i) all of the representations and warranties of the Credit Parties set forth in Section 6 of the Credit Agreement, and (ii) all of the affirmative and negative covenants set forth in Sections 7 and 8 of the Credit Agreement. The Applicant Borrower requests approval [as a Primary Borrower[, a Co-Borrower] and] of a Designated Borrower Limit of $__________. Unless it is a Co-Borrower or it is approved by the Required Lenders, the Applicant Borrower will not be a Primary Borrower. 2. The Applicant Borrower acknowledges and confirms that it has received a copy of the Credit Agreement and the Schedules and Exhibits thereto. The information on the Schedules to the Credit Agreement and the Pledge Agreement are amended to provide the information shown on the attached SCHEDULE A. 3. National Medical Care, Inc. ("NMC") confirms that all of its obligations under the Credit Agreement are, and upon the Applicant Borrower becoming a Designated Borrower shall continue to be, in full force and effect. NMC further confirms that immediately upon the Applicant Borrower becoming a Designated Borrower the term "Obligations", as used in the Credit Agreement, shall include all Obligations of such Designated Borrower under the Credit Agreement and under each other Credit Document. 4. The Applicant Borrower hereby agrees that upon becoming a Designated Borrower it will assume all Obligations of a Borrower as set forth in the Credit Agreement [Co-Borrowers only: and all Obligations of the Company and the other Co-Borrowers (if any) thereunder in respect of outstanding Revolving Loans and outstanding Domestic Swingline Loans and that its liability in respect of the Obligations shall be joint and several with the other Co-Borrowers]. 5. Each of NMC and the Applicant Borrower agrees that at any time and from time to time, upon the written request of the Paying Agent, it will execute and deliver such further documents and do such further acts and things as the Paying Agent may reasonably request in order to effect the purposes of this Certificate. 10 11 6. This Agreement may be executed in two or more counterparts, each of which shall constitute an original but all of which when taken together shall constitute one contract. 7. This Agreement shall be governed by and construed and interpreted in accordance with the laws of the State of New York. [Remainder of Page Intentionally Left Blank] 11 12 IN WITNESS WHEREOF, the Applicant Borrower has caused the Borrower Joinder Agreement to be duly executed by its authorized officers, and the Paying Agent, for the benefit of the Lenders, has caused the same to be accepted by its authorized officer, as of the day and year first above written. APPLICANT BORROWER: By: ---------------------------------------- Name: Title: NATIONAL MEDICAL CARE, INC., a Delaware corporation By: ---------------------------------------- Name: Title: Acknowledged and accepted: NATIONSBANK, N.A., as Paying Agent By: ---------------------------------------- Name: Title: 12 13 ANNEX B to Amendment No. 7 DESIGNATED CO-BORROWERS LifeChem, Inc. Bio-Medical Applications of Alabama, Inc. Bio-Medical Applications of Florida, Inc. Bio-Medical Applications of Georgia, Inc. Bio-Medical Applications of Indiana, Inc. Bio-Medical Applications of Kentucky, Inc. Bio-Medical Applications of Louisiana, Inc. Bio-Medical Applications of Maryland, Inc. Bio-Medical Applications of Massachusetts, Inc. Bio-Medical Applications of North Carolina, Inc. Bio-Medical Applications of Ohio, Inc. Bio-Medical Applications of Pennsylvania, Inc. Bio-Medical Applications of South Carolina, Inc. Bio-Medical Applications of Texas, Inc. Bio-Medical Applications of Virginia, Inc. 13 EX-10.18 3 EMPLOYMENT AGREEMENT 1 EXHIBIT 10.18 EMPLOYMENT AGREEMENT THIS AGREEMENT, is made and entered into this 23rd day October, 1998, by and between National Medical Care, Inc. d/b/a Fresenius Medical Care North America ("FMC") or the "EMPLOYER"), with principal offices located at 95 Hayden Avenue, Lexington, MA 02420 and Roger G. Stoll (`EMPLOYEE") currently residing at 106 Clearview Lane, New Canaan, CT 06840. WITNESSETH: WHEREAS, FMC desires to employ EMPLOYEE as Executive Vice President of Fresenius Medical Care North America ("FMC"), and WHEREAS, the parties hereto desire to express the terms and conditions of such employment. NOW THEREFORE, it is understood and agreed to between the parties as follows: 1. EMPLOYMENT. FMC hereby employs EMPLOYEE as its Executive Vice President, and EMPLOYEE hereby accepts the employment upon the terms and conditions of this Agreement. 