ITEM 1. BUSINESS
Overview
Everest Healthcare Services Corporation is a leading provider of dialysis and other blood treatment services. Founded in 1968 and principally owned by nephrologists, the Company has a long-standing focus on developing strong relationships with physicians to provide high-quality patient care. Everest is the nation's sixth-largest provider of chronic dialysis outpatient services and serves over 6,700 patients through 74 facilities in 11 states. In addition to its outpatient dialysis center operations, the Company provides acute dialysis services through contractual relationships with 34 hospitals in five states. Everest also contracts with 67 hospitals in 13 states to provide a broad range of other extracorporeal (outside-the-body) blood treatment services, including perfusion, apheresis and auto-transfusion ("Contract Services"). Pursuant to management contracts, Everest provides management services to (i) a physician practice group comprised of 31 nephrologists, primarily in the Chicago and northwest Indiana areas, and (ii) certain minority-owned or unaffiliated dialysis facilities. The Company derived 88.8% of its net revenues for fiscal 2000 from chronic and acute dialysis services, 10.1% from Contract Services and 1.1% from management services.
Everest's dialysis operations were founded in 1968 as a single dialysis center and grew over the next three decades through a combination of de novo facility development, acquisitions and internal growth. Everest has completed 19 acquisitions encompassing 34 facilities and developed 40 de novo centers since its inception. Through geographic clustering of its outpatient dialysis centers, the Company has created regional market positions, particularly in the Midwest. The Company focuses on accelerating its growth within each market by: (i) capitalizing on its strong physician and hospital relationships; (ii) expanding capacity; and (iii) providing high-quality service which leads to new patient referrals. Everest operates 62 full-service outpatient dialysis centers which provide on-site dialysis services as well as training for home dialysis patients. Everest also operates 12 home dialysis training and support centers which provide services and equipment to home dialysis patients.
Capitalizing on its strong hospital and physician relationships and its core competencies in blood processing, Everest significantly expanded its Contract Services business with the completion of three
acquisitions in fiscal 1997 and one acquisition in fiscal 1998. The Company believes it is uniquely positioned as the only company currently offering hospitals an outsourcing solution to all of their extracorporeal blood treatment needs.
On November 2, 2000, the Company announced that it had entered into an Agreement and Plan of Merger, dated November 1, 2000, by and among the Company, Fresenius Medical Care AG, ("FMC"), Edmund Acquisition Sub, Inc. and certain stockholders of the Company (the "Merger Agreement"). The Merger Agreement provides for a merger of the Company with and into Edmund Acquisition Sub, Inc. (See "Management's Discussion and Analysis of Financial Condition and Results of Operations--Recent Developments" for further information). While the merger is anticipated by management to be completed in the first calendar quarter of 2001, because all the conditions of the Merger Agreement have not been met, the exact timing for consummation of the merger is uncertain at this time. Therefore, the Company's Form 10-K has been prepared so as to describe its business in an ongoing manner, thus providing an understanding of the Company's strategies, business and ongoing obligations as they existed at the end of its fiscal year ended September 30, 2000 for which this report is filed. Further information can be found in the Form 8-K filed by the Company with respect to the Merger Agreement on November 14, 2000.
Dialysis Industry Overview
End-Stage Renal Disease. End-Stage Renal Disease ("ESRD") is a chronic medical condition characterized by the irreversible loss of kidney function which prevents the removal of waste products and excess water from the blood. ESRD most commonly results from complications associated with diabetes, hypertension, certain renal and hereditary diseases, old age and other factors. In order to survive, ESRD patients must receive dialysis treatments for the rest of their lives or undergo kidney transplantation. The number of kidney transplants has been limited due to a shortage of suitable donors along with growth in the number of ESRD patients, the incidence of rejection of transplanted organs and the unsuitability of many ESRD patients for transplantation based on age or health.
Therapeutic Approaches for End-Stage Renal Disease. Currently, three treatment options exist for patients with ESRD: (i) hemodialysis, which is performed either in an outpatient dialysis facility, a hospital or a patient's home; (ii) peritoneal dialysis, which is generally performed in the patient's home; and (iii) kidney transplant surgery.
