-----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, WwxXNGU9lOa23fx+6Mos1bjGqTgaLxkP2CDMnmcRikCoSsvVfaaCjsw7qpBMZe/3 12OwTRpWqFyZnoKs+PLpmQ== 0000898430-00-000211.txt : 20000203 0000898430-00-000211.hdr.sgml : 20000203 ACCESSION NUMBER: 0000898430-00-000211 CONFORMED SUBMISSION TYPE: 10-Q/A PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 19990630 FILED AS OF DATE: 20000128 FILER: COMPANY DATA: COMPANY CONFORMED NAME: TOTAL RENAL CARE HOLDINGS INC CENTRAL INDEX KEY: 0000927066 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-MISC HEALTH & ALLIED SERVICES, NEC [8090] IRS NUMBER: 510354549 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q/A SEC ACT: SEC FILE NUMBER: 001-04034 FILM NUMBER: 515216 BUSINESS ADDRESS: STREET 1: 21250 HAWTHORNE BLVD STREET 2: SIE 800 CITY: TORRANCE STATE: CA ZIP: 90503-5517 BUSINESS PHONE: 3107922600 MAIL ADDRESS: STREET 1: 21250 HAWTHORNE BLVD SUITE 800 STREET 2: 21250 HAWTHORNE BLVD SUITE 800 CITY: TORRANCE STATE: CA ZIP: 90503-5517 FORMER COMPANY: FORMER CONFORMED NAME: TOTAL RENAL CARE INC DATE OF NAME CHANGE: 19940719 10-Q/A 1 AMD. #1 TO FORM 10-Q (6-30-99) - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ---------------- FORM 10-Q/A (AMENDMENT NO. 1) (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 1999 OR [_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to Commission File Number: 1-4034 TOTAL RENAL CARE HOLDINGS, INC. (Exact name of registrant as specified in its charter) FOR THE QUARTER ENDED JUNE 30, 1999 Delaware 51-0354549 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 21250 Hawthorne Blvd., Suite 800 Torrance, California 90503-5517 (Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (310) 792-2600 Not Applicable (Former name or former address, if changed since last report) Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [_] APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE PRECEDING FIVE YEARS: Indicate by check mark whether the Registrant has filed all documents and reports required to be filed by Sections 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. Yes [_] No [_] APPLICABLE ONLY TO CORPORATE ISSUERS: Indicate the number of shares outstanding of each of the issuer's classes of common stock as of the latest practicable date.
Outstanding at Class August 1, 1999 ----- ----------------- Common Stock, Par Value $0.001.......................... 81,182,310 shares
- -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- TOTAL RENAL CARE HOLDINGS, INC. Unless otherwise indicated in this Form 10-Q/A, "we," "us," "our" and similar terms refer to Total Renal Care Holdings, Inc. and its subsidiaries. INTRODUCTORY STATEMENT We are filing this Amendment No. 1 on Form 10-Q/A for the quarterly period ended June 30, 1999 to restate our financial statements for the three months and six months ended June 30, 1998 and 1999 as summarized below. Concurrent restatements for the three years ended December 31, 1998 have been reported on our 1998 Form 10-K/A (Amendment No. 2). Decreases (increases) to income before taxes
For the three months For the six months ended June 30, ended June 30, ---------------------- ---------------------- 1998 1999 1998 1999 ---------- ---------- ---------- ----------- To reflect goodwill adjustments associated with acquisition transactions:(1) Valuation adjustments(2).... $ (126,000) $ (69,000) $ 400,000 $ (138,000) Pre-acquisition management fees(3).................... (35,000) 138,000 852,000 102,000 Other acquisition costs..... 460,000 6,000 173,000 12,000 To recognize a calculated fair value of stock options granted to medical directors and contract labor........... 1,129,000 1,036,000 2,626,000 114,000 To reflect accounts payable accruals in the quarters the liabilities were subsequently determined to have been incurred..................... (3,800,000) ---------- ---------- ---------- ----------- Decrease (increase) to income before taxes........ $1,428,000 $1,111,000 $4,051,000 $(3,710,000) ========== ========== ========== ===========
- --------------------- Additional information is provided in Note 1A to the condensed consolidated financial statements. (1) Adjustments include the impact on goodwill amortization associated with the goodwill adjustments. (2) Accounts receivable and other valuation adjustments originally considered to be acquisition valuation contingencies and included in goodwill have been restated to be included in results of operations. (3) Pre-acquisition management fee income has been restated to be included as acquisition consideration. i INDEX
Page No. ---- PART I. FINANCIAL INFORMATION Item 1. Financial Statements: Condensed Consolidated Balance Sheets--as Restated as of June 30, 1999 and December 31, 1998.......................................... 1 Condensed Consolidated Statements of Income and Comprehensive Income--as Restated for the three months and six months ended June 30, 1999 and June 30, 1998 ......................................... 2 Condensed Consolidated Statements of Cash Flows--as Restated for the six months ended June 30, 1999 and June 30, 1998.................... 3 Notes to Condensed Consolidated Financial Statements................. 4 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.......................................... 15 Item 3. Quantitative and Qualitative Disclosures About Market Risk..... 25 Risk Factors............................................................ 26 PART II. OTHER INFORMATION Item 1. Legal Procedings............................................... 33 Item 6. Exhibits and Reports on Form 8-K............................... 33 Signatures.............................................................. 34
- --------------------- Note: Items 2, 3, 4 and 5 of Part II are omitted because they are not applicable. ii TOTAL RENAL CARE HOLDINGS, INC. CONDENSED CONSOLIDATED BALANCE SHEETS--AS RESTATED
June 30, December 31, 1999 1998 -------------- -------------- ASSETS ------ Current assets: Cash and cash equivalents.................... $ 24,673,000 $ 41,487,000 Patient accounts receivable, less allowance for doubtful accounts of $103,578,000 and $61,848,000, respectively................... 444,239,000 416,472,000 Deferred income taxes........................ 61,199,000 39,014,000 Other current assets......................... 69,374,000 69,541,000 -------------- -------------- Total current assets....................... 599,485,000 566,514,000 Property and equipment, net.................... 273,785,000 233,337,000 Notes receivable and other long-term assets.... 79,491,000 38,268,000 Intangible assets, net of accumulated amortization of $146,706,000 and $114,536,000, respectively.................................. 1,149,702,000 1,073,500,000 -------------- -------------- Total assets............................... $2,102,463,000 $1,911,619,000 ============== ============== LIABILITIES AND STOCKHOLDERS' EQUITY ------------------------------------ Current liabilities: Current portion of long-term obligations..... $ 23,633,000 $ 21,847,000 Other current liabilities.................... 157,193,000 156,603,000 -------------- -------------- Total current liabilities.................. 180,826,000 178,450,000 Long term debt and other....................... 1,409,077,000 1,227,671,000 Deferred income taxes.......................... 14,022,000 8,212,000 Minority interests............................. 24,697,000 23,422,000 Stockholders' equity: Preferred stock, ($0.001 par value; 5,000,000 shares authorized; none outstanding)........ Common stock, voting, ($0.001 par value; 195,000,000 shares authorized; 81,182,000 and 81,030,000 shares issued and outstanding, respectively).................. 81,000 81,000 Additional paid-in capital................... 424,578,000 421,675,000 Notes receivable from stockholders........... (371,000) (356,000) Accumulated other comprehensive income....... (4,059,000) Retained earnings............................ 53,612,000 52,464,000 -------------- -------------- Total stockholders' equity................. 473,841,000 473,864,000 -------------- -------------- Total liabilities and stockholders' equity.................................... $2,102,463,000 $1,911,619,000 ============== ==============
See accompanying Notes to Condensed Consolidated Financial Statements and Management's Discussion and Analysis of Financial Condition and Results of Operations. 1 TOTAL RENAL CARE HOLDINGS, INC. CONDENSED CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME-- AS RESTATED Three months and six months ended June 30, 1999 and 1998
Three months Six months -------------------------- -------------------------- 1999 1998 1999 1998 ------------ ------------ ------------ ------------ STATEMENTS OF INCOME Net operating revenues.. $352,819,000 $288,350,000 $705,063,000 $546,183,000 Operating expenses: Facilities............ 249,298,000 184,399,000 480,188,000 352,839,000 General and administrative....... 30,809,000 18,087,000 53,167,000 34,709,000 Provision for doubtful accounts............. 35,707,000 7,741,000 46,185,000 15,112,000 Depreciation and amortization......... 27,293,000 22,714,000 54,219,000 42,250,000 Write-off of investments and loans................ 16,600,000 16,600,000 Merger and related costs................ 79,435,000 ------------ ------------ ------------ ------------ Total operating expenses............ 359,707,000 232,941,000 650,359,000 524,345,000 Operating income (loss)............... (6,888,000) 55,409,000 54,704,000 21,838,000 Interest expense, net of capitalized interest... (24,370,000) (16,544,000) (47,137,000) (31,061,000) Interest rate swap-- early termination costs.................. (9,823,000) (9,823,000) Interest income and other.................. 1,934,000 1,022,000 3,264,000 2,664,000 ------------ ------------ ------------ ------------ Income (loss) before income taxes, minority interests, extraordinary item and cumulative effect of change in accounting principle............ (29,324,000) 30,064,000 10,831,000 (16,382,000) Income taxes (benefit).. (9,786,000) 11,658,000 4,844,000 11,778,000 ------------ ------------ ------------ ------------ Income (loss) before minority interests, extraordinary item and cumulative effect of change in accounting principle............ (19,538,000) 18,406,000 5,987,000 (28,160,000) Minority interests in income of consolidated subsidiaries........... 2,521,000 1,565,000 4,839,000 2,958,000 ------------ ------------ ------------ ------------ Income (loss) before extraordinary item and cumulative effect of change in accounting principle............ (22,059,000) 16,841,000 1,148,000 (31,118,000) Extraordinary loss, net of tax of $6,087,000 and $7,688,000, respectively........... 9,932,000 12,744,000 Cumulative effect of change in accounting principle, net of tax of $4,300,000.......... 6,896,000 ------------ ------------ ------------ ------------ Net income (loss)....... $(22,059,000) $ 6,909,000 $ 1,148,000 $(50,758,000) ============ ============ ============ ============ Earnings (loss) per common share: Income (loss) before extraordinary item and cumulative effect of change in accounting principle............ $ (0.27) $ 0.21 $ 0.01 $ (0.39) Extraordinary loss, net of tax........... (0.12) (0.16) Cumulative effect of change in accounting principle, net of tax.................. (0.09) ------------ ------------ ------------ ------------ Net income (loss)..... $ (0.27) $ 0.09 $ 0.01 $ (0.64) ============ ============ ============ ============ Weighted average number of common shares outstanding............ 81,149,000 80,714,000 81,125,000 79,692,000 ============ ============ ============ ============ Earnings (loss) per common share--assuming dilution: Income (loss) before extraordinary item and cumulative effect of change in accounting principle............ $ (0.27) $ 0.20 $ 0.01 $ (0.39) Extraordinary loss, net of tax........... (0.12) (0.16) Cumulative effect of change in accounting principle, net of tax.................. (0.09) ------------ ------------ ------------ ------------ Net income (loss)..... $ (0.27) $ 0.08 $ 0.01 $ (0.64) ============ ============ ============ ============ Weighted average number of common shares and equivalents outstanding--assuming dilution............... 81,149,000 82,384,000 82,019,000 79,692,000 ============ ============ ============ ============ STATEMENTS OF COMPREHENSIVE INCOME Net income (loss)..... $(22,059,000) $ 6,909,000 $ 1,148,000 $(50,758,000) Other comprehensive income: Foreign currency translation......... (3,723,000) (4,059,000) ------------ ------------ ------------ ------------ Comprehensive income (loss)............... $(25,782,000) $ 6,909,000 $ (2,911,000) $(50,758,000) ============ ============ ============ ============
See accompanying Notes to Condensed Consolidated Financial Statements and Management's Discussion and Analysis of Financial Condition and Results of Operations. 2 TOTAL RENAL CARE HOLDINGS, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS--AS RESTATED Six months ended June 30, 1999 and 1998
Six months ----------------------------- 1999 1998 ------------ --------------- Cash flows from operating activities: Net income (loss)............................. $ 1,148,000 $ (50,758,000) Adjustments to reconcile net loss to net cash provided by (used in) operating activities: Depreciation and amortization............... 54,219,000 42,250,000 Extraordinary item, net of tax.............. 12,744,000 Deferred income taxes....................... (1,182,000) Provision for doubtful accounts............. 46,185,000 15,112,000 Write-off of investments and loans.......... 16,600,000 Change in accounting principle, net of tax.. 6,896,000 Compensation expense from stock option exercise................................... 16,000,000 Stock option expense........................ 114,000 2,626,000 Changes in working capital.................. (87,489,000) (74,460,000) ------------ --------------- Total adjustments......................... 29,629,000 19,986,000 ------------ --------------- Net cash provided by (used in) operating activities............................. 30,777,000 (30,772,000) ------------ --------------- Cash flows from investing activities: Purchases of property and equipment........... (61,799,000) (35,842,000) Cash paid for acquisitions, net of cash acquired..................................... (127,627,000) (216,669,000) Other......................................... (37,551,000) (26,973,000) ------------ --------------- Net cash used in investing activities... (226,977,000) (279,484,000) ------------ --------------- Cash flows from financing activities: Borrowings from bank credit facility.......... 181,875,000 1,397,000,000 Principal payments on long-term obligations... (7,237,000) (1,114,070,000) Net proceeds from sale of common stock........ 2,033,000 19,615,000 Other......................................... 2,715,000 5,395,000 ------------ --------------- Net cash provided by financing activities............................. 179,386,000 307,940,000 ------------ --------------- Net decrease in cash............................ (16,814,000) (2,316,000) Cash at beginning of period..................... 41,487,000 6,700,000 ------------ --------------- Cash at end of period........................... $ 24,673,000 $ 4,384,000 ============ ===============