2. TERM. The term of this Agreement shall commence as of the date EMPLOYEE begins employment at FMC's Lexington, Massachusetts headquarters but no later than October 5, 1998 and shall continue thereafter, unless terminated in accordance with the provisions hereinafter stated. 3. DUTIES AND RESPONSIBILITIES. EMPLOYEE shall serve full-time as FMC's Executive Vice President and will be responsible for business activities, including full P&L responsibilities, for the company's Renal Products and Laboratory and Diagnostic Services businesses and Corporate Information Services. EMPLOYEE will also assume responsibility for future activities as mutually agreed upon by EMPLOYEE and Ben Lipps. EMPLOYEE shall report directly to Ben Lipps, the Chief Executive Officer of FMC. EMPLOYEE shall to the best of his ability and experience competently, loyally, diligently and conscientiously perform all of the duties and obligations expressly or implicitly required under this Agreement. EMPLOYEE further agrees that he will not in conducting business in the interest of the EMPLOYER engage in, or knowingly permit others under his control to carry on, or induce others to engage in any practice or commit acts in violation of any federal, state or local law, ordinance, or in any material respect, any written company policy or procedure. During the term of his employment, Stoll may continue to serve on the Boards of Directors of St. Jude Medical, Inc. and Ribogene, Inc. 4. COMPENSATION AND BENEFITS. a) BASE SALARY. EMPLOYER shall pay EMPLOYEE for all services rendered a base salary of $541,000 per year, (the "Base Salary"), payable in accordance with FMC's payroll procedures, subject to customary withholding and employment taxes. Salary will be reviewed annually. 2 b) INCENTIVE COMPENSATION. During EMPLOYEE'S employment with FMC, EMPLOYEE shall be entitled to participate in FMC's Management Bonus Plan ("MBP") and such other incentive compensation plans as are now available or may become available to other similarly positioned officers of FMC. For executives, the target level bonus is forty percent (40%) and the maximum bonus is one hundred percent (100%) of base salary, pro-rated for the date employment commences. Funding for the plan is based upon attainment of specific individual and company financial objectives. c) STOCK PLAN. EMPLOYEE shall be entitled to participate in the Fresenius Medical Care AG ("Fresenius") 1998 Stock Incentive Plan (the "Stock Plan"), subject to IRS approval of the Stock Plan. EMPLOYEE shall be recommended to receive options to purchase 90,000 Preference Shares (equivalent to 270,000 American Depository shares) constituting a grant under that non-qualified stock plan for employees of Fresenius' United States subsidiaries. Preference Shares are traded on the Frankfort Stock Exchange and are Deutsche Mark denominations. A vesting schedule will be recommended such that 15,000 shares vest on the date of grant and 15,000 vest on each of the next five anniversaries of the grant. In the event the 1998 Stock Plan does not receive IRS approval, Stoll will be recommended to receive options under the 1996 Stock Plan, as amended, subject to IRS approval of that Plan. In the event the 1996 Stock Plan, as amended, does not receive IRS approval, Stoll will be recommended to receive options under the original 1996 Stock Plan which has been approved by the IRS. d) BENEFIT PROGRAMS. EMPLOYEE shall be eligible to participate in the FMC group employee benefits program as now established or which subsequently becomes available, including all executive benefits. e) LIFE INSURANCE. EMPLOYEE will be provided with life insurance in accordance with FMC's policy, currently capped at $400,000. EMPLOYEE will be provided with the opportunity to purchase supplemental life insurance in excess of $400,000 but not to exceed $2,000,000 of coverage at his own expense. f) AUTOMOBILE. EMPLOYEE will be provided with a company car. g) TAX PREPARATION. EMPLOYEE will be reimbursed annually for expenses associated with individual income tax preparation up to a total of Two Thousand Dollars ($2,000) each year. h) VACATION. EMPLOYEE shall be eligible to participate in FMC's Paid Time Off program which provides for thirty-five (35) days of Paid Time-Off per year. i) EXPENSE REIMBURSEMENT. EMPLOYEE will be reimbursed for all business related expenses in accordance with FMC's Reimbursement policy. 