Hemodialysis uses a dialyzer, or artificial kidney, to remove certain toxins, fluids and chemicals from the patient's blood. The dialysis machine controls external blood flow and monitors certain vital signs of the patient. The screening process involves a semipermeable membrane that divides the dialyzer into two chambers; while the blood is circulated through one chamber, a premixed dialysis fluid is circulated through the adjacent chamber. The toxins and excess fluid contained in the blood cross the membrane into the dialysis fluid. Hemodialysis treatment is usually performed three times per week for three to five hours.
Peritoneal dialysis is generally performed by the patient at home and uses the patient's peritoneal, or abdominal, cavity to eliminate fluids and toxins in the patient's blood. There are several variations of peritoneal dialysis, the most common of which are continuous ambulatory peritoneal dialysis ("CAPD") and continuous cycling peritoneal dialysis ("CCPD"). CAPD utilizes a sterile dialysis solution which is introduced through a surgically implanted catheter into the patient's peritoneal cavity. Toxins in the blood continuously cross the peritoneal membrane into the dialysis solution. After several hours, the patient drains the used solution and replaces it with fresh solution. CCPD is performed in a manner similar to CAPD, but utilizes a mechanical device to cycle dialysis solution while the patient is sleeping or at rest. Patients treated at home are monitored monthly at a designated full-service outpatient facility or by a nurse from a home dialysis training and support facility.
Kidney transplantation, when successful, is the most desirable treatment for patients with ESRD. However, the shortage of suitable donors severely limits the availability of this surgical procedure as a viable alternative for many ESRD patients.
New medical therapies that cure or mitigate the primary causative diseases linked to kidney failure could potentially reduce the ESRD patient population growth rate. Such new medical therapies include diet control, intensive diabetes therapy, improved control of hypertension, improved treatment of causative primary infections and techniques for widening blocked renal arteries. The Company believes, however, that most of these therapies will only provide benefits over an extended time horizon and will not, therefore, significantly reduce the growth of the ESRD patient population in the near term.
Non-Dialysis Extracorporeal Services Industry Overview
Non-dialysis extracorporeal services include perfusion, apheresis and auto- transfusion.
Perfusion Services. Cardiovascular perfusion is required during open-heart surgery to replace the function of the heart and lungs using mechanical devices. This technique maintains relatively normal physiologic equilibrium during cardiovascular surgery by providing adequate circulation and oxygenation. The patient's blood is routed through a system of disposable extracorporeal circuits that oxygenate, filter, adjust temperature and then return the blood to the patient.
Apheresis Services. Apheresis is the selective removal of a specific component (plasma, platelets, or white or red blood cells) of a person's blood. The two general categories of apheresis include: (i) donor apheresis, which is the removal of a healthy component of the blood from a patient or third-party donor for subsequent transfusion to a patient; and (ii) therapeutic apheresis, which is the removal of a diseased or disease-producing component of a patient's blood in order to arrest a disease process.
The types of donor apheresis include Autologous Peripheral Blood Stem Cell ("PBSC") and Single Donor Platelets ("SDP"). PBSC is a procedure performed on cancer patients, including those suffering from leukemia, Hodgkins disease and breast cancer. These patients undergo intensive chemotherapy and/or radiation to eliminate the patient's bone marrow. Bone marrow regeneration is accomplished by the reinfusion of stem cells previously collected from the patient. SDP is a procedure in which platelets are collected from a single third-party donor and reinfused into a patient whose platelets have been depleted through blood loss, cancer, or cancer treatment. Therapeutic apheresis selectively removes unwanted substances from the blood. These substances include toxins, metabolic residues and plasma components implicated in disease.
Auto-Transfusion Services. Auto-transfusion is performed during surgery to collect, filter, clean and reinfuse the patient's own blood as an alternative to using donor blood. An auto-transfusion device may be utilized in a variety of surgical procedures, such as open-heart, vascular or orthopedic surgery, which typically entail blood loss of more than two units. Auto-transfusion reduces the risks of transfusion error and infection associated with outside donor blood.
Chronic Dialysis Operations
Facility Information. The Company operates 74 outpatient dialysis facilities, including 62 full-service dialysis facilities and 12 centers exclusively providing home dialysis training and support. The facilities are located in Illinois (19), Indiana (12), Kansas (1), Kentucky (2), New Jersey (5), New York (8), Ohio (14), Oklahoma (2), South Dakota (2), Texas (8) and Wisconsin (1).