See accompanying Notes to Condensed Consolidated Financial Statements and Management's Discussion and Analysis of Financial Condition and Results of Operations. 3 TOTAL RENAL CARE HOLDINGS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS 1A. Restatement of previously reported financial statements and subsequent event. Restatement Our financial statements have been restated for the three and six months ended June 30, 1998 and 1999, as summarized below. Such restatements supersede our financial statements included in Form 10-Q previously reported. Decreases (increases) to income before taxes
For the three months For the six months ended June 30, ended June 30, ---------------------- ---------------------- 1998 1999 1998 1999 ---------- ---------- ---------- ----------- To reflect goodwill adjustments associated with acquisition transactions:(1) Valuation adjustments(2).... $ (126,000) $ (69,000) $ 400,000 $ (138,000) Pre-acquisition management fees(3).................... (35,000) 138,000 852,000 102,000 Other acquisition costs..... 460,000 6,000 173,000 12,000 To recognize a calculated fair value of stock options granted to medical directors and contract labor........... 1,129,000 1,036,000 2,626,000 114,000 To reflect accounts payable accruals in the quarters the liabilities were subsequently determined to have been incurred..................... (3,800,000) ---------- ---------- ---------- ----------- Decrease (increase) to income before taxes........ $1,428,000 $1,111,000 $4,051,000 $(3,710,000) ========== ========== ========== ===========
- --------------------- (1) Adjustments include the impact on goodwill amortization associated with the goodwill adjustments. (2) Accounts receivable and other valuation adjustments originally considered to be acquisition valuation contingencies and included in goodwill have been restated to be included in results of operations. (3) Pre-acquisition management fee income has been restated to be included as acquisition consideration. 4 TOTAL RENAL CARE HOLDINGS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued) A reconciliation of the amounts previously reported for the three and six months ended June 30, 1998 and 1999 to the amounts presented in the restated consolidated financial statements is as follows:
For the three months ended ------------------------------------------------------------------------- June 30, 1998 June 30, 1999 ------------------------------------ ------------------------------------ As previously As previously reported Adjustment As restated reported Adjustment As restated ------------- ---------- ----------- ------------- ---------- ----------- (in thousands except per share) Net operating revenues.. $288,350 $288,350 $352,993 $ (174) $352,819 Operating expenses Facilities............ 183,324 $1,075 184,399 248,530 768 249,298 General and administrative....... 17,605 482 18,087 30,541 268 30,809 Provision for doubtful accounts............. 7,779 (38) 7,741 35,707 35,707 Depreciation and amortization......... 22,805 (91) 22,714 27,392 (99) 27,293 Write off of investments and loans................ 16,600 16,600 Total operating expenses............ 231,513 1,428 232,941 358,770 937 359,707 Operating income........ 56,837 (1,428) 55,409 (5,777) (1,111) (6,888) Income before extraordinary item and cumulative effect of change in accounting principle.............. 17,839 (998) 16,841 (20,982) (1,077) (22,059) Net income (loss)....... 7,907 (998) 6,909 (20,982) (1,077) (22,059) Income (loss) per common share: Income before extraordinary item and cumulative effect of change in accounting principle............ 0.22 (0.01) 0.21 (0.26) (0.01) (0.27) Extraordinary loss.... (0.12) (0.12) Cumulative effect of change in accounting principle............ Net income (loss) per share................ 0.10 (0.01) 0.09 (0.26) (0.01) (0.27) Income (loss) per common share-- assuming dilution: Income before extraordinary item and cumulative effect of change in accounting principle............ 0.22 (0.02) 0.20 (0.26) (0.01) (0.27) Extraordinary loss.... (0.12) (0.12) Cumulative effect of change in accounting principle............ Net income (loss) per share................ 0.10 (0.02) 0.08 (0.26) (0.01) (0.27)
5 TOTAL RENAL CARE HOLDINGS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For the six months ended ------------------------------------------------------------------------- June 30, 1998 June 30, 1999 ------------------------------------ ------------------------------------ As previously As previously reported Adjustment As restated reported Adjustment As restated ------------- ---------- ----------- ------------- ---------- ----------- (in thousands, except per share) Net operating revenues.. $547,099 $ (916) $546,183 $705,237 $ (174) $705,063 Operating expenses Facilities............ 350,319 2,520 352,839 483,763 (3,575) 480,188 General and administrative....... 34,515 194 34,709 53,278 (111) 53,167 Provision for doubtful accounts............. 14,542 570 15,112 46,185 46,185 Depreciation and amortization......... 42,399 (149) 42,250 54,417 (198) 54,219 Merger and related costs................ 79,435 79,435 Write off of investments and loans................ 16,600 16,600 Total operating expenses............ 521,210 3,135 524,345 654,243 (3,884) 650,359 Operating income........ 25,889 (4,051) 21,838 50,994 3,710 54,704 Income before extraordinary item and cumulative effect of change in accounting principle.............. (28,249) (2,869) (31,118) (1,041) 2,189 1,148 Net income (loss)....... (47,889) (2,869) (50,758) (1,041) 2,189 1,148 Income (loss) per common share: Income before extraordinary item and cumulative effect of change in accounting principle............ (0.35) (0.04) (0.39) (0.01) 0.02 0.01 Extraordinary loss.... (0.16) (0.16) Cumulative effect of change in accounting principle............ (0.09) (0.09) Net income (loss) per share................ (0.60) (0.04) (0.64) (0.01) 0.02 0.01 Income (loss) per common share--assuming dilution: Income before extraordinary item and cumulative effect of change in accounting principle............ (0.35) (0.04) (0.39) (0.01) 0.02 0.01 Extraordinary loss.... (0.16) (0.16) Cumulative effect of change in accounting principle............ (0.09) (0.09) Net income (loss) per share................ (0.60) (0.04) (0.64) (0.01) 0.02 0.01
June 30, 1999 December 31, 1998 ------------------------------------ ------------------------------------ As previously As previously reported Adjustment As restated reported Adjustment As restated ------------- ---------- ----------- ------------- ---------- ----------- (in thousands) Current assets.......... $ 592,513 $ 6,972 $ 599,485 $ 559,542 $ 6,972 $ 566,514 Long term assets........ 1,513,888 (10,910) 1,502,978 1,356,039 (10,934) 1,345,105 Total assets............ 2,106,401 (3,938) 2,102,463 1,915,581 (3,962) 1,911,619 Current liabilities..... 179,119 1,707 180,826 174,464 3,986 178,450 Long term liabilities, other.................. 1,447,796 1,447,796 1,259,305 1,259,305 Stockholders' equity.... 479,486 (5,645) 473,841 481,812 (7,948) 473,864 Liabilities and stockholders' equity... 2,106,401 (3,938) 2,102,463 1,915,581 (3,962) 1,911,619
6 TOTAL RENAL CARE HOLDINGS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Subsequent event Our credit facilities contain numerous financial and operating covenants. Throughout 1999 we either complied with these covenants or obtained waivers and continued to utilize these credit facilities. Based on our expectations developed as of the date of this filing regarding our fourth quarter 1999 financial results, we anticipate not being in compliance with the covenants in our credit facilities when measured as of December 31, 1999. Our anticipated inability to maintain compliance results from an expected loss for the fourth quarter of 1999, primarily due to asset impairments and valuation losses. These fourth quarter asset impairments and valuation losses include: an impairment loss for non-continental United States operations held for sale as of December 31, 1999, provision for uncollectible accounts receivable based on current collection experience, and other asset impairments and valuation losses associated with facility closures and other facility related assessments. If our lenders do not waive this failure to comply, a majority of the lenders could declare an event of default, which would allow the lenders to accelerate payment of all amounts due under our credit facilities. Additionally, this noncompliance will result in higher interest costs, and the lenders may require additional concessions from us before giving us a waiver. In the event of default under the credit facilities, the holders of our convertible subordinated notes could also declare us to be in default. We are highly leveraged, and we would be unable to pay the accelerated amounts that would become immediately payable if a default is declared. 1. In our opinion the interim financial information reflects all normal recurring adjustments which are necessary to state fairly our consolidated financial position, results of operations, and cash flows as of and for the periods indicated. We presume that users of the interim financial information have read or have access to our audited consolidated financial statements and Management's Discussion and Analysis of Financial Condition and Results of Operations for the preceding fiscal year and that the adequacy of additional disclosure needed for a fair presentation, except in regard to material contingencies or recent significant events, may be determined in that context. Accordingly, we have omitted footnote and other disclosures which would substantially duplicate the disclosures contained in our Form 10-K/A (Amendment No. 2) for the year ended December 31, 1998. We have made certain reclassifications of prior period amounts to conform to current period classifications. The interim financial information herein is not necessarily representative of a full year's operations. The information related to the activity for the three months and six months ended June 30, 1998 has been restated for certain reclassifications and adjustments. The accrued merger and related costs initially reported by us in the first six months of 1998 amounted to $92,835,000. We have revised our financial reporting relating to certain costs initially included in our merger and related costs and accrual resulting in a decrease in merger and related costs of $13,400,000, partially offset by an increase to facilities operating costs of $1,700,000 and an increase to depreciation and amortization of $590,000 for a net decrease to our first quarter 1998 operating expenses of $11,110,000 and a net increase to our second quarter 1998 operating expenses of $2,870,000. These reclassifications and adjustments are more fully described in our Form 10-K/A (Amendment No. 2) for the year ended December 31, 1998. 2. On February 27, 1998, we acquired Renal Treatment Centers, Inc., or RTC, in a merger transaction. The merger was accounted for as a pooling of interests. As a result, we restated our condensed consolidated financial statements to include RTC for all periods presented. We had no transactions with RTC prior to the combination and no adjustments were necessary to conform RTC's accounting policies to ours. 7 TOTAL RENAL CARE HOLDINGS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Merger and related costs recorded during the first six months of 1998 in connection with our merger with RTC included costs associated with certain of the integration activities, transaction costs and costs of employee severance and amounts due under employment agreements and other compensation programs. A summary of merger and related costs and accrual activity through June 30, 1999 is as follows:
Severance Direct and Costs to Transaction Employment Integrate Costs Costs Operations Total ------------ ------------ ------------ ------------ Initial expense......... $ 21,580,000 $ 41,960,000 $ 15,895,000 $ 79,435,000 Amounts utilized in 1998................... (22,885,000) (37,401,000) (13,137,000) (73,423,000) Adjustment of estimates.............. 1,305,000 (959,000) (1,593,000) (1,247,000) ------------ ------------ ------------ ------------ Accrual, December 31, 1998................... $ -- 3,600,000 1,165,000 4,765,000 ============ Amounts utilized--1st quarter 1999........... (600,000) (90,000) (690,000) ------------ ------------ ------------ Accrual, March 31, 1999................... 3,000,000 1,075,000 4,075,000 Amounts utilized--2nd quarter 1999........... (90,000) (90,000) ------------ ------------ ------------ Accrual, June 30, 1999.. $ 3,000,000 $ 985,000 $ 3,985,000 ============ ============ ============
The remaining balance of severance and employment costs represents tax gross- up payments expected to be paid by the end of 1999. The remaining balance of costs to integrate operations represents remaining lease payments on RTC's vacant laboratory lease space. 3. During the six months ended June 30, 1999, we purchased 35 centers and additional interests from minority partners in certain of our partnerships. Total cash consideration for these transactions was approximately $127.6 million. We accounted for these transactions under the purchase method. The cost of these acquisitions has been allocated primarily to intangible assets such as patient charts, noncompete agreements and goodwill to the extent the purchase price exceeds the value of the tangible assets, primarily capital equipment. The assets and liabilities of the acquired centers were recorded at their estimated fair market values at the dates of acquisition. The initial allocations of fair market value are preliminary and subject to adjustment. The results of operations of the facilities have been included in our financial statements from their respective effective acquisition dates. The results of operations on a pro forma basis, as though the above acquisitions had been combined with us at the beginning of each period presented for the six months ended June 30, are as follows:
1999 1998 ------------ ------------ Pro forma net operating revenues................ $718,206,000 $575,789,000 Pro forma income (loss) before extraordinary item and cumulative effect of change in accounting principle........................... $ 1,825,000 $(29,905,000) Pro forma net income (loss)..................... $ 1,825,000 $(49,545,000) Pro forma income (loss) per share before extraordinary item and cumulative effect of change in accounting principle: Basic......................................... $ 0.02 $ (0.38) Assuming dilution............................. $ 0.02 $ (0.38)