5. RELOCATION. EMPLOYEE will relocate from New Canaan, CT to the Lexington, MA area promptly upon commencement of employment. Relocation will be covered under existing FMC policy and will include all costs of sale of his existing residence and purchase of a new residence, all costs for packing, moving and unpacking of household goods, househunting trips for EMPLOYEE and his wife, travel to and from New Canaan during any transition 2 3 period, and other miscellaneous relocation costs. Temporary housing will be provided if needed for up to six (6) months. 6. TERMINATION OF EMPLOYMENT. a) TERMINATION BY FMC. This Agreement may be terminated by FMC for cause immediately upon notice to EMPLOYEE. FMC shall have cause for termination in the event of: i) A refusal by EMPLOYEE to perform duties incident to his employment responsibilities, or violation of any written policy of FMC in any material respect or failure to abide by the covenants set forth in Paragraph 3 of this Agreement. ii) EMPLOYEE'S death. iii) The final, unappealable conviction of EMPLOYEE of any felony. No severance benefits are due to EMPLOYEE in the event he is terminated for cause. b) TERMINATION BY FMC FOR DISABILITY. FMC may also terminate this Agreement in the event of the disability of EMPLOYEE during his employment under this Agreement through any illness, injury, accident or condition of either a physical or psychological nature and, as a result in the opinion of a physician mutually agreeable to the parties is expected to be unable to perform substantially all of his duties and responsibilities hereunder for one hundred eighty (180) consecutive calendar days during the year following the physician's examination of EMPLOYEE. c) TERMINATION BY EMPLOYEE. This Agreement may be terminated by the EMPLOYEE in the event of a breach by FMC of any of its obligations under this Agreement, provided EMPLOYEE gives FMC written notice specifying the manner in which he believes FMC has breached this Agreement, and FMC has thirty (30) days from receipt of such notice to cure such breach, or in the case of other than a non-payment of money breach, if such breach cannot be cured within thirty (30) days, to commence a good faith effort to cure. Additionally, this Agreement may be terminated by EMPLOYEE if Ben Lipps is replaced as CEO by any individual other than EMPLOYEE, if there is a reduction in EMPLOYEE'S position or responsibilities, if EMPLOYEE suffers a reduction in salary or significant reduction in benefits or FMC experiences a change in control defined as any of the following: (i) the transfer (whether by sale, dividend, exchange, lease, merger, consolidation or otherwise) of greater than 50 percent of the voting power of FMC, within any 12 month period, (ii) the transfer (whether by sale, dividend, exchange, lease, merger, consolidation or otherwise) of all or substantially all the assets or stock of FMC or (iii) any other action which results in persons other than the current majority shareholders of FMC, having the voting power to direct the management of FMC or if FMC relocates its corporate headquarters more than fifty (50) miles from its present location in Lexington, Massachusetts. d) PAYMENT UPON TERMINATION. In the event this Agreement is terminated for any reason, EMPLOYEE shall be entitled to receive all accrued but unpaid annual base salary earned by EMPLOYEE to the date of termination. In addition, if FMC terminates this Agreement for any reason other than a reason set forth in Section 6(a) or 6(b) or if EMPLOYEE terminates 3 4 this Agreement pursuant to Section 6(c), EMPLOYEE shall also receive (i) Salary and benefits continuation for a period of two (2) years following termination of employment. EMPLOYER will at it option pay such