Everest's 62 full-service facilities offer on-site dialysis treatments as well as home dialysis training and support services. As of September 30, 2000, the Company operated a total of 1,191 dialysis stations, most of which are available 16 hours a day, six days a week. As of September 30, 2000, the Company's utilization rate for its then-existing stations was 79%. Each full- service facility has patient examination rooms, staff areas and offices, water treatment areas and amenities such as color televisions for the patients. Everest also operates 12 facilities that exclusively provide the necessary equipment, supplies, training and support services to those patients who prefer and are able to receive their treatments at home.
Organizational Structure. Of the Company's 74 facilities, 52 are operated as wholly-owned subsidiaries, eight are majority-owned, seven are minority-owned, and seven are unaffiliated and operated pursuant to management contracts in New York, South Dakota, Ohio and New Jersey.
The terms of these management contracts vary, but they generally extend for five years with renewal options. Everest's compensation under these agreements typically consists of a fixed fee. From time to time Everest has entered into joint ventures with physicians to facilitate the development of outpatient facilities in new and existing markets and may again in the future.
Everest's dialysis facilities are managed by the Company's Executive Vice President and Chief Operating Officer, Dialysis Services, who oversees 3 regional Vice-Presidents and eight regional directors. The regional directors manage the operations of the facilities in their respective regions and are responsible for staffing, quality outcomes and regional profitability. Each facility has a facility manager who reports to the regional director. Facility managers are responsible for facility staffing, quality outcomes, patient satisfaction results, facility profitability and promoting and maintaining a strong teamwork environment. Generally, key managers and staff are eligible to receive incentives based upon the achievement of certain quality measurements, patient satisfaction results, financial performance goals and teamwork objectives. See "--Human Resources," and "--Training and Development."
The Company has an expert team of dialysis specialists assigned to assist each patient in designing a program to fit the patient's lifestyle and to help patients and families adjust to the changes in their lives. Each team generally consists of: (i) a nephrologist who oversees the medical care; (ii) a nurse who assesses the medical condition and coordinates and implements the program; (iii) a nutritionist who customizes the diet; (iv) a social worker who helps the family with lifestyle changes and financial planning; and (v) technicians who provide much of the routine patient care.
Everest's medical directors and local and regional management teams market the Company's outpatient dialysis services to hospitals, physicians, patients, health plans and the community at large. In marketing its services, the Company emphasizes its excellent reputation and tradition of providing high-quality, consistent patient care, as well as its patient outcomes and the cost savings that these outcomes can provide.
Physician Relationships. The Company believes that its physician relationships are a key factor in the success of its dialysis facilities. As required by the Medicare ESRD program, each of the Company's dialysis facilities is supervised by a qualified medical director who is a physician. The medical director at each facility is responsible for patient care and relationships with referring physicians. Generally, medical directors are board certified in internal medicine and nephrology and have at least twelve months of training or experience in the care of patients at ESRD centers. In all cases, the Company's medical directors refer patients to the Company's centers. In most cases, the medical director is the sole or substantial source of referrals to the centers served.
Ancillary Services. In addition to dialysis services, ESRD patients require a significant amount of ancillary services. The Company has developed a number of ancillary services to complement its dialysis services to boost patient satisfaction and to improve quality, facility growth and profitability. The most significant of the Company's ancillary services is the administration of Erythropoietin ("EPO") upon a physician's prescription. As the kidney deteriorates, it loses the ability to regulate the red blood cell count, causing anemia. EPO is a bio-engineered protein that stimulates the production of red blood cells and is used in connection with all forms of dialysis to treat anemia. A majority of the ESRD population requires EPO. Additionally, the Company interacts with kidney centers nationwide to arrange treatments for patients traveling in other areas and for non-Everest patients visiting areas where Everest has facilities.
Contract Services Operations
Everest significantly expanded its Contract Services business with the acquisition of three and one Contract Services providers in fiscal 1997 and 1998, respectively. Everest believes that it can build on its core competencies in blood processing to market extracorporeal blood services through its existing relationships and that it can use relationships developed in its Contract Services business to market dialysis services. The Contract Services business also provides the Company with a business that is not directly dependent on government reimbursement.