4. In March 1998, Statement of Position No. 98-1, Accounting for the Cost of Computer Software Developed or Obtained for Internal Use, or SOP 98-1, was issued. We adopted SOP 98-1 in the first quarter of 8 TOTAL RENAL CARE HOLDINGS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued) 1999, effective January 1, 1999. SOP 98-1 defines internal-use software and identifies whether internal-use software costs that we incur must be expensed or capitalized. Costs that should be capitalized include external direct costs of materials and services, payroll and payroll related costs for employees directly associated with the internal-use software projects and certain interest costs incurred in the application development stage. All other internal-use software costs are expensed as incurred. The impact of the adoption of SOP 98-1 was not material to our operations. In April 1998, Statement of Position No. 98-5, Reporting on the Costs of Start-up Activities, or SOP 98-5, was issued. We adopted SOP 98-5 effective January 1, 1998. SOP 98-5 requires that pre-opening and organization costs, incurred in conjunction with facility pre-opening activities, which previously had been treated as deferred costs and amortized over five years, should be expensed as incurred. As a result of the adoption of SOP 98-5, all remaining unamortized pre-opening, development and organizational costs existing prior to January 1, 1998 of $11,196,000 were recognized, net of tax of $4,300,000, as the cumulative effect of a change in accounting principle in the first quarter of 1998. 5. The reconciliation of the numerators and denominators used to calculate earnings (loss) per common share for all periods presented is as follows:
Three months ended Six months ended June 30, June 30, ------------------------- ------------------------- 1999 1998 1999 1998 ------------ ----------- ----------- ------------ Income (loss) before extraordinary item and cumulative effect of change in accounting principle.............. $(22,059,000) $16,841,000 $ 1,148,000 $(31,118,000) Extraordinary loss, net of tax................. 9,932,000 12,744,000 Cumulative effect of change in accounting principle, net of tax.. 6,896,000 ------------ ----------- ----------- ------------ Income (loss)--assuming dilution............... $(22,059,000) $ 6,909,000 $ 1,148,000 $(50,758,000) ============ =========== =========== ============ Applicable common shares Average outstanding during the period.... 81,176,000 80,724,000 81,149,000 79,703,000 Reduction in shares in connection with notes receivable from employees.............. (27,000) (10,000) (24,000) (11,000) ------------ ----------- ----------- ------------ Weighted average number of shares outstanding for use in computing earnings per share..... 81,149,000 80,714,000 81,125,000 79,692,000 Dilutive effect of outstanding stock options................ 1,670,000 894,000 ------------ ----------- ----------- ------------ Weighted average number of shares and equivalents outstanding for use in computing earnings per share-- assuming dilution...... 81,149,000 82,384,000 82,019,000 79,692,000 ============ =========== =========== ============ Earnings (loss) per common share: Income (loss) per common share before extraordinary item and cumulative effect of change in accounting principle............ $ (0.27) $ 0.21 $ 0.01 $ (0.39) Extraordinary loss, net of tax........... (0.12) (0.16) Cumulative effect of change in accounting principle, net of tax.................. (.09) ------------ ----------- ----------- ------------ Net income (loss) per common share........... $ (0.27) $ 0.09 $ 0.01 $ (0.64) ============ =========== =========== ============ Earnings (loss) per common share--assuming dilution: Income (loss) before extraordinary item and cumulative effect of change in accounting principle............ $ (0.27) $ 0.20 $ 0.01 $ (0.39) Extraordinary loss, net of tax........... (0.12) (0.16) Cumulative effect of change in accounting principle, net of tax.................. (0.09) ------------ ----------- ----------- ------------ Net income (loss) per common share--assuming dilution............... $ (0.27) $ 0.08 $ 0.01 $ (0.64) ============ =========== =========== ============
9 TOTAL RENAL CARE HOLDINGS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued) The effect of RTC's 5 5/8% convertible subordinated notes due 2006 and our 7% convertible notes due 2009 were anti-dilutive for all periods presented. 6. In conjunction with the refinancing of our credit facilities, our two existing forward interest rate swap agreements with notional amounts of $100,000,000 and $200,000,000 were canceled in April 1998. The loss associated with the early cancellation of these swaps was approximately $9,823,000. During the quarter ended June 30, 1998, we entered into forward interest rate cancelable swap agreements, with a combined notional amount of $800,000,000. The lengths of the agreements are between three and ten years with cancellation clauses at the swap holders' option from one to seven years. The underlying blended rate is fixed at approximately 5.65% plus an applicable margin based upon our current leverage ratio. At June 30, 1999, the effective interest rate for borrowings under the swap agreements was 8.53%. During the second quarter of 1999, we received notification from two of our swap agreement counterparties that they had exercised their right to cancel agreements in the aggregate notional amount of $100,000,000. The remaining $700,000,000 of swap agreements with maturities from the years 2003 through 2008 and cancellation option dates from the years 2001 through 2005 are still in effect. 7. In June 1996, RTC issued $125,000,000 of 5 5/8% convertible subordinated notes due 2006. These notes are convertible, at the option of the holder, at any time after August 12, 1996 through maturity, unless previously redeemed or repurchased, into our common stock at a conversion price of $25.62 principal amount per share, subject to certain adjustments. All or any part of these notes are redeemable at our option on at least 15 and not more than 60 days' notice as a whole or, from time to time, in part at redemption prices ranging from 103.94% to 100% of the principal amount thereof, depending on the year of redemption, together with accrued interest to, but excluding, the date fixed for redemption. TRCH has guaranteed these notes. 10 TOTAL RENAL CARE HOLDINGS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued) The following is summarized financial information of RTC:
June 30, December 31, 1999 1998 ------------ ------------ Cash and cash equivalents......................... $ 746,000 $ 5,396,000 Accounts receivable, net.......................... 131,912,000 130,129,000 Other current assets.............................. 20,348,000 19,106,000 ------------ ------------ Total current assets............................ 153,006,000 154,631,000 Property and equipment, net....................... 92,990,000 75,641,000 Intangible assets, net............................ 416,867,000 406,603,000 Other assets...................................... 8,241,000 9,249,000 ------------ ------------ Total assets.................................... $671,104,000 $646,124,000 ============ ============ Current liabilities (includes intercompany payable to TRCH of $278,452,000 and $306,628,000, respectively).................................... $368,604,000 $354,489,000 Long-term debt.................................... 128,495,000 125,199,000 Stockholder's equity.............................. 174,005,000 166,436,000 ------------ ------------ Total liabilities and stockholder's equity...... $671,104,000 $646,124,000 ============ ============
Three months ended Six months ended June 30, June 30, ------------------------- ------------------------- 1999 1998 1999 1998 ------------ ------------ ------------ ------------ Net operating revenues... $125,900,000 $123,990,000 $246,302,000 $238,651,000 Total operating expenses................ 112,119,000 99,858,000 226,360,000 236,465,000 ------------ ------------ ------------ ------------ Operating income......... 13,781,000 24,132,000 19,942,000 2,186,000 Interest expense, net.... 1,745,000 1,201,000 3,547,000 4,789,000 ------------ ------------ ------------ ------------ Income before income taxes................... 12,036,000 22,931,000 16,395,000 (2,603,000) Income taxes............. 4,814,000 4,996,000 8,855,000 7,028,000 ------------ ------------ ------------ ------------ Income (loss) before extraordinary item and cumulative effect of change in accounting principle............. $ 7,222,000 $ 17,935,000 $ 7,540,000 $ (9,631,000) ============ ============ ============ ============
8. In November 1998, we issued $345,000,000 of 7% convertible subordinated notes due 2009, or the 7% notes, in a private placement offering. The 7% notes are convertible, at the option of the holder, at any time into our common stock at a conversion price of $32.81 per share. We may redeem the 7% notes on or after November 15, 2001. The 7% notes are general, unsecured obligations junior to all of our existing and future senior debt and, effectively, all existing and future liabilities of us and our subsidiaries. 11 TOTAL RENAL CARE HOLDINGS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued) We subsequently filed a registration statement covering the resale of the 7% notes which has not yet been declared effective by the SEC. As further described in the registration statement, commencing May 18, 1999, we are accruing certain monetary penalties on a weekly basis until the registration statement is declared effective, as follows:
Days following Weekly Cumulative 180 days after closing Penalty Penalty ---------------------- ------- ---------- 0-90..................... $17,250 $ 207,000 91-180................... 34,500 656,000 181-270.................. 51,750 1,328,000 271-360.................. 69,000 2,225,000 Thereafter............... 86,250
Payment of these accrued penalties is due upon the next interest due date. The accrued penalty as of June 30, 1999 was $103,500. 9. Contingencies Our Florida-based laboratory subsidiary is the subject of a third-party carrier review relating to certain claims submitted by us for Medicare reimbursement. We understand that similar reviews have been undertaken with respect to other providers' laboratory activities in Florida and elsewhere. The carrier has alleged that approximately 97% of the tests performed by this laboratory for the review periods the carrier has identified, from January 1995 to April 1996, and May 1996 to March 1998, were not properly supported by the prescribing physicians' medical justification. The carrier has issued formal overpayment determinations in the amount of $5.6 million for the review period from January 1995 to April 1996 and $14.2 million for the review period from May 1996 to March 1998. The carrier also has suspended all payments of claims related to this laboratory, regardless of when the laboratory performed the tests. From the beginning of the suspension through June 30, 1999, the carrier has withheld approximately $23 million. In addition the carrier has informed the local offices of the Department of Justice, or DOJ, and the Department of Health and Human Services, or HHS, of this matter, and we are cooperating with DOJ and HHS. We have consulted with outside counsel, reviewed our records, are disputing the overpayment determinations vigorously and have provided extensive supporting documentation of our claims. We have cooperated with the carrier to resolve this matter and have initiated the process of a formal review of the carrier's determinations. The first step in this formal review process is a hearing before a hearing officer at the carrier. The hearing regarding the initial review period from January 1995 to April 1996 was held in late July 1999. We expect the hearing officer to render a decision by mid-November 1999. We have received minimal responses from the carrier to our repeated requests for clarification and information regarding the continuing payment suspension. In February 1999, our Florida-based laboratory subsidiary filed a complaint against the carrier and HHS seeking a court order to lift the payment suspension. We initiated this action only after serious consideration and the unanimous approval of our board of directors, and we believed it was necessary to bring a prompt resolution to this payment dispute. The court dismissed our complaint because we did not exhaust all administrative remedies. We are unable to determine at this time: . When this matter will be resolved or when this laboratory's payment suspension will be lifted; . What, if any, of this laboratory's claims will be disallowed; 12 TOTAL RENAL CARE HOLDINGS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued) . What action the carrier, DOJ or HHS may take with respect to this matter; . Whether additional periods may be reviewed by the carrier; or . Any other outcome of this investigation. Any determination adverse to us could have an adverse impact on our business, results of operations, financial condition, or cash flows. Following the announcement on February 18, 1999 of our preliminary results for the fourth quarter of fiscal 1998 and the full year then ended, several class action lawsuits were filed against us and certain of our officers in the U.S. District Court for the Central District of California. The complaints are similar and allege violations of federal securities laws arising from alleged false and misleading statements primarily regarding our accounting for the integration of RTC into TRCH and request unspecified monetary damages. The lawsuits have been consolidated into a single action. We believe that all of the claims are without merit and we intend to defend ourselves vigorously. We anticipate that the attorneys' fees and related costs of defending these lawsuits should be covered primarily by our directors and officers insurance policies and we believe that any additional costs will not have a material impact on our financial condition, results of operations or cash flows. In addition, we are subject to claims and suits in the ordinary course of business for which we believe most will be covered by insurance. We do not believe that the ultimate resolution of these additional pending proceedings, whether the underlying claims are covered by insurance or not, will have a material adverse effect on our financial condition, results of operations or cash flows. 10. Subsequent to June 30, 1999 the lenders under our credit facilities have waived compliance with a financial covenant that requires us to maintain a specified leverage ratio. This waiver expires March 15, 2000. The lenders also have waived our violation of a covenant that placed a limit on our aggregate borrowings for international acquisitions, which we had exceeded. The terms of the waiver: . Reduce our permitted borrowings under the revolving credit facility from $950,000,000 to $650,000,000 during the waiver period; . Commencing after July 1, 1999, limit the amount of additional borrowings that we may use for acquisitions, de novo developments and expansion or relocation of existing dialysis centers; . Accelerated the maturity dates on the term loan and revolving credit facilities by two years, to March 31, 2006 and March 31, 2003, respectively; and . Increased the applicable margins used to determine the interest rates for our borrowings under the credit facilities. Other than the issues specifically addressed in the waiver agreement, all other covenants and conditions of the credit facilities remain unchanged. The outstanding balances on our term loan and revolving credit facilities at June 30, 1999 were $396,000,000 and $533,500,000, respectively. As modified by the waiver agreement, borrowings under the credit facilities generally bear interest at one of two floating rates selected by us: . The Alternate Base Rate, defined as the higher of The Bank of New York's prime rate or the federal funds rate plus 0.5%, plus a margin ranging from 0% to 1.5% for borrowings under the revolving credit facility and 1.0% to 1.75% for borrowings under the term loan facility; or . Adjusted LIBOR, defined as the 30-, 60-, 90- or 180-day London Interbank Offered Rate, adjusted for statutory reserves, plus a margin ranging from 1.25% to 2.75% for borrowings under the revolving credit facility and 2.25% to 3.00% for borrowings under the term loan facility. 13 TOTAL RENAL CARE HOLDINGS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued) The applicable margin used in determining the interest rate is based on our leverage ratio. Currently, the applicable margin is at the top of the ranges listed above. 11. On July 1, 1999, we completed an acquisition of seven dialysis facilities for consideration of approximately $17,500,000. 12. Notes receivable and other long term assets, which are associated with dialysis businesses, consisted of the following:
June 30, 1999 December 31, 1998 ------------- ----------------- Operating advances to managed facilities... $32,588,000 Notes receivable, less allowance of $9,415,000 and $0......................... 25,082,000 $29,257,000 Equity investments......................... 10,787,000 7,323,000 Other...................................... 11,034,000 1,688,000 ----------- ----------- $79,491,000 $38,268,000 =========== ===========
Operating advances to managed facilities are generally unsecured and interest bearing under the terms of the applicable management agreements. The notes receivable are due commencing in 2001, bear interest at the prime rate plus 1.5%, are convertible into equity of these businesses and are secured by assets of the respective businesses. The equity investments are accounted for under the equity method of accounting for businesses in which we own at least a 20% interest and have significant influence over the businesses. The remaining investments are accounted for under the cost method. During the second quarter of 1999, we provided an allowance of $5,315,000 against notes receivable and wrote off a $5,000,000 equity investment balance associated with one business that was unable to obtain additional financing as planned that was necessary to meet its operating goals and commitments. We do not expect recovery of these amounts, even through a bankruptcy process. We also increased the allowance for notes receivable by $4,100,000 for other accounts based on our reviews of the respective businesses' financial performance and projected operating results. We conducted these reviews because of the deteriorating financial results of these businesses as of this time. The remaining net balances represent our best estimate of ultimate recoveries based on the underlying assets and projected cash flows. We will not accrue interest on these balances unless the estimated recovery amounts justify such accruals in the future. The second quarter write-offs included the above charges as well as $2,185,000 of software acquisition costs associated with a planned software operating system that we terminated and abandoned in the second quarter of 1999. We will review the adequacy of the notes receivable allowance and the equity investments for further possible impairments as events or circumstances indicate that additional valuation adjustments may be necessary. 14 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations. As described in Note 2 to our condensed consolidated financial statements, we acquired Renal Treatment Centers, Inc., or RTC, on February 27, 1998 in a merger accounted for as a pooling of interests. Accordingly, our condensed consolidated financial statements have been restated to include RTC for all periods presented. The information related to the activity for the three months and six months ended June 30, 1998 has been restated for certain reclassifications and adjustments. The accrued merger and related costs initially reported by us in the first and second quarters of 1998 amounted to $92,835,000. We have revised our financial reporting relating to certain costs initially included in our merger and related costs and accrual resulting in a decrease in merger and related costs of $13,400,000, partially offset by an increase to facilities operating costs of $1,700,000 and an increase to depreciation and amortization of $590,000 for a net decrease to our first quarter 1998 operating expenses of $11,110,000 and a net increase to our second quarter 1998 operating expenses of $2,870,000. These reclassifications and adjustments are more fully described in our Form 10-K/A (Amendment No. 2) for the year ended December 31, 1998. Net operating revenues Net operating revenues are derived primarily from five sources: (a) outpatient facility hemodialysis services; (b) ancillary services, including the administration of erythropoetin, or EPO, and other intravenous pharmaceuticals, clinical laboratory services, oral pharmaceutical products and other ancillary services; (c) home dialysis services and related products; (d) inpatient hemodialysis services provided to hospitalized patients pursuant to arrangements with hospitals; and (e) international operations. Additional revenues are derived from the provision of dialysis facility management services to certain subsidiaries and affiliated and unaffiliated dialysis centers. Our dialysis and ancillary services are reimbursed primarily under the Medicare ESRD program in accordance with rates established by HCFA. Payments are also provided by other third party payors, generally at rates higher than those reimbursed by Medicare for up to the first 33 months of treatment as mandated by law. Rates paid for services provided to hospitalized patients are negotiated with individual hospitals. We maintain a usual and customary fee schedule for our dialysis treatment and other patient services. We often do not realize our usual and customary rates, however, because of negotiated limitations on the amounts we can bill to or collect from the payors for our services. We generally bill the Medicare and Medicaid programs at net realizable rates determined by applicable fee schedules for these programs, which are established by statute or regulation. We bill most non-governmental payors, including managed care payors with which we have contracted, at our usual and customary rates. Since we bill most non- governmental payors at our usual and customary rates, but often expect to receive payments at the lower contracted rates, we also record a contractual allowance in order to record expected net realizable revenue for services provided. This process involves estimates and we record revisions to these estimates in subsequent periods as they are determined to be necessary. Results of operations Three months ended June 30, 1999 compared to the three months ended June 30, 1998 Net operating revenues. Net operating revenues increased $64,469,000 to $352,819,000 in the second quarter of 1999 from $288,350,000 in the second quarter of 1998, representing a 22% increase. Of this increase, $68,087,000 was due to increased treatments, of which $51,840,000 was from acquisitions consummated after the second quarter of 1998, $20,354,000 was from de novo developments commencing operations after the second quarter of 1998 and the remainder was from existing facilities as of June 30, 1998. The difference between the $68,087,000 described above and the total change of $64,469,000 resulted from an overall decrease in net operating revenues per treatment which decreased from $243.01 in the second quarter of 1998 to $240.54 in the second quarter of 1999. This decrease in net operating revenue per treatment primarily was attributable to a $17,843,000 overall decline in the rates we receive for our dialysis services. The decline in 15 rates is the result of increasing our contractual allowances, primarily related to billings from our Tacoma office, to reflect recent trends in collection experience as further described under "Provision for doubtful accounts" below. This decline was partially offset by an increase in ancillary services intensity and pricing of $11,390,000, primarily in the administration of EPO of $11,160,000, an increase of $460,000 in corporate and ancillary program fees, primarily from the expansion of laboratory services to former RTC facilities of $443,000; and an increase in non-patient services revenue of $2,375,000 from the increase in dialysis facility management services to facilities that we do not own or control. Facility operating expenses. Facility operating expenses consist of costs and expenses specifically attributable to the operation of dialysis facilities, including operating and maintenance costs of such facilities, equipment, direct labor, and supply and service costs relating to patient care. Facility operating expenses increased $64,899,000 to $249,298,000 in the second quarter of 1999 from $184,399,000 in the second quarter of 1998 and as a percentage of net operating revenues, facility operating expenses increased to 70.7% in the second quarter of 1999 from 63.9% in the second quarter of 1998. This increase was primarily attributable to increased usage in EPO and other medical supplies and the impact of a lower net revenue per treatment. Additionally, during the second quarter of 1999, a provision of $4,500,000 was recorded for the resolution of claims made by pharmaceutical and medical supply vendors. We had conducted a comprehensive search for potentially unrecorded liabilities, including requesting complete vendor statements from vendors who had not previously provided them to us. Some claims provided by the vendors related to acquired businesses or did not correspond to our records and therefore required extensive research and investigation. The amount of the provision was less than the estimate of $8,000,000 to $10,000,000 that we disclosed in our July 18, 1999 press release. In the press release, we disclosed the maximum possible provision that we expected we might need to record. After the press release, we continued our analysis of these vendor claims and settlement activities. Substantial amounts of these claims were resolved in our favor. General and administrative expenses. General and administrative expenses include headquarters expense and administrative, legal, quality assurance, information systems and centralized accounting support functions. General and administrative expenses increased $12,722,000 to $30,809,000 in the second quarter of 1999 from $18,087,000 in the second quarter of 1998 and as a percentage of net operating revenues, general and administrative expenses increased to 8.7% in the second quarter of 1999 from 6.3% in the second quarter of 1998. This increase was primarily attributable to increased staff at both our business and corporate offices and the impact of a lower net revenue per treatment. Additionally, general and administrative expense for the second quarter of 1999 includes approximately $2,500,000 of expenses related to costs of business purchase transactions we will not consummate and operating costs associated with a corporate jet we are no longer using. Provision for doubtful accounts. The provision for doubtful accounts is influenced by the amount of net operating revenues generated from all payor sources in addition to the relative percentage of accounts receivable by aging category and collection trends. The provision for doubtful accounts increased by $27,966,000 to $35,707,000 in the second quarter of 1999 from $7,741,000 in the second quarter of 1998. As a percentage of net operating revenues, the provision for doubtful accounts increased to 10.1% in the second quarter of 1999 from 2.7% in the second quarter of 1998. This is primarily a result of a $24,000,000 increase in the provision for doubtful accounts relating to patient accounts receivable billed from our Tacoma business office. Our Tacoma office collection practices had not kept pace with the growth of our business and receivables have aged, causing them to be more difficult to collect. During the second quarter of 1999 we identified large amounts of old accounts receivable balances from our Tacoma office that were continuing to age without significant reduction. This caused us to reassess the adequacy of our provision for these balances. During 1997 and 1998, our rapid growth and the associated increase in the volume of our third party payors and the complexity of our relationships with them put many of the processes that had been successful on a smaller scale in prior periods under increased pressure. Additionally, the billing system used in our Tacoma office during 1997 and 1998 required more estimates and individual biller judgment than the current system. Our continual monitoring subsequently revealed that these events and circumstances were impacting the earlier estimates of our ability to collect these balances. 16 As of July 1999, we have transitioned all of our domestic accounts receivable billings and collections to a more automated system that requires less biller judgment and organizes billers into major payor categories, which allows specialization by payor. This is an updated version of the system that has been in use at our Berwyn office since our merger with RTC. Furthermore, we have placed an increased emphasis on initial and ongoing training for all of our patient accounting employees. We continually assess the adequacy of the provision for doubtful accounts. We will recognize adjustments to those amounts, as additional information becomes available to us based upon current collection trends. Depreciation and amortization. Depreciation and amortization increased $4,579,000 to $27,293,000 in the second quarter of 1999 from $22,714,000 in the second quarter of 1998. As a percentage of net operating revenues, depreciation and amortization decreased slightly to 7.7% in the second quarter of 1999 from 7.9% in the second quarter of 1998. Write-off of investments. Write-off of investments and loans recorded in the second quarter of 1999 of $16,600,000 represents allowances provided for loans to, and investments in, several dialysis related businesses. The amount of the write-offs increased from our previous estimate of $10 million in our July 18, 1999 press release because: . Upon further investigation of one of these investments, we determined that we did not expect the investment to have any value because the business was unable to raise additional capital as planned; . We made a decision not to utilize software acquired from one of these entities resulting in $2,185,000 of additional write-offs; and . Upon review of other loans to dialysis related businesses, we identified additional loans requiring allowances. Operating income (loss). Operating results decreased $62,297,000 to an operating loss of $6,888,000 in the second quarter of 1999 from an operating income of $55,409,000 in the second quarter of 1998. As a percentage of net operating revenues, operating results decreased to an operating loss of 2.0% in the second quarter of 1999 from an operating income of 19.2% in the second quarter of 1998 primarily due to the increases in both facility operating and general and administrative expenses and the additions to the valuation allowances for patient accounts receivables and the write-off of loans to, and investments in, dialysis related businesses as described above. Interest expense. Interest expense increased $7,826,000 to $24,370,000 in the second quarter of 1999 from $16,544,000 in the second quarter of 1998. The increase in interest expense primarily was due to an increase in borrowings made under our credit facilities to fund acquisitions. Interest rate swap-early termination costs. In conjunction with the refinancing of our credit facilities, two existing forward interest swap agreements were canceled in April 1998. The early termination costs associated with the cancellation of those swaps was $9,823,000. Interest income and other. Interest income is generated as a result of the short-term investment of surplus cash from operations and excess proceeds from borrowings under our credit facilities. Other income is income generated by unconsolidated partnerships. Interest income and other increased by $912,000 to $1,934,000 in the second quarter of 1999 from $1,022,000 in the second quarter of 1998. Provision for income taxes. Provision for income taxes decreased $21,444,000 to a benefit of $9,786,000 for the second quarter of 1999 from an expense of $11,658,000 in the second quarter of 1998. The effective tax rate was a benefit of 30.6% for the second quarter of 1999 compared to 46.0% in the second quarter of 1998, after minority interest. The change in the effective tax rate primarily was due to $3.8 million from the non-deductible amortization of intangible assets spread over a smaller pre-tax base. Before consideration of these permanent tax differences, the consolidated effective tax rate benefit was 34.7%, after minority interests. 