severance as Salary Continuation or in lump sum payment without benefits. If FMC terminates this Agreement pursuant to Section 6(b), EMPLOYEE shall be entitled to salary and benefits continuation or an equivalent lump sum payment without benefits, at EMPLOYER'S option, for a period not to exceed one and one-half years beginning on the 181st day of disability. In addition, if EMPLOYEE is terminated other than for reasons set forth in Section 6(a), EMPLOYER will grant EMPLOYEE one (1) year from date of termination to exercise any outstanding options and Ben Lipps, or his successors, with use his best efforts to recommend that EMPLOYEE be granted up to 10 years from date of grant to exercise any such options. 7. NON-DISCLOSURE/NON-COMPETITION AGREEMENT. EMPLOYEE, as a condition of employment, agrees to execute a Non-Disclosure/Non-Competition Agreement which is incorporated by reference herein. 8. ENTIRE AGREEMENT AND AMENDMENTS. This Agreement shall constitute the entire Agreement between the parties, with the exception of the Non-Disclosure/Non-Competition Agreement referenced in Paragraph 7 above, and supersedes all existing agreements between them, whether oral or written, with respect to the subject matter hereof. Any waiver, alteration, or modification of any of the provisions of this Agreement, or cancellation or replacement of this Agreement shall be accomplished in writing and signed by the respective parities. If subsequent to EMPLOYEE'S employment, FMC decides to materially modify this Agreement, FMC will reimburse EMPLOYEE for legal fees he may incur with regard to any such modification in an amount not to exceed Five Thousand Dollars ($5,000) per occurrence. 9. NOTICES. All notices hereunder shall be in writing and shall be deemed to be given when sent by certified mail to either party at the address of such party set forth above or at such other address as shall have been designated by written notice by such party to the other party. 10. GOVERNING LAW. This Agreement shall be construed in accordance with, and the rights of the parties shall be governed by, the laws of the Commonwealth of Massachusetts. IN WITNESS WHEREOF, the parties have caused this Agreement to be executed by the undersigned duly authorized persons as of the day and year first stated above. FRESENIUS MEDICAL CARE NORTH AMERICA BY: /s/ Ben J. Lipps /s/ Roger Stoll ------------------------------ ------------------------------- Ben J. Lipps Roger Stoll Chief Executive Officer 4 EX-10.19 4 EMPLOYMENT AGREEMENT 1 EXHIBIT 10.19 EMPLOYMENT AGREEMENT THIS AGREEMENT, is made and entered into this 11th day of November, 1998, by and between National Medical Care, Inc., d/b/a Fresenius Medical Care North America ("FMC" or the "EMPLOYER"), with principal offices located at 95 Hayden Avenue, Lexington, MA 02420 and William F. Grieco ("EMPLOYEE") currently residing at 115 Marlborough Street, Boston, MA 02116. WITNESSETH: WHEREAS, FMC desires to employ EMPLOYEE as Senior Vice President and General Counsel of FMC and its affiliated corporations in North America, and WHEREAS, the parties hereto desire to express the terms and conditions of such employment. NOW THEREFORE, it is understood and agreed to between the parties as follows: 1. EMPLOYMENT. FMC hereby employs EMPLOYEE as Senior Vice President and General Counsel, and EMPLOYEE hereby accepts the employment upon the terms and conditions of this Agreement. 2. TERM. The term of this Agreement shall commence as of November 11, 1998 and shall continue thereafter, unless terminated in accordance with the provisions hereinafter stated. 3. DUTIES AND RESPONSIBILITIES. EMPLOYEE shall serve full time as FMC's Senior Vice President and General Counsel and will be responsible for the management and organization of the Law Department and coordination of the provisions of all legal services, through both in-house counsel reporting to EMPLOYEE and outside counsel engaged by EMPLOYEE, to FMC and its affiliated organizations in North America. EMPLOYEE shall report directly to the Chief Executive Officer of FMC. EMPLOYEE shall to the best of his ability and experience competently, loyally, diligently and conscientiously perform all of the duties and obligations expressly or implicitly required under this Agreement. EMPLOYEE further agrees that, in conducting business in the interest of the EMPLOYER, he will not engage in, knowingly permit others under his control to carry on, or induce others to engage in any practice or commit any acts in violation of any federal or state or local law or ordinance. 