As of September 30, 2000, the Company had contracts with 67 hospitals in 13 states. Everest acts as the exclusive provider of extracorporeal blood services for most of these hospitals. Contracts with customer hospitals generally provide for a portfolio of services including professional staffing, disposable supplies, inventory management services, clinical quality management services, and capital equipment. The professional staffing required by the contracts may include a perfusionist, a registered nurse, or a technician, who are on-call 24 hours a day. The Company typically owns or leases the equipment used in providing these services, such as heart-lung machines, transfusion machines, and apheresis machines and supplies the necessary disposable accessories for these machines and related equipment. This equipment is usually stored at the hospital, but is operated and maintained by the Company. Everest operates regional offices in Florida, Illinois, Indiana, Michigan and Texas, where the Company provides centralized support services for Contract Services.
The Company markets its extracorporeal services to hospital administrators, physicians, operating room directors and blood banks. Sales contacts result from referrals from physicians, vendors, current customers and employees. The Company also solicits direct sales, works closely with pharmaceutical and equipment companies and cooperates with such companies in regional workshops.
Dialysis Quality Programs
The Company believes that it enjoys a reputation of providing high-quality care to dialysis patients and that it achieves superior patient outcomes compared to other providers due to its strong training program and focus on quality assurance standards.
Continuous Quality Improvement. Everest seeks to deliver high-quality dialysis services to its patients and engages in systematic efforts to measure, maintain and improve the quality of the services that it delivers. Quality assurance and patient data are regularly collected, analyzed and reviewed by management. An important part of Everest's quality assurance program is its Continuous Quality Improvement ("CQI") program. The CQI program is overseen by the Company's Corporate Quality Improvement Committee, whose purpose is to evaluate quality of care data, set policy and procedures affecting quality, encourage sharing of techniques and procedures and develop practice guidelines. This Committee meets quarterly. The CQI Program monitors quality of care indicators as well as patient satisfaction. The philosophy of CQI encourages continual and consistent improvement in the quality of care. The Company sets quality and patient satisfaction objectives, and progress toward such objectives is routinely measured. The CQI committee at each facility meets monthly to manage the CQI process for the various indicators.
Outcomes Measurement. Everest's clinical patient data are entered into a computerized medical record maintained at each local dialysis facility, and patient chemistry data are downloaded directly from laboratories. Outcomes data are transmitted to and maintained at Everest's corporate headquarters. The Company tracks such data by patient, by facility and for the entire corporation and distributes such data monthly to each facility. Adequacy in hemodialysis is measured by the Urea Reduction Ratio (URR) and Kt/V and in peritoneal dialysis by either the Kt/V or creatinine clearance. The Company monitors these data as well as many other indicators of quality including nutrition, anemia, infection rates, access patency, patient compliance, hospitalization rates and mortality rates.
Contract Services Quality Programs
The Company has applied its experience in developing quality assurance programs for its dialysis services business to its Contract Services business, and has developed software in furtherance of its commitment to provide high- quality extracorporeal services. This software, which is currently being implemented throughout the Company's perfusion operations, records approximately 15 clinical indicators similar to those tracked by the Company's CQI Committee with respect to the Company's dialysis services. The Company believes that this software is a factor in its ability to achieve favorable outcomes for its Contract Services patients. The Company's outcome projections help predict the anticipated length of patients' stays and probable patient outcomes, and the Company tracks actual patient outcomes to verify the accuracy of such predictions. The Company's Contract Services quality assurance personnel meet monthly to review outcomes data and analyze the Company's performance. These data are also shared with physicians and hospitals on a regular basis. The Company believes that the indicators tracked by its software provide value assessments that can help reduce lengths of stay and improve the utilization of blood products. The Company believes this software is the most advanced system of its kind and that the Company's use of the system is a substantial value-added service for its customers. The Company has similar programs for its hemodialysis and peritoneal dialysis operations, and is in the process of writing corresponding programs for use in its inpatient acute dialysis operations.
Management Information Systems
The Company maintains comprehensive management information systems for financial systems and for patient care, quality assurance and outcome tracking purposes, and is continually developing and upgrading such systems. The Company's Client Tracking System, which keeps a record of each of the Company's patients, is currently available in almost all facilities. The Company's chronic dialysis units have systems that track clinical, administrative and financial activities for a dialysis patient. These systems provide the patient's medical record and the database for quality programs and performance indicators.