17 Minority interests. Minority interests represent the pretax income earned by minority partners who directly or indirectly own minority interests in our partnership affiliates and the net income in certain of our corporate subsidiaries. Minority interests increased $956,000 to $2,521,000 from $1,565,000 in the second quarter of 1998. As a percentage of net operating revenues, minority interest increased slightly to 0.7% in the second quarter of 1999 from 0.5% in the second quarter of 1998. Extraordinary loss. In the second quarter of 1998 in conjunction with refinancing our credit facilities, we recorded all of the remaining related unamortized deferred financing costs as an extraordinary loss of $9,932,000, net of income tax effect. Six months ended June 30, 1999 compared to the six months ended June 30, 1998 Net operating revenues. Net operating revenues increased $158,880,000 to $705,063,000 in the six months ended June 30, 1999 from $546,183,000 in the six months ended June 30, 1998, representing a 29.1% increase. Of this increase, $136,865,000 was due to increased treatments, of which $85,845,000 was from acquisitions consummated after the six months ended June 30, 1998, $35,698,000 was from de novo developments commencing operations after the six months ended June 30, 1998 and $15,322,000 was from existing facilities as of June 30, 1998. The remaining increase of $22,015,000 resulted from an increase in net operating revenues per treatment which increased from $238.90 in the six months ended June 30, 1998 to $246.68 in the six months ended June 30, 1999. The increase in net operating revenue per treatment was mainly attributable to an increase in ancillary services intensity and pricing of $28,999,000, primarily in the administration of EPO of $26,203,000, an increase in corporate and ancillary program fees of $5,207,000, primarily from the expansion of laboratory services to former RTC facilities of $3,680,000, an increase in non- patient services revenue of $3,381,000 from the increase in dialysis facility management services to facilities that we do not own or control, and an offsetting decrease in our net operating revenue per treatment of $15,392,000, as a result of increasing our contractual allowances primarily related to billings from our Tacoma office to reflect recent trends in collection experience as discussed above. Facility operating expenses. Facility operating expenses increased $127,349,000 to $480,188,000 in the six months ended June 30, 1999 from $352,839,000 in the six months ended June 30, 1998 and as a percentage of net operating revenues, facility operating expenses increased to 68.1% in the six months ended June 30, 1999 from 64.6% in the six months ended June 30, 1998. This increase was primarily attributable to increased usage in EPO and other medical supplies and the impact of a lower net revenue per treatment. Additionally, during the second quarter of 1999, a provision of $4,500,000 was recorded for the resolution of claims made by vendors, as discussed above. General and administrative expenses. General and administrative expenses increased $18,458,000 to $53,167,000 in the six months ended June 30, 1999 from $34,709,000 in the six months ended June 30, 1998 and as a percentage of net operating revenues, general and administrative expenses increased to 7.5% in the six months ended June 30, 1999 from 6.4% in the six months ended June 30, 1998. This increase was primarily attributable to increased staff at both our business and corporate offices and the impact of a lower net revenue per treatment. Additionally, general and administrative expense for the six months ended June 30, 1999 includes approximately $2,500,000 of expenses related to costs of business purchase transactions which we will not consummate and operating costs associated with a corporate jet we are no longer using. Provision for doubtful accounts. The provision for doubtful accounts increased $31,073,000 to $46,185,000 in the six months ended June 30, 1999 from $15,112,000 in the six months ended June 30, 1998. As a percentage of net operating revenues, the provision for doubtful accounts increased to 6.6% in the six months ended June 30, 1999 from 2.8% in the six months ended June 30, 1998. This is primarily a result of the $24,000,000 increase in the provision for doubtful accounts relating to collectibility problems of patient accounts receivable billed from our Tacoma business office, as discussed above. 18 Depreciation and amortization. Depreciation and amortization increased $11,969,000 to $54,219,000 in the six months ended June 30, 1999 from $42,250,000 in the six months ended June 30, 1998. As a percentage of net operating revenues, depreciation and amortization was 7.7% in both six month periods. Write-off of investments. Write-off of investments and loans recorded in the six months ended June 30, 1999 of $16,600,000 represents allowances provided for loans to, and investments in, several dialysis related businesses, which we are unlikely to recover as a result of recent deterioration in the financial condition of these businesses, as discussed above. Merger and related costs. Merger and related costs recorded during the six months ended June 30, 1998 include costs associated with certain integration activities, transaction costs and costs of employee severance and amounts due under employment agreements and other compensation programs, in connection with our merger with RTC. A summary of merger and related costs and accrual activity through June 30, 1999 is as follows:
Direct Transaction Severance and Costs to Integrate Costs Employment Costs Operations Total ------------------ ---------------- ------------------ ------------ Initial expense......... $ 21,580,000 $ 41,960,000 $ 15,895,000 $ 79,435,000 Amounts utilized in 1998................... (22,885,000) (37,401,000) (13,137,000) (73,423,000) Adjustment of estimates.............. 1,305,000 (959,000) (1,593,000) (1,247,000) ------------ ------------ ------------ ------------ Accrual, December 31, 1998................... $ -- 3,600,000 1,165,000 4,765,000 ============ Amounts utilized--1st quarter 1999........... (600,000) (90,000) (690,000) ------------ ------------ ------------ Accrual, March 31, 1999................... 3,000,000 1,075,000 4,075,000 Amounts utilized--2nd quarter 1999........... (90,000) (90,000) ------------ ------------ ------------ Accrual, June 30, 1999................... $ 3,000,000 $ 985,000 $ 3,985,000 ============ ============ ============
The remaining balance of severance and employment costs represents tax gross- up payments expected to be paid by the end of the year. The remaining balance of costs to integrate operations represents remaining lease payments on RTC's vacant laboratory lease space. Operating income. Operating income decreased $46,569,000 to $54,704,000 in the six months ended June 30, 1999 from $101,273,000, before merger and related costs, in the six months ended June 30, 1998. As a percentage of net operating revenues, operating income before merger and related costs decreased to 7.8% in the six months ended June 30, 1999 from 18.5% in the six months ended June 30, 1998. This decrease was primarily attributable to increases in both facility operating and general and administrative expenses and the additions to valuation allowances for patient accounts receivable and the write-off of loans and investments in dialysis related businesses. Interest expense. Interest expense increased $16,076,000 to $47,137,000 in the six months ended June 30, 1999 from $31,061,000 in the six months ended June 30, 1998. The increase in interest expense primarily was due to an increase in borrowings made under our credit facilities to fund acquisitions. Interest rate swap-early termination costs. In conjunction with the refinancing of our credit facilities, two existing forward interest swap agreements were canceled in April 1998. The early termination costs associated with the cancellation of those swaps was $9,823,000. Interest income and other. Interest income and other increased $600,000 to $3,264,000 in the six months ended June 30, 1999 from $2,664,000 in the six months ended June 30, 1998 and as a percentage of net operating revenues, interest income and other was 0.5% for both periods. 19 Provision for income taxes. Provision for income taxes decreased $6,934,000 to $4,844,000 for the six months ended June 30, 1999 from $11,778,000 in the six months ended June 30, 1998. The effective tax rate was 81.7% for the six months ended June 30, 1999 compared to 41.2% in the six months ended June 30, 1998, after minority interest but before merger and related costs. The change in the effective tax rate primarily was due to $5.8 million from the non- deductible amortization of intangible assets spread over a smaller pre-tax income base. Before consideration of these permanent tax differences, the consolidated effective tax rate was 41.5%, after minority interests. Minority interests. Minority interests increased $1,881,000 to $4,839,000 in the six months ended June 30, 1999 from $2,958,000 in the six months ended June 30, 1998. As a percentage of net operating revenues, minority interest increased slightly to 0.7% in the six months ended June 30, 1999 from 0.5% in the six months ended June 30, 1998. Extraordinary loss. In February 1998, in conjunction with our merger with RTC, we terminated the RTC revolving credit agreement, and recorded all of the remaining related unamortized deferred financing costs as an extraordinary loss of $2,812,000, net of income tax effect. In April 1998, in conjunction with refinancing our credit facilities, we also recorded all of the remaining related unamortized deferred financing costs as an extraordinary loss of $9,932,000, net of income tax effect. Cumulative effect of change in accounting principle. Effective January 1, 1998, we adopted Statement of Position No. 98-5, Reporting on the Costs of Start-up Activities, or SOP 98-5. SOP 98-5 requires that pre-opening and organizational costs, incurred in conjunction with our pre-opening activities on our de novo facilities, which previously had been treated as deferred costs and amortized over five years, should be expensed as incurred. In connection with the adoption of SOP 98-5, we recorded a charge of $6,896,000, net of income tax effect as a cumulative effect of a change in accounting principle. Liquidity and capital resources Sources and uses of cash Our primary capital requirements have been the funding of our growth through acquisitions and de novo developments, and equipment purchases. Net cash provided by operating activities was $30.8 million for the first six months of 1999 and net cash used in operating activities was $30.8 million for the first six months of 1998. Net cash provided by operating activities consists of our net income (loss), increased by non-cash expenses such as depreciation, amortization, non-cash interest and the provision for doubtful accounts, and adjusted by changes in components of working capital, primarily accounts receivable. Accounts receivable, net of allowance for doubtful accounts, increased during the first six months of 1999 by $27.8 million, of which approximately $12.0 million was due to the continuance of the payment suspension imposed on our Florida-based laboratory by its Medicare carrier, cumulatively $23 million. The remaining $15.8 million primarily was due to the increase in our net operating revenues. We have recorded no allowances as a result of the payment suspension imposed on our Florida-based laboratory because we believe that we will ultimately collect these amounts. Until it is resolved, the payment suspension will negatively impact our cash flows from operations and may require us to borrow additional amounts to fund our working capital needs, depending on our other cash flows. Net cash used in investing activities was $227.0 million for the first six months of 1999 and $279.5 million for the first six months of 1998. Our principal uses of cash in investing activities have been related to acquisitions, purchases of new equipment and leasehold improvements for our facilities, as well as the development of new facilities. Net cash provided by financing activities was $179.4 million for the first six months of 1999 and $307.9 million for the first six months of 1998 primarily consisting of borrowings from our credit facilities. The decreases in net cash used in investing activities and in net cash provided by financing activities were due to our completing fewer acquisitions in the first six months of 1999 as compared to the first six months of 1998. As of June 30, 1999, we had working capital of $418.7 million, including cash of $24.7 million. 