4. COMPENSATION AND BENEFITS. a) BASE SALARY. EMPLOYER shall pay EMPLOYEE for all services rendered a base salary of $450,000 per year, (the "Base Salary"), payable in accordance with FMC's payroll procedures, subject to customary withholding and employment taxes. At the end of each year of employment hereunder, EMPLOYEE's performance for the prior year shall be reviewed and evaluated. If EMPLOYEE's performance is satisfactory, EMPLOYEE shall receive an increase in his base salary consistent with the percent increase available to other similarly positioned senior executives of FMC. 2 b) INCENTIVE COMPENSATION. During EMPLOYEE's employment with FMC, EMPLOYEE shall be entitled to participate in FMC's Management Bonus Plan and any other such incentive compensation plans as are now available or may become available to other similarly positioned senior executives of FMC. EMPLOYEE will be in the 1998 senior executive eligibility level, wherein the target level bonus is forty percent (40%) and the maximum bonus is eighty percent (80%) per plan of base salary. Although funding for the plan is based upon attainment of specific individual and company financial objectives, EMPLOYEE will be treated similarly with other senior executives of FMC. EMPLOYEE's entitlement to a bonus under the Management Bonus Plan will be governed by terms of that Plan. Additionally, in consideration of the extraordinary additional demands and resulting work load imposed by the current investigation being conducted by the Office of the United States Attorney for the District of Massachusetts and other United States Government agencies (the "Investigation"), upon the successful resolution of the Investigation, EMPLOYEE shall be eligible for a special bonus consideration based upon his performance throughout the course of the Investigation and its resolution (the "Special Bonus"). Such Special Bonus shall be determined by Ben Lipps, as the Chief Executive Officer, or in whatever capacity he may then be serving the EMPLOYER or any of its affiliates. c) STOCK PLAN. EMPLOYEE shall be entitled to participate in the current Fresenius Medical Care AG Stock Incentive Plan, and any future stock incentive plan (individually a "Stock Plan" and collectively, the "Stock Plans"), subject to IRS approval of such respective Stock Plans. In addition to the existing options to purchase Fresenius Medical Care AG Preference Shares previously granted to EMPLOYEE (the "Existing Options"), EMPLOYEE shall be entitled to receive additional option grants in amounts and on such terms as granted to other similarly positioned senior executives of FMC, as approved by the Fresenius Medical Care AG Managing Board. d) BENEFIT PROGRAMS. EMPLOYEE shall continue to be eligible to participate in the group employee benefits programs at the senior executive level as now established or which subsequently become available. e) LIFE INSURANCE. EMPLOYEE will be provided with life insurance in accordance with FMC's policy, currently capped at Four Hundred Thousand Dollars ($400,000). EMPLOYEE will be provided with the opportunity to purchase supplemental life insurance of an additional Six Hundred Thousand Dollars ($600,000) beyond the current policy of coverage at his own expense, with proof of good health. f) AUTOMOBILE. EMPLOYEE will be provided with a company car allowance. 