Sources of Revenue Reimbursement
The following table provides information regarding the percentage of the Company's net revenues provided with respect to: (i) chronic and acute dialysis services, by Medicare, Medicaid and other third-party payors such as indemnity insurers, managed care companies, hospitals and others; (ii) Contract Services, by hospitals and, to a much lesser extent, other payors; and (iii) management fees earned through services performed under contract.
Under the Medicare ESRD program, Medicare reimburses dialysis providers for the treatment of individuals who are diagnosed with ESRD and are eligible for participation in the Medicare program, regardless of age or financial circumstances. As described in more detail below, for each treatment, Medicare pays 80% of the amount set by the Medicare prospective reimbursement system. A secondary payor, usually a Medicare supplemental insurer, a state Medicaid program or, to a lesser extent, the patient or the patient's private insurer, is responsible for paying any co-payment (typically 20%), other approved services not paid by
Medicare and the annual deductible. All of the states in which the Company operates dialysis facilities provide Medicaid benefits to qualified recipients to supplement their Medicare entitlement. The Medicare and Medicaid programs are subject to statutory and regulatory changes, administrative rulings, interpretations of policy and governmental funding restrictions, some of which may have the effect of decreasing program payments, increasing costs or modifying how the Company operates its dialysis business. See "--Regulatory Matters."
Assuming an ESRD patient is eligible for participation in the Medicare program, the commencement date of Medicare benefits for ESRD patients electing in-center hemodialysis (and not entering into a self-care training program) is dependent on several factors. For ESRD patients 65 years of age or older and already enrolled in the Medicare program due to age entitlement, Medicare coverage for ESRD services begins immediately. ESRD patients under 65 years of age who are not covered by an employer group health plan (for example, the uninsured, those covered by Medicaid and those covered by an individual health insurance policy) must wait until the first day of the third month after the month in which a renal dialysis treatment program begins. During this three month period, the patient, Medicaid or private insurers are responsible for payment. In the case of the individual covered by private insurance, such responsibility is limited to the terms of the policy with the patient being responsible for the balance. ESRD patients under 65 years of age who are covered by an employer group health plan must wait 30 or 33 months after commencing dialysis treatments (depending on whether the patient has entered into a self-care training program) before Medicare becomes the primary payor. During the 30 to 33-month period, the employer group health plan is responsible for payment at its negotiated rate or, in the absence of such a rate, at the company's usual and customary rates, and the patient is responsible for deductibles and co-payments applicable under the terms of the employer group health plan.
If an ESRD patient elects to enter into a self-care training program or home dialysis training program during the first three months of dialysis, the three- month waiting period is waived. In this case, if the patient has an employer group health plan, the period for which the health plan will be the primary payor is 30 months. If the patient has only Medicare coverage, Medicare immediately becomes the primary payor effective as of the initiation of dialysis.
Medicare Reimbursement. Each of the Company's dialysis facilities is certified to participate in the Medicare program. The Company is reimbursed by Medicare under a reimbursement system for chronic dialysis services provided to ESRD patients. Under this system, the reimbursement rates are fixed in advance and have been adjusted from time to time by Congress. Although this form of reimbursement limits the allowable charge per treatment, it provides the Company with predictable and recurring per treatment revenues and allows the Company to retain any profit earned. Medicare has established a composite rate set by HCFA that governs the Medicare reimbursement available for a designated group of dialysis services, including the dialysis treatment, supplies used for such treatment, certain laboratory tests and certain medications. When Medicare assumes responsibility as the primary payor, it pays for dialysis and related services (as described below) at 80% of the composite rate. The Medicare composite rate is subject to regional differences based upon certain factors, including regional differences in wage earnings. Certain other services and items are eligible for separate reimbursement under Medicare and are not part of the composite rate, including certain drugs (including EPO), blood (for amounts in excess of three units per patient per year), and certain physician- ordered tests provided to dialysis patients. Claims for Medicare reimbursement must generally be presented within 15 to 27 months of treatment depending on the month in which the service was rendered. The Company generally submits claims monthly and is usually paid by Medicare within 30 days of the submission. If, in the future, Medicare were to include in its composite reimbursement rate any of the ancillary services presently reimbursed separately, the Company would not be able to seek separate reimbursement for these services, adversely affecting the Company's operating and financial results.