20 We believe that we will have sufficient liquidity to fund our debt service obligations over at least the next twelve months. Expansion In the six months ended June 30, 1999, we developed ten new facilities, four of which we do not own but we manage, and we expect to develop approximately 18 additional de novo facilities in the remainder of 1999. We anticipate that our capital requirements for purchases of equipment and leasehold improvements for facilities, including de novo facilities, will be approximately $60 to $70 million in aggregate for the remaining six months of 1999. During the six months ended June 30, 1999, we paid cash of approximately $127.6 million to acquire 35 facilities and additional interests from minority partners in certain of our partnerships. On July 1, 1999, we completed an acquisition of seven dialysis facilities for consideration of approximately $17.5 million. Credit facilities Subsequent to June 30, 1999, the lenders under our credit facilities have waived compliance with a financial covenant that requires us to maintain a specified leverage ratio. This waiver expires March 15, 2000. The lenders also have waived our violation of a covenant that placed a limit on our aggregate borrowings for international acquisitions, which we had exceeded. The terms of the waiver: . Reduce our permitted borrowings under the revolving credit facility from $950.0 million to $650.0 million during the waiver period; . Commencing after July 1, 1999, limit the amount of additional borrowings that we may use for acquisitions, de novo developments and expansion or relocation of existing dialysis centers; . Accelerated the maturity dates on the term loan and revolving credit facilities by two years, to March 31, 2006 and March 31, 2003, respectively; and . Increased the applicable margins used to determine the interest rates for our borrowings under the credit facilities. Other than the issues specifically addressed in the waiver agreement, all other covenants and conditions of the credit facilities remain unchanged. As of June 30, 1999 the principal amount outstanding under our revolving facility was $534.0 million and under our term facility was $396.0 million. The term facility requires annual principal payments of $4.0 million, with the $368.0 million balance due on maturity. As of June 30, 1999, we had $116.0 million available for borrowing under the revolving facility. The credit facilities contain financial and operating covenants including, among other things, requirements that we maintain certain financial ratios and satisfy certain financial tests, and impose limitations on our ability to make capital expenditures, to incur other indebtedness and to pay dividends. Interest rate swaps During the quarter ended June 30, 1998, we entered into forward interest rate cancelable swap agreements with a combined notional amount of $800.0 million. The lengths of the agreements are between three and ten years with cancellation clauses at the swap holder's option from one to seven years. The underlying blended interest rate is fixed at approximately 5.65% plus an applicable margin based upon our current leverage ratio. Currently, the effective interest rate for these swaps is 8.53%. During the second quarter of 1999, we received notification from two of our swap agreement counterparties that they had exercised their right to cancel agreements in the aggregate notional amount of $100.0 million. The remaining $700.0 million of swap 21 agreements with maturities from the years 2003 through 2008 and cancellation option dates from the years 2001 through 2005 are still in effect. In June 1998, the FASB issued Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities, or SFAS 133. SFAS 133 is effective for all fiscal quarters of all fiscal years beginning after June 15, 2000. Accordingly, for us, SFAS 133 will become effective January 1, 2001. SFAS 133 requires that all derivative instruments be recorded on the balance sheet at their fair value. Changes in the fair value of derivatives are recorded each period in current earnings or other comprehensive income, depending on whether a derivative is designated as part of a hedge transaction and, if it is, the type of hedge transaction. For fair-value hedge transactions in which we are hedging changes in an asset's, liability's or firm commitment's fair value, changes in the fair value of the derivative instrument will generally be offset in the income statement by changes in the hedged item's fair value. For cash-flow hedge transactions, in which we are hedging the variability of cash flows related to a variable-rate asset, liability, or a forecasted transaction, changes in the fair value of the derivative instrument will be reported in other comprehensive income. The gains and losses on the derivative instrument that are reported in other comprehensive income will be reclassified as earnings in the periods in which earnings are impacted by the variability of the cash flows of the hedged item. The ineffective portion of all hedges will be recognized in current-period earnings. We have not yet determined the impact that the adoption of SFAS 133 will have on our earnings or statement of financial position. Subordinated notes The $125.0 million outstanding 5 5/8% convertible subordinated notes due 2006 issued by RTC bear interest at the rate of 5 5/8%, payable semi-annually and require no principal payments until 2006. The 5 5/8% notes are convertible into shares of our common stock at an effective conversion price of $25.62 per share and are redeemable by us beginning in July 1999. In November 1998 we issued 7% convertible subordinated notes due 2009 in the aggregate principal amount of $345.0 million. The 7% notes are convertible at any time, in whole or in part, into shares of our common stock at a conversion price of $32.81 and will be redeemable after November 16, 2001. We used the net proceeds from the sale of the 7% notes to pay down debt under the revolving facility, which may be reborrowed, subject to the modified terms of our credit facilities. Year 2000 considerations Since the summer of 1998, all of our departments have been meeting with our information systems department to determine the extent of our Year 2000, or Y2K, exposure. Project teams have been assembled to work on correcting Y2K problems and to perform contingency planning to reduce our total exposure. Our goal is to have all corrective action and contingency plans in place by the end of the third quarter of 1999. Software applications and hardware. Each component of our software application portfolio, or SAP, must be examined with respect to its ability to properly handle dates in the next millennium. As part of our software assessment plan, key users will test each component of our SAP. These tests will be constructed to make sure each component operates properly with the system date advanced to the next millennium. The major phases of our software assessment plan are as follows: . Complete SAP inventory; . Implement Y2K compliant software as necessary; . Analyze which computers have Y2K problems and the cost to repair; . Test all vendors' representations; and . Fix any computer-specific problems. 22 Our billing and accounts receivable software is known to have a significant Y2K problem. We have already addressed this issue by obtaining a new, Y2K compliant version of this software. We expect to complete conversion to this Y2K compliant version by the end of the third quarter of 1999. Operating systems. We are also reviewing our operating systems to assess possible Y2K exposure. We use several different network operating systems, or NOS, for multi-user access to the software that resides on the respective servers. Each NOS must be examined with respect to its ability to properly handle dates in the next millennium. Key users will test each component of our SAP with a compliant version of the NOS. One level beneath the NOS is a special piece of software that comes into play when the computer is "booted" that potentially has a Y2K problem and that is the basic input output system software, or BIOS. The BIOS takes the date from the system clock and uses it in passing the date to the NOS which in turn passes the date to the desktop operating system. The system clock poses another problem in that some system clocks were only capable of storing a two-digit year while other computer clocks stored a four-digit year. This issue affects each and every computer we have purchased. To remedy these problems, we plan to inventory all computer hardware using a Y2K utility program to determine whether we have a BIOS or a system clock problem. We then intend to perform a BIOS upgrade or perform a processor upgrade to a Y2K compliant processor. Dialysis centers, equipment and suppliers. The operations of our dialysis centers can be affected by the Y2K problem so a contingency plan must be in place to prevent the shutdown of these centers. Each center will be responsible for completing a survey of the possible consequences of a failure of the information systems of our vendors and formulating a contingency plan by the end of the third quarter of 1999. Divisional vice presidents will then review these plans to assure compliance. All of our biomedical devices, including dialysis machines that have a computer chip in them, will be checked for Y2K compliance. We have contacted or will contact each of the vendors of the equipment we use and ask them to provide us with documentation regarding Y2K compliance. Where it is technically and financially feasible without jeopardizing any warranties, we will test our equipment by advancing the clock to a date in the next millennium. In general, we expect to have all of our biomedical devices Y2K compliant by the end of the third quarter of 1999. We have not yet been able to estimate the costs of upgrading or replacing certain of our biomedical devices as we do not yet know which of these machines, if any, are not currently Y2K compliant. In addition to factors noted above which are directly within our control, factors beyond our direct control may disrupt our operations. If our suppliers are not Y2K complaint, we may experience inventory shortages and run short of critical supplies. If the utilities companies, transportation carriers and telecommunications companies which service us experience Y2K difficulties, our operations will also be adversely affected and some of our facilities may need to be closed. We are in the process of taking steps to reduce the impact on our operations in such instances and implementing contingency plans to address any possible unavoidable effect which these difficulties would have on our operations. To address the possibility of a physical plant failure, we are contacting the landlords of each of our facilities to insure that they will provide access to our staff and any other key service providers. We are also providing written notification to our utilities companies of the locations, schedules and emergency services required of each of our dialysis facilities. In case a physical plant failure should result in an emergency closure of any of our facilities, we are currently: . Confirming that backup hospital affiliation agreements are up-to-date and complete; . Reviewing appropriate elements of our disaster preparedness plan with our staff and patients; . Adopting/modifying emergency treatment orders and rationing plans with our medical directors to provide patient safety; and . Conducting patient meetings with social workers and dieticians. 23 To minimize the affect of any Y2K non-compliance on the part of suppliers, we are currently taking steps to: . Identify our critical suppliers and survey each of them to assess their Y2K compliance status; . Identify alternative supply sources where necessary; . Identify Y2K compliant transportation/shipping companies and establish agreements with them to cover situations where our current suppliers' delivery systems go down; . Include language in contracts with new suppliers addressing Y2K performance obligations, requirements and failures; . Stock our dialysis facilities with one week of additional inventory; . Require critical distributors to carry additional inventory earmarked for us; and . Prepare a critical supplier contact/pager list for Y2K emergency supply problems and ensure that contact persons will be on call 24 hours a day. Our financial exposure from all sources of SAP and operating system Y2K issues as well as from dialysis center, equipment and supplier Y2K issues known to date ranges from approximately $500,000 to $1,200,000, the majority of which has not been expended. General. The extent and magnitude of the Y2K problem as it will affect us, both before, and for some period after, January 1, 2000, are difficult to predict or quantify for a number of reasons. Among the most important are our lack of control over systems that are used by the third parties who are critical to our operations, such as telecommunications and utilities companies, the complexity of testing interconnected networks and applications that depend on third-party networks and the uncertainty surrounding how others will deal with liability issues raised by Y2K-related failures. Moreover, the estimated costs of implementing our plans for fixing Y2K problems do not take into account the costs, if any, that might be incurred as a result of Y2K-related failures that occur despite our implementation of these plans. With respect to third-party non-governmental payors, we are in the process of determining where our exposure is and developing contingency plans to prevent the interruption of cash flow. With respect to Medicare payments, both the Health Care Financing Administration, or HCFA, and the two primary fiscal intermediaries we utilize have contingency plans in place. The HCFA mandated contingency plans have been tested by HCFA to ensure that no interruption of Medicare payments results from Y2K-related failures of their systems. With respect to MediCal, the largest of our third-party state payors, we are already submitting our claims with a four-digit numerical year in accordance with the current system. We are currently working with our other state payors individually to determine the extent of their Y2K compliance. Although we currently are not aware of any material operational issues associated with preparing our internal computer systems, facilities and equipment for Y2K, we cannot assure you, due to the overall complexity of the Y2K issues and the uncertainty surrounding third party responses to Y2K issues, that we will not experience material unanticipated negative consequences and/or material costs caused by undetected errors or defects in our or third party systems or by our failure to adequately prepare for the results of such errors or defects, including costs of related litigation, if any. The impact of such consequences could have a material adverse effect on our business, financial condition or results of operations. 24 Item 3. Quantitative and Qualitative Disclosures About Market Risk. Interest rate sensitivity Due to the acceleration of the maturity of our credit facilities, our repayment requirements have been modified. The table below has been revised from the one disclosed in our Form 10-K/A (Amendment No. 1) for the fiscal year ended December 31, 1998, to reflect the modified principal repayments on our debt obligations and the related variable weighted average interest rates by expected maturity dates. The table also reflects the cancellation of $100,000,000 of interest rate swaps. For our interest rate swap agreements, the table presents the repayment of the notional amounts of these swaps at maturity, the fixed weighted average interest rates we must pay the swap holders according to the swap agreements, and the weighted average interest rates we will receive from the swap holders, based upon the current LIBOR. Notional amounts are used to calculate the contracted payments we will exchange with the swap holders under the swap agreements. The interest rates we will receive from the swap holders are variable, and are based on the LIBOR.