5. TERMINATION OF EMPLOYMENT. a) TERMINATION BY FMC. This Agreement may be terminated by FMC for cause immediately upon notice to EMPLOYEE. FMC shall have cause for termination in the event of: i) A default by EMPLOYEE in the performance of any material provision of this Agreement, and such default continues for a period of thirty (30) days after written notice to EMPLOYEE from EMPLOYER stating the specific default, unless such default is cured to the reasonable satisfaction of EMPLOYER within such thirty (30) day period, or if such failure cannot be cured within thirty (30) days, EMPLOYEE has commenced a good faith effort to cure in which case 2 3 EMPLOYER, within its sole discretion, may extend such period, in which case the notice of termination shall not be effective, and this Agreement shall not be terminated. No severance benefits are due to EMPLOYEE in the event he is terminated for cause. ii) EMPLOYEE's death. iii) The final, unappealable conviction of EMPLOYEE of any felony. b) TERMINATION BY FMC FOR DISABILITY. The disability of EMPLOYEE during his employment under this Agreement through any illness, injury, accident or condition of either a physical or psychological nature and, as a result, in the opinion of a physician mutually agreeable to the parties, is expected to be unable to perform substantially all of his duties and responsibilities hereunder for one hundred eighty (180) consecutive calendar days during the year following the physician's examination of EMPLOYEE. c) TERMINATION BY EMPLOYEE. This Agreement may be terminated by EMPLOYEE in the event of a breach by FMC of any of its obligations under this Agreement, provided EMPLOYEE gives FMC written notice specifying the manner in which he believes FMC has breached this Agreement and FMC has thirty (30) days from receipt of such notice to cure such breach, or in the case of other than a non-payment of money breach, if such breach cannot be cured within thirty (30) days, to commence a good faith effort to cure. Additionally, EMPLOYEE shall be entitled to terminate for "Good Reason." For purposes of this Agreement, "Good Reason" means the occurrence of any of the following circumstances: (i) a reduction in salary or significant reduction in benefits or reduction in EMPLOYEE's position, responsibilities, duties, or status as a senior executive of FMC; (ii) change in office location outside of the metropolitan Boston area; (iii) change in reporting to CEO; (iv) Change in Control of FMC; or (v) change in reporting to the current CEO. For purposes of this Agreement, a Change in Control shall be defined as any of the following: (i) the transfer (whether by sale, dividend, exchange, lease, merger, consolidation or otherwise) of greater than fifty percent (50%) of the voting power of FMC, within any twelve (12) month period, (ii) the transfer (whether by sale, dividend, exchange, lease, merger, consolidation, or otherwise) of all or substantially all the assets or stock of FMC, (iii) any other action which results in persons, other than the current majority shareholders of FMC, having the voting power to direct the management of FMC, or (iv) FMC relocates its corporate headquarters more than fifty (50) miles from its present location in Lexington, Massachusetts. Upon the occurrence of any of the foregoing circumstances which may constitute Good Reason for termination by EMPLOYEE, EMPLOYEE shall have twelve (12) months in which to notify FMC of his intention to terminate for Good Reason. Failure to do so will constitute a waiver of any right EMPLOYEE may have had to terminate his employment with Good Reason on the basis of the specific event at issue. Such waiver will not impair EMPLOYEE's ability to terminate with Good Reason in response to any subsequent occurrence of any of the events identified. 3 4 d) PAYMENT UPON TERMINATION. In the event this Agreement is terminated for any reason (including termination for Good Reason by EMPLOYEE), EMPLOYEE shall be entitled to receive all accrued but unpaid base salary and any manner of bonus compensation earned by EMPLOYEE as of the date of termination (all such bonus amounts shall be earned on a pro-rata basis for the portion of the year that EMPLOYEE is employed prior to termination). In addition, if FMC terminates this Agreement for any reason, other than a reason set forth in Section 5(a) or 5(b), or if EMPLOYEE terminates this Agreement pursuant to Section 5(c) (i)-(iv), EMPLOYEE shall also receive (i) salary and benefits continuation for a period of two (2) years following termination of employment; (ii) vesting of any unvested Existing Options and any Future Options as of the date of termination (together with any previously vested options, the "Vested Options"), and (iii) payout of any accrued vacation/PTO time. EMPLOYEE shall have three (3) years