The Company receives reimbursement for outpatient dialysis services provided to Medicare-eligible patients at rates that are currently between $118 and $141 per treatment for routine dialysis services, depending upon regional wage variations. The Medicare reimbursement rate is subject to change by legislation and recommendations by the Medicare Payment Advisory Commission ("MedPAC"). MedPAC is a new commission that was mandated by the Balanced Budget Act of 1997 to continue and expand upon the work of
the Prospective Payment Assessment Commission ("PROPAC"). The Medicare ESRD reimbursement rate was unchanged from commencement of the program in 1972 until 1983. From 1983 through December 1990 numerous Congressional actions resulted in net reduction of the average reimbursement rate from a fixed fee of $138 per treatment in 1983 to approximately $125 per treatment in 1990. Congress increased the ESRD reimbursement rate, effective January 1, 1991, resulting in an average ESRD reimbursement rate of $126 per treatment. In 1990, Congress required that the Department of Health and Human Services ("HHS") and PROPAC study dialysis costs and reimbursement and make findings as to the appropriateness of ESRD reimbursement rates. In March 1998, MedPAC recommended a 2.7% increase in the reimbursement rate. The Balanced Budget Refinement Act of 1999 updated the composite rate for payment by 1.2% for renal dialysis services furnished in 2000 and an additional 1.2% for such services furnished in 2001.
On June 1, 1989, the FDA approved the production and sale of EPO, and HCFA approved Medicare reimbursement for EPO's use by dialysis patients. EPO stimulates the production of red blood cells and is beneficial in the treatment of anemia, with the effect of reducing or eliminating the need for blood transfusions for dialysis patients.
From June 1, 1989 through December 31, 1990, the Medicare ESRD program reimbursed for EPO at the fixed rate of $40.00 per administration of EPO in addition to the dialysis facility's allowable composite rate for dosages of up to 9,999 units per administration. For higher dosages, an additional $30.00 per EPO administration was allowed. Effective January 1, 1991, the Medicare allowable prescribed rate for EPO was changed to $11.00 per 1,000 units, rounded to the nearest 100 units. Subsequently, legislation was enacted to reduce the Medicare prescribed rate for EPO by $1.00 to $10.00 per 1,000 units after December 31, 1993.
In September 1997, HCFA promulgated a policy that would deny Medicare reimbursement for EPO where a patient's proportion of red blood cells to total blood volume exceeds an average of 36.5% during a 90-day period. That rule was modified effective March 10, 1998, to provide that, if a doctor provides medical justification for the prescription, Medicare will continue to reimburse for EPO even if a patient's red blood cell count exceeds the maximum level otherwise allowed for reimbursement. Further, even if no medical justification is provided, the reimbursement will be reduced rather than denied, to an amount equal to the lower of the actual EPO dosage administered or 80% of the allowable dosage for the previous month.
Medicaid Reimbursement. The Company is a certified ESRD Medicaid provider in all states in which it does business. Medicaid programs are state-administered programs partially funded by the federal government. These programs are intended to provide coverage for patients whose income and assets fall below state-defined levels or who are otherwise uninsured. The programs also serve as supplemental insurance programs for the Medicare co-insurance portion and provide certain coverage (e.g., oral medications) that is not provided by Medicare. State regulations generally follow Medicare reimbursement levels and coverage without any co-insurance amounts. Certain states, however, require beneficiaries to pay a monthly share of the cost based upon levels of income or assets.
Private Reimbursement. Everest derives a portion of its revenues from reimbursement provided by non-governmental third-party payors. A substantial portion of third-party health insurance in the U.S. is now furnished through some type of managed care plan, including HMOs. Managed care plans are increasing their market share, and this trend may accelerate as a result of the merger and consolidation of providers and payors in the health care industry, as well as discussions among members of Congress and the executive branch regarding ways to increase the number of Medicare and Medicaid beneficiaries served through managed care plans.
The Company generally is reimbursed for dialysis treatments at higher rates by non-governmental payors than by governmental payors. However, managed care plans are becoming more aggressive in selectively contracting with a smaller number of providers willing to furnish services for lower rates and subject to a variety of service restrictions. For example, managed care plans and traditional indemnity third-party payors increasingly are demanding alternative fee structures, such as capitation arrangements whereby a provider
receives a fixed payment per month per enrollee and bears the risk of loss if the costs of treating such enrollee exceed the capitation payment. These market forces are creating downward pressure on the reimbursement that Everest receives for its services and products.