Expected Maturity Date ---------------------------------------- Fair 1999 2000 2001 2002 2003 Thereafter Total Value ---- ---- ---- ---- ---- ---------- ----- ----- (in millions) Liabilities Long-term debt Fixed rate.............. $470 $470 $469 Average interest rate................. 6.6% 6.6% Variable rate........... $ 20 $ 11 $ 95 $154 $300 $377 $957 $957 Average interest rate................. 6.88% 6.88% 6.88% 6.88% 6.88% 6.88% 6.88% Expected Maturity Date ---------------------------------------- Fair 1999 2000 2001 2002 2003 Thereafter Total Value ---- ---- ---- ---- ---- ---------- ----- ----- (in millions) Interest rate derivatives Interest rate swaps Variable to fixed....... $100 $600 $700 $(29) Average pay rate...... 5.51% 5.69% 5.75% Average receive rate.. 5.03% 5.01% 5.01%
Our swaps have a one-time call provision for our counterparty at varying times based upon the maturity of the underlying swaps as follows:
Notional Swap Maturity Call Provision Amount ------------- -------------- -------- Ten-year swaps: Seven-year $200 Five-year 200 Seven-year swaps: Four-year 100 Three-year 100 Five-year swaps: Two-year 100 ---- $700 ====
Other than as described above, there have been no material changes in our market risk exposure from that reported in our Form 10-K/A (Amendment No. 1) for the fiscal year ended December 31, 1998. 25 RISK FACTORS In addition to the other information set forth in this Form 10-Q/A, you should note the following risks related to our business. If we fail to build adequate internal systems and controls then our revenue and net income may be adversely affected. We have experienced rapid growth in the last five years, and especially in 1998, as a result of our business strategy to acquire, develop and manage a large number of dialysis centers. We also intend to continue to acquire, develop and manage additional dialysis centers, both in the U.S. and internationally. This historical growth and business strategy subjects us to the following risks: . Our billing and collection structures, systems and personnel may prove inadequate to collect all amounts owed to us for services we have rendered, resulting in a lack of sufficient cash flow; . We may require additional management, administrative and clinical personnel to manage and support our expanded operations, and we may not be able to attract and retain sufficient personnel; . Our assessment of the requirements of our growth on our information systems may prove inaccurate, and we may have to spend substantial amounts to enhance or replace our information systems; . Our expanded operations may require cash expenditures in excess of the cash available to us after paying our debt service obligations; . We may inaccurately assess the historical and projected results of operations of acquisition candidates, which may cause us to overpay for acquisitions; . We may inaccurately assess the historical and projected results of operations of existing and recently acquired facilities, which may cause us not to achieve the results of operations expected for these facilities; and . We may not be able to integrate acquired facilities as quickly or smoothly as we expect, which may cause us not to achieve the results of operations expected for these acquired facilities. These risks are enhanced when we acquire entire regional networks or other national dialysis providers, such as RTC, or enter into multi-facility management agreements. Future declines, or the lack of an increase, in Medicare reimbursement rates could substantially decrease our net income. We are reimbursed for dialysis services primarily at fixed rates established in advance under the Medicare end stage renal disease, or ESRD, program. Unlike many other Medicare programs, which receive periodic cost of living increases, these rates have not increased since 1991. Increases in operating costs that are subject to inflation, such as labor and supply costs, have occurred and continue to occur without a compensating increase in reimbursement rates. In addition, if Medicare should begin to include in its composite reimbursement rate any ancillary services that it currently reimburses separately, our revenue would decrease to the extent there was not a corresponding increase in that composite rate. We cannot predict whether future rate changes will be made. Approximately 50% of our net operating revenues in the first six months of 1999 was generated from patients who had Medicare as the primary payor. The Department of Health and Human Services, or HHS, has recommended, and the Clinton administration has included in its fiscal year 2000 budget proposal to the Congress, a 10% reduction in Medicare reimbursement for erythropoietin, or EPO. We cannot predict whether this proposal or other future rate or reimbursement method changes will be made. Approximately 14% of our net operating revenues in the first six months of 1999 was generated from EPO reimbursement through Medicare and Medicaid programs. Consequently, any reduction in the rate of EPO reimbursement through Medicare and Medicaid programs could materially reduce our revenues and net income. 26 Medicare separately reimburses us for other outpatient prescription drugs that we administer to dialysis patients at the rate of 95% of the average wholesale price of each drug. The Clinton administration has also included in its fiscal year 2000 budget proposal to the Congress a reduction in the reimbursement rate for outpatient prescription drugs to 83% of average wholesale price. We cannot predict whether Congress will approve this rate change, or whether other reductions in reimbursement rates for outpatient prescription drugs will be made. If such changes are implemented, they could have a material adverse effect on our revenues and net income. Many Medicaid programs base their reimbursement rates for the services we provide on the Medicare reimbursement rates. Any reductions in the Medicare rates could also result in reductions in the Medicaid reimbursement rates. Approximately 5% of our net operating revenues in the first six months of 1999 was generated from patients who had Medicaid or comparable state programs as the primary payer. If Medicare changes its ESRD program to a capitated reimbursement system, our revenues and profits could be materially reduced. HCFA has initiated a pilot demonstration project, expected to end in 2001, to test the feasibility of allowing managed care plans to participate in the Medicare ESRD program on a capitated basis. Under a capitated plan we or managed care plans would receive a fixed periodic payment for servicing all of our Medicare-eligible ESRD patients regardless of certain fluctuations in the number of services provided in that period or the number of patients treated. Under the current demonstration project, Medicare is paying managed care plans a capitated rate equal to 95% of Medicare's current average cost of treating dialysis patients. If HCFA considers this pilot program successful, HCFA or Congress could lower the average Medicare reimbursement for dialysis. If we charge private payors at rates less than our current rates, then our revenues and net income could be substantially reduced. Approximately 35% of our net operating revenues in the first six months of 1999 was generated from patients who had domestic private payors as the primary payor. Domestic private payors, particularly managed care payors, have become more aggressive in demanding contract rates approaching or at Medicare reimbursement rates. We believe that the financial pressures on private payors to decrease the rates at which they reimburse us will continue to increase and could have a material impact on our revenues and net income. If our assumptions regarding the beneficial life of our goodwill prove to be inaccurate, or subsequently change, our current earnings may be overstated and future earnings also may be affected. Our balance sheet has an amount designated as "goodwill" that represents 46% of our assets and 203% of our stockholders' equity at June 30, 1999. Goodwill arises when an acquiror pays more for a business than the fair value of the tangible and separately measurable intangible net assets. Generally accepted accounting principles require the amortization of goodwill and all other intangible assets over the period benefited. The current average useful life is 34 years for our goodwill and 21 years for all of our intangible assets that relate to business combinations. We have determined that most acquisitions after December 31, 1996 will continue to provide a benefit to us for no less than 40 years after the acquisition. In making this determination, we have reviewed with our independent accountants the significant factors that we considered in arriving at the consideration we paid for, and the expected period of benefit from, acquired businesses. We and our independent accountants continuously review the appropriateness of the amortization periods we are using and change them as necessary to reflect current expectations. If the factors we considered, and which give rise to a material portion of our goodwill, result in an actual beneficial period shorter than our determined useful life, earnings reported in periods immediately following some acquisitions would be overstated. In addition, in later years, we would be burdened by a continuing charge against earnings without the associated benefit to income. Earnings in later years could also be affected significantly if we subsequently determine that the remaining balance of goodwill has been impaired. 27 Interruption in the supply of, or cost increases in, EPO could materially reduce our net income and affect our ability to care for our patients. A single manufacturer, Amgen Corporation, produces EPO. In the future, Amgen may be unwilling or unable to supply us with EPO. Additionally, shortages in the raw materials or other resources necessary to manufacture EPO, or simply an arbitrary decision on the part of this sole supplier, may increase the wholesale price of EPO. Interruptions of the supply of EPO or increases in the price we pay for EPO could have a material adverse effect on our financial condition as well as our ability to provide appropriate care to our patients. If we fail to identify, assess and respond successfully to the unique attributes of each of our foreign operations, our net income could be adversely affected. We only recently commenced operations outside the U.S., and expect to enter additional foreign markets in the next few years. Our failure to identify, understand and respond to the unique attributes of any of the foreign markets that we enter could cause us to: . Overpay for acquisitions of foreign dialysis centers; . Fail to integrate foreign acquisitions into our operations successfully; and . Assess the performance of our foreign operations incorrectly. The unique attributes of our foreign operations include: . Differences in payment and reimbursement rules and procedures, including unanticipated slowdowns in payments from large payors in Argentina; . Differences in accepted clinical standards and practices; . Differences in management styles and practices; . The unfamiliarity of foreign companies with U.S. financial reporting standards; and . Local laws that restrict or limit employee discharges and disciplinary actions. If we fail to adhere to all of the complex government regulations that apply to our business, we could incur substantial fines or be excluded from participating in government reimbursement programs. Our dialysis operations are subject to extensive federal, state and local government regulations in the U.S. and to extensive government regulation in every foreign country in which we operate. Any of the following could adversely impact our revenues: . Loss of required government certifications; . Loss of authorizations to participate in or exclusion from government reimbursement programs, such as the Medicare ESRD Program and Medicaid programs; . Suspension of payments from government programs; . Loss of licenses required to operate health care facilities in some of the states in which we operate; and . Any challenge to the relationships we have structured in some foreign countries to comply with barriers to direct foreign ownership of healthcare businesses. The regulatory scrutiny of healthcare providers has increased significantly in recent years. For example, the Office of Inspector General of HHS has reported that it recovered $1.2 billion in fiscal year 1997 and $480 million in fiscal year 1998 from health care fraud investigations. 28 . We may never collect the revenues from the payments suspended as a result of an investigation of our laboratory subsidiary Our Florida-based laboratory subsidiary is the subject of a third-party carrier review relating to claims the laboratory submitted for Medicare reimbursement. In May 1998, the carrier suspended all further Medicare payments to this laboratory. Medicare revenues from this laboratory represent approximately 2% of our net revenues. For the review periods the carrier has identified, January 1995 to April 1996, and May 1996 to March 1998, the carrier has alleged that the prescribing physician's medical justification did not properly support approximately 97% of the tests this laboratory performed. The carrier has determined that it overpaid this laboratory $5.6 million for the period from January 1995 to April 1996, and $14.2 million for the period from May 1996 to March 1998. The suspension of payments relates to all payments due after the suspension started, regardless of when this laboratory performed the tests. The carrier has withheld approximately $23 million as of June 30, 1999, which has adversely affected our cash flow. We may never recover the amounts withheld. . Our failure to comply with federal and state fraud and abuse statutes could result in sanctions Neither our arrangements with the medical directors of our facilities nor the minority ownership interests of referring physicians in some of our dialysis facilities meet all of the requirements of published safe harbors to the anti- kickback provisions of the Social Security Act and similar state laws. These laws impose civil and criminal sanctions on anyone who receives or makes payments for referring a patient for any service reimbursed by Medicare, Medicaid or similar federal and state programs. Arrangements within published safe harbors are deemed not to violate these provisions. Enforcement agencies may subject arrangements that do not fall within a safe harbor to greater scrutiny. If we are challenged under these statutes, we may have to change our relationships with our medical directors and with referring physicians holding minority ownership interests. The laws of several states in which we do business prohibit a physician from making referrals for laboratory services to entities with which the physician, or an immediate family member, has a financial interest. We currently operate a large number of facilities in these states, which account for a significant percentage of our business. These state statutes could apply to laboratory services incidental to dialysis services. If so, we may have to change our relationships with referring physicians who serve as medical directors of our facilities or hold minority interests in any of our facilities. We may not have sufficient cash flow from our business to service our debt. The amount of our outstanding debt is large compared to the net book value of our assets, and we have substantial repayment obligations under our outstanding debt. As of June 30, 1999 we had: . Total consolidated debt of approximately $1.4 billion; . Stockholders' equity of approximately $474 million; and . A ratio of earnings to fixed charges of 1.11. The following chart shows our aggregate interest and principal payments due on all of our currently outstanding debt for each of the next five fiscal years. Under interest swap agreements covering $700 million of debt, the interest rate under our credit facilities varies based on the amount of debt we incur relative to our assets and equity. Accordingly, the amount of these interest payments could fluctuate in the future.