from any such termination to exercise the Vested Options. Should he fail to exercise these options, they will be forfeited at the end of that three (3) year period. Additionally, Ben Lipps, or his successor, will use his best efforts to recommend that EMPLOYEE be granted up to ten (10) years from the date of grant to exercise the Vested Options. If EMPLOYEE terminates this Agreement pursuant to Section 5(c)(v), EMPLOYEE shall be entitled to all of the compensation, benefits and rights referenced in this Section 5(d), except that he shall be entitled to salary and benefits continuation for a period of one (1) year on a guaranteed basis and salary and benefits continuation for up to but not to exceed one (1) additional year or until EMPLOYEE finds full-time employment provided EMPLOYEE continues to make good faith effort to do so. If EMPLOYER terminates this Agreement pursuant to Section 5(b), EMPLOYEE shall be entitled to salary and benefits continuation for a period not to exceed one and one half (1 1/2 ) years beginning on the 181st day of disability. EMPLOYEE may elect to receive salary continuation as a lump sum payment and to forego benefits. 6. NON-DISCLOSURE/NON COMPETITION AGREEMENT. EMPLOYEE acknowledges that during the term of employment with EMPLOYER, he will have access to and become acquainted with Confidential Information of the EMPLOYER. Confidential Information means all information related to the present or planned business of FMC that has not been released publicly by authorized representatives of FMC, and shall include but not be limited to, trade secrets and know-how, inventions, marketing and sales programs, employee, customer, patient and supplier information, information from patient medical records, financial data, pricing information, regulatory approval and reimbursement strategies, data, operations and clinical manuals. EMPLOYEE agrees not to use or disclose, directly or indirectly, any Confidential Information of FMC at any time and in any manner, except as required in the course of his employment with FMC or with the express written authority of FMC. EMPLOYEE understands that his non-disclosure obligations will continue following his termination of employment. All documents and equipment relating to the business of FMC, whether prepared by EMPLOYEE or otherwise coming into EMPLOYEE's possession, are the exclusive property of FMC, and must not be removed from the premises of FMC except as required in the 4 5 course of employment. Any such documents and equipment must be returned to FMC when EMPLOYEE leaves the employment of FMC. 7. EXPENSES. EMPLOYEE will be reimbursed for travel and other expenses related to the performance of his duties under the Agreement and in accordance with the EMPLOYER's policies. 8. VACATION/PTO. In recognition of EMPLOYEE'S previous inability over the past thirty three (33) months to take advantage of available vacation/PTO time, EMPLOYER will credit EMPLOYEE's Vacation/PTO account with one hundred twenty (120) additional hours of time and will pay out one hunderd sixty (160) additional hours of time in the form of a lump sum payment. EMPLOYEE shall be allowed to carry-over up to two hundred (200) hours from year-to-year without losing such time. EMPLOYEE shall also accrue PTO days at the maximum available to senior executives under the Executive Vacation Policy which currently provides for thirty (30) days of PTO per year. 9. ENTIRE AGREEMENT AND AMENDMENTS. This Agreement shall constitute the entire agreement between the parties and supersedes all existing agreements between them, whether oral or written, with respect to the subject matter hereof. Any waiver, alteration, or modification of any of the provisions of this Agreement, or cancellation or replacement of this Agreement shall be accomplished in writing and signed by the respective parties. 10. NOTICES. All notices hereunder shall be in writing and shall be deemed to be given when sent by certified mail to either party at the address of such party set forth above or at such other address as shall have been designated by written notice by such party to the other party. 