Everest's ability to secure favorable rates with indemnity and managed care plans has largely been due to the relatively small number of ESRD patients enrolled in any single HMO. By regulation, ESRD patients have been prohibited from joining an HMO unless they are otherwise eligible for Medicare coverage, due to age or disability, and are members of a managed care plan when they first experience kidney failure. HCFA has implemented a pilot project in which several managed care companies were allowed to recruit ESRD patients beginning in 1997 and which, if successful, could result in the opening of the ESRD treatment market to many managed care companies thereafter. As Medicare HMO enrollments increase and the number of ESRD patients in managed care plans also increases, managed care plans may have increased leverage in negotiating lower rates. In addition, an HMO may contract with another provider for, or may have tighter utilization controls with respect to, certain ancillary services typically provided by Everest to ESRD patients, which could limit Everest's revenues from such services.
As managed care companies expand their market share and gain greater bargaining power vis-a-vis health care providers, there may be increasing pressure to reduce the amounts paid for outpatient dialysis services and products. These trends could be accelerated if future changes to the Medicare ESRD program require private payors to assume a greater percentage of the cost of care given to dialysis patients. Everest believes that the historically higher rates of reimbursement paid by non-governmental payors may not be maintained at such levels. Everest is presently seeking to expand the portion of its revenues attributable to non-governmental private payors. However, if substantially more patients join managed care plans or such plans reduce reimbursement levels, Everest's business and results of operations could be materially adversely affected.
Competition
Dialysis Services Market. The dialysis industry is fragmented and highly competitive, particularly with respect to competition for the acquisition of existing dialysis centers. Because, in most cases, the prices of dialysis services and products in the U.S. are directly or indirectly regulated by Medicare, competition for patients is based primarily on quality and accessibility of service and the ability to obtain referrals from physicians and hospitals. Certain of the Company's competitors in the dialysis services market have greater financial resources than the Company and compete with the Company for the acquisition of centers in markets targeted by the Company. Competition for acquisitions has increased the costs of acquiring dialysis facilities. There is no assurance that the Company can continue to compete effectively with existing and new competitors.
Competition for recruiting qualified physicians to act as medical directors is intense. In addition, the Company may experience competition from the establishment of a facility by a former medical director or referring physician. In cases where the Company has acquired a facility from one or more physicians, or where one or more physicians own interests in facilities as partners or co-shareholders with the Company, such physicians are generally required to agree to refrain from owning interests in competing facilities for various periods. Substantially all physicians who provide medical director services to the Company have also executed non-competition agreements. Such non-competition agreements may not be enforceable in certain jurisdictions.
Contract Services Market. The Contract Services market is also fragmented and highly competitive. The Company estimates there are approximately 3,000 perfusionists practicing in the U.S., the majority of whom are employed by hospitals, with the balance practicing as sole proprietors or employed by companies offering perfusion services. Most hospitals requiring perfusion services use their own staff to provide such services and equipment and, as such, are the largest source of competition for the Company. The Company also competes in regional markets with other independent providers of perfusion services and with perfusionists in private practice. The Company's principal competitor in the perfusion services market is Baxter International Inc. The Company competes with hospitals and blood banks in the provision of apheresis and auto-transfusion services. Management believes that the competitive factors in the Contract Services market are primarily cost, quality
and breadth of service. Certain of the Company's competitors in the Contract Services market have greater financial resources than the Company. There can be no assurance that Everest will be able to compete effectively with its competitors or that additional competitors with greater resources will not enter the Company's markets.
Human Resources
As of September 30, 2000, the Company had 2,020 employees, including a professional staff of approximately 686 nurses, social workers, dietitians and perfusionists, a corporate and regional staff of approximately 313 employees and a facilities support staff of approximately 1,021 employees. The Company also contracts with numerous health care professionals, including physicians, nurses, social workers, dietitians, perfusionists and technicians who are not employees of Everest. Medical directors of the Company's dialysis facilities are independent contractors rather than employees of the Company, although some medical directors are employees of either Nephrology Associates of Northern Illinois Ltd. ("NANI-IL") or Nephrology Associates of Northern Indiana, P.C. ("NANI-IN"), each of which is owned by directors, officers and/or shareholders of the Company. In these cases, professional service fees for the medical directors are paid by the Company to NANI-IL and NANI-IN for medical director services performed for such corporations' dialysis units. See "Certain Relationships and Related Transactions." In the majority of cases, however, the fees are payable directly by the Company to the medical directors (or their physician practices) pursuant to individually negotiated contracts.
Perfusionists generally enter into written agreements with the Company which specify their duties and establish their compensation. Such agreements are terminable by either party on advance written notice.
As of September 30, 2000, 119 of the Company's employees were members of unions. The Company believes that its relationships with its employees are good.
Training and Development
The Company believes that its dialysis patient care staff, Contract Services professionals, facility managers and regional directors represent its most valuable corporate assets. Accordingly, Everest devotes substantial efforts and resources to recruiting, training and retaining these individuals. The Company's training emphasizes teamwork to facilitate an environment based upon skilled individuals working together to provide high-quality care. The Company trains its patient care staff and requires that such employees undertake continuing education and meet with trainers who provide ongoing competency testing. If such testing reveals skills that are below the level required for a specific employee, the Company implements further training as required.
Liability Insurance
The Company maintains property and general liability insurance, professional liability insurance and other insurance coverage in amounts deemed adequate by management based upon historical claims and the nature and risks of the business. The Company's property, casualty and worker's compensation insurance is provided by an affiliated entity. See "Certain Relationships and Related Transactions." The Company's professional liability insurance would provide coverage, subject to policy limits, in the event the Company is held liable in a lawsuit for professional malpractice against a physician, however, there can be no assurance that future claims will not exceed applicable insurance coverage, that malpractice and other liability insurance will be available at a reasonable cost or that the Company will be able to maintain adequate levels of malpractice insurance and other liability insurance in the future or that the insurers will not be successful in denying claims. Physicians practicing at the dialysis facilities are required to maintain their own malpractice insurance. However, the Company maintains coverage for the activities of its medical directors (but not for their individual private medical practices).
Regulatory Matters
General
The Company is subject to extensive federal, state and local governmental regulations. These regulations require the Company to meet various standards relating to, among other things, the management of centers, personnel, maintenance of proper records, equipment and quality assurance programs. The Company's dialysis centers are subject to periodic inspection by state agencies and other governmental authorities to determine if the premises, equipment, personnel and patient care meet applicable standards. To receive Medicare and Medicaid reimbursement, the Company's dialysis centers must be certified by HCFA. All of the Company's dialysis centers are so certified.
Any loss by the Company of its federal certifications, its authorization to participate in the Medicare or Medicaid programs or its licenses under the laws of any state or other governmental authority from which a substantial portion of its revenues is derived or any change resulting from health care reform reducing dialysis reimbursement or reducing or eliminating coverage for dialysis services would have a material adverse effect on the Company's operating and financial results. To date, the Company has maintained its licenses and Medicare and Medicaid authorizations. The Company believes that the health care services industry will continue to be subject to intense regulation at the federal, state and local levels, the scope and effect of which cannot be predicted. No assurance can be given that the activities of the Company will not be reviewed and challenged by government regulators or that health care reform will not result in a material adverse effect on the Company. Furthermore, the Company could be held responsible for actions previously taken by entities it has acquired. There can be no assurance that previous operating practices of the Company or the entities it has acquired will not be reviewed and challenged by governmental regulators or that the Company will not be liable for such practices.
Federal Fraud and Abuse
The Company's operations are subject to the illegal remuneration provisions of the Social Security Act (sometimes referred to as the "Anti-Kickback Law") that impose criminal and civil sanctions on persons who knowingly and willfully solicit, offer, receive or pay any remuneration, whether directly or indirectly, in return for, or to induce, the referral of a patient for treatment, or, among other things, the ordering, purchasing, or leasing, of items or services that may be paid for in whole or in part by Medicare, Medicaid or other federal health care programs. Additionally, federal enforcement officials may attempt to impose civil false claims liability with respect to claims resulting from an Anti-Kickback Law violation. Violations of the federal Anti-Kickback Law are punishable by