Interest Principal Payments Payments ------------ ------------ For the year ending December 31: 1999.......................................... $110,023,000 $ 19,561,000 2000.......................................... 108,927,000 10,534,000 2001.......................................... 100,860,000 94,580,000 2002.......................................... 87,782,000 153,567,000 2003.......................................... 72,391,000 300,059,000
29 Due to the large amount of these principal and interest payments, we may not have enough cash to pay the interest on our debt as it becomes due. The large amount and terms of our outstanding debt may prevent us from taking actions we would otherwise consider in our best interest. Our credit facilities contain numerous financial and operating covenants that limit our ability, and the ability of most of our subsidiaries, to engage in activities such as incurring additional senior debt and disposing of our assets. These covenants require that we meet interest coverage, net worth and leverage tests. Additionally, as we are highly leveraged and if we are not in compliance with our covenants, we may be required to renegotiate the terms of our credit facilities on terms that are more unfavorable including: higher interest rates, shorter maturities or more restrictive borrowing terms; all of which may have an adverse impact on net income. Our level of debt and the limitations our credit facilities impose on us could have other important consequences to you, including: . We will have to use a portion of our cash flow from operations, approximately $129.6 million in 1999 and $119.5 million in 2000, for debt service rather than for our operations; . We may not be able to obtain additional debt financing for future working capital, capital expenditures, acquisitions or other corporate purposes; . We could be less able to take advantage of significant business opportunities, including acquisitions, and react to changes in market or industry conditions. If a change of control occurs, we may not have sufficient funds to repurchase our outstanding notes. Upon a change of control, generally the sale or transfer of a majority of our voting stock or almost all of our assets, our noteholders may require us to repurchase all or a portion of their notes. If a change of control occurs, we may not be able to pay the repurchase price for all of the notes submitted for repurchase. In addition, the terms of our credit facilities generally prohibit us from purchasing any notes until we have repaid all debt outstanding under these credit facilities. Future credit agreements or other agreements relating to debt may contain similar provisions. We may not be able to secure the consent of our lenders to repurchase our outstanding notes or refinance the borrowings that prohibit us from repurchasing our outstanding notes. If we do not obtain a consent or repay the borrowings, we could not repurchase these notes. We may experience material unanticipated negative consequences beginning in the year 2000 due to undetected computer defects. The Y2K issue concerns the potential exposures related to the automated generation of incorrect information from the use of computer programs which have been written using two digits, rather than four, to define the applicable year of business transactions. Due to the overall complexity of the Y2K issues and the uncertainty surrounding third party responses to Y2K issues, we cannot assure you that undetected errors or defects in our or third party systems or our failure to prepare adequately for the results of those errors or defects will not cause us material unanticipated problems or costs. The extent and magnitude of the Y2K problem as it will affect us, both before, and for some period after, January 1, 2000, are difficult to predict or quantify for a number of reasons. Among the most important are: . Our lack of control over third party systems that are critical to our operations, including those of telecommunications and utilities companies and governmental and non-governmental payors; . The complexity of testing interconnected internal and external computer networks, software applications and dialysis equipment; and . The uncertainty surrounding how others will deal with liability issues raised by Y2K-related failures. 30 Moreover, the estimated costs of implementing our plans for fixing Y2K problems do not take into account the costs, if any, that we might incur as a result of Y2K-related failures that occur despite our implementation of these plans. While we are developing contingency plans to address possible computer failure scenarios, we recognize that there are "worst case" scenarios which may occur. We may experience the extended failure of external and internal computer networks and equipment that control . Medicare, Medicaid and other third party payors' ability to reimburse us; . Regional infrastructures, such as power, water and telecommunications systems; . Equipment and machines that are essential for the delivery of patient care; and . Computer software necessary to support our billing process. If any one of these events occurs, our cash flow could be materially reduced. Even in the absence of a failure of these networks and equipment, we will likely continue to incur costs related to remediation efforts, the replacement or upgrade of equipment, continued efforts regarding contingency planning, increased staffing for the periods immediately preceding and after January 1, 2000 and the possible implementation of alternative payment schemes with our payors. Provisions in our charter documents may deter a change of control which our stockholders may otherwise determine to be in their best interests. Our certificate of incorporation and bylaws and the Delaware General Corporation Law include provisions which may deter hostile takeovers, delay or prevent changes in control or changes in our management, or limit the ability of our stockholders to approve transactions that they may otherwise determine to be in their best interests. These provisions include: . A provision requiring that our stockholders may take action only at a duly called annual or special meeting of our stockholders and not by written consent; . A provision requiring a stockholder to give at least 60 days' advance notice of a proposal or director nomination that the stockholder desires to present at any annual or special meeting of stockholders; and . A provision granting our board of directors the authority to issue up to five million shares of preferred stock and to determine the rights and preferences of the preferred stock without the need for further stockholder approval. The existence of this "blank-check" preferred stock could discourage an attempt to obtain control of us by means of a tender offer, merger, proxy contest or otherwise. Furthermore, this "blank- check" preferred stock may have other rights, including economic rights, senior to our common stock. Therefore, issuance of the preferred stock could have an adverse effect on the market price of our common stock. We may, in the future, adopt other measures that may have the effect of delaying, deferring or preventing an unsolicited takeover, even if such a change in control were at a premium price or favored by a majority of unaffiliated stockholders. We may adopt certain of these measures without any further vote or action by our stockholders. 31 Forward-looking statements We believe that this Form 10-Q/A contains statements that are forward-looking statements within the meaning of the federal securities laws. These include statements about our expectations, beliefs, intentions or strategies for the future, which we indicate by words or phrases such as "anticipate," "expect," "intend," "plan," "will," "believe" and similar language. These statements involve known and unknown risks, including risks resulting from economic and market conditions, the regulatory environment in which we operate, competitive activities and other business conditions, and are subject to uncertainties and assumptions set forth elsewhere in this Form 10-Q/A. Our actual results may differ materially from results anticipated in these forward-looking statements. We base our forward-looking statements on information currently available to us, and we assume no obligation to update these statements. 32 PART II OTHER INFORMATION Item 1. Legal Procedings The information in Note 9 of the Notes to Condensed Consolidated Financial Statements in Part I, Item 1 of this report is incorporated by this reference in response to this item. Items 2, 3, 4 and 5 are not applicable. Item 6. Exhibits and Reports on Form 8-K (a) Exhibits 10.1 Employment Agreement, dated as of May, 6 1999, by and between TRCH and George DeHuff.*+ 10.2 Amendment No. 3 and Waiver, dated as of August 9, 1999, to and under the Revolving Credit Agreement.+ 10.3 Limited Waiver and Second Amendment, dated as of August 9, 1999, to the Term Loan Agreement.+ 27.1 Financial Data Schedule--three months ended June 30, 1999 and three months ended June 30, 1998.U 27.2 Financial Data Schedule--six months ended June 30, 1999 and six months ended June 30, 1998.U
- --------------------- * Management contract or executive compensation plan or arrangement. U Filed herewith. + Filed on August 16, 1999 as an exhibit to our Form 10-Q for the quarter ended June 30, 1999. (b) Reports on Form 8-K None. 33 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. TOTAL RENAL CARE HOLDINGS, INC. /s/ John J. McDonough By: _________________________________ John J. McDonough Vice President and Chief Accounting Officer Date: January 28, 2000 John J. McDonough is signing in the dual capacities as the registrant's principal accounting officer and a duly authorized officer of the registrant. 34 INDEX TO EXHIBITS
Exhibit Number Description ------- ----------- 10.1 Employment Agreement, dated as of May, 6 1999, by and between TRCH and George DeHuff.*+ 10.2 Amendment No. 3 and Waiver, dated as of August 9, 1999, to and under the Revolving Credit Agreement.+ 10.3 Limited Waiver and Second Amendment, dated as of August 9, 1999, to the Term Loan Agreement.+ 27.1 Financial Data Schedule--three months ended June 30, 1999 and three months ended June 30, 1998.U 27.2 Financial Data Schedule--six months ended June 30, 1999 and six months ended June 30, 1998.U
- --------------------- * Management contract or executive compensation plan or arrangement. U Filed herewith. + Filed on August 16, 1999 as an exhibit to our Form 10-Q for the quarter ended June 30, 1999. EX-27.1 2 FINANCIAL DATA SCHEDULE (3 MONTHS)
5 3-MOS 3-MOS DEC-31-1999 DEC-31-1998 APR-01-1999 APR-01-1998 JUN-30-1999 JUN-30-1998 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 2,102,463,000 0 352,819,000 228,350,000 352,819,000 228,350,000 0 0 359,707,000 232,941,000 0 0 35,707,000 7,741,000 24,370,000 16,544,000 (31,845,000) 28,499,000 (9,786,000) 11,658,000 (22,059,000) 16,841,000 0 0 0 9,932,000 0 0 (22,059,000) 6,909,000 (0.27) 0.09 (0.27) 0.08
EX-27.2 3 FINANCIAL DATA SCHEDULE (6 MONTHS)
5 6-MOS 6-MOS DEC-31-1999 DEC-31-1998 JAN-01-1999 JAN-01-1998 JUN-30-1999 JUN-30-1998 24,673,000 0 0 0 547,817,000 0 103,578,000 0 25,506,000 0 599,485,000 0 273,785,000 0 0 0 2,102,463,000 0 180,826,000 0 470,000,000 0 0 0 0 0 81,000 0 473,760,000 0 2,102,463,000 0 705,063,000 546,183,000 705,063,000 546,183,000 0 0 650,359,000 524,345,000 0 0 46,185,000 15,112,000 47,137,000 31,061,000 5,992,000 (19,340,000) 4,844,000 11,778,000 1,148,000 (31,118,000) 0 0 0 12,744,000 0 6,896,000 1,148,000 (50,758,000) 0.01 (0.64) 0.01 (0.64)
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