11. GOVERNING LAW. This Agreement shall be construed in accordance with, and the rights of the parties shall be governed by, the laws of the Commonwealth of Massachusetts. IN WITNESS WHEREOF, the parties have caused this Agreement to be executed by the undersigned duly authorized persons as of the day and year first stated above. NATIONAL MEDICAL, INC. d/b/a FRESENIUS MEDICAL CARE WITNESS NORTH AMERICA, EMPLOYER /s/ Barbara A. Read By: /s/ Ben J. Lipps - -------------------------- ----------------------------- Barbara A. Read Ben J. Lipps Chief Executive Officer WITNESS WILLIAM F. GRIECO, EMPLOYEE /s/ Susan Zeller-Kent /s/ William F. Grieco - -------------------------- --------------------------------- Susan Zeller-Kent William F. Grieco 5 EX-11 5 COMPUTATION OF PER SHARE PER SHARE EARNINGS 1 FRESENIUS MEDICAL CARE HOLDINGS, INC. AND SUBSIDIARIES WEIGHTED AVERAGE NUMBER OF SHARES AND EARNINGS USED IN PER SHARE COMPUTATION (DOLLARS AND SHARES IN THOUSANDS)
EXHIBIT 11 --------------- --------------- --------------- --------------- At December 31, At December 31, At December 31, At September 30, 1998 1997 1996 1996 --------------- --------------- --------------- --------------- The weighted average number of shares of Common stock were as follows 90,000 90,000 90,000 90,000 ======= ======= ====== ======= Income used in the computation of earnings per share were as follows: CONTINUING OPERATIONS ------------- ------------- ------------- ------------- Twelve Months Twelve Months Twelve Months Nine Months Ended Ended Ended Ended December 31, December 31, December 31, September 30, 1998 1997 1996 1996 ------------- ------------- ------------- ------------- Net Income from continuing operations $ 51,837 $ 33,920 $ 5,377 $ 62,881 Dividends paid on preferred stocks (520) (520) (130) (390) --------- -------- ------- -------- Income used in per share computation of earnings $ 51,317 $ 33,330 $ 5,247 $ 62,491 ========= ======== ======= ======== Earnings per share $ 0.57 $ 0.37 $ 0.06 $ 0.69 ========= ======== ======= ======== DISCONTINUED OPERATIONS ------------- ------------- ------------- ------------- Twelve Months Twelve Months Twelve Months Nine Months Ended Ended Ended Ended December 31, December 31, December 31, September 30, 1998 1997 1996 1996 ------------- ------------- ------------- ------------- Loss from discontinued operations $(105,897) $(13,783) $(1,787) $ 0 Dividends paid on preferred stocks 0 0 0 0 --------- -------- ------- -------- Loss used in per share computation of earnings $(105,897) $(13,783) $(1,787) $ 0 ========= ======== ======= ======== Earnings per share $ (1.18) $ (0.15) $ (0.02) $ 0.00 ========= ======== ======= ======== CUMULATIVE EFFECT OF ACCOUNTING CHANGE ------------- ------------- ------------- ------------- Twelve Months Twelve Months Twelve Months Nine Months Ended Ended Ended Ended December 31, December 31, December 31, September 30, 1998 1997 1996 1996 ------------- ------------- ------------- ------------- Cumulative effect of accounting change $ 4,890 $ 0 $ 0 $ 0 Dividends paid on preferred stocks 0 0 0 0 ---------- -------- ------- -------- Loss used in per share computation of earnings $ (4,890) $ 0 $ 0 $ 0 ========== ======== ======= ======== Earnings per share $ (0.05) $ 0.00 $ 0.00 $ 0.00 ========== ======== ======= ======== CONSOLIDATED ------------- ------------- ------------- -------------- Twelve Months Twelve Months Twelve Months Nine Months Ended Ended Ended Ended December 31, December 31, December 31, September 30, 1998 1997 1996 1996 ------------- ------------- ------------ -------------- Net Income (loss) $ (58,950) $ 20,137 $ 3,590 $ 62,881 Dividends paid on preferred stock (520) (520) (130) (390) ========== -------- ------- ======== Income (loss) used in per share computation of $ (59,470) $ 19,547 $ 3,460 $ 62,491 earnings ========== ======== ======= ======== Earnings per share $ (0.66) $ 0.22 $ 0.04 $ 0.69 ========== ======== ======= ========
EX-27 6 FIANCIAL DATA SCHEDULE
5 0000042872 FRESENIUS MEDICAL CARE 1,000 U.S. DOLLARS YEAR DEC-31-1998 JAN-01-1998 DEC-31-1998 1 6,579 0 254,783 0 169,789 814,665 603,675 174,035 4,613,403 520,256 0 0 16,318 90,000 1,843,116 4,613,403 470,984 2,571,406 317,122 1,707,443 474,194 54,709 208,776 126,284 74,447 51,837 (105,897) 0 (4,890) (58,950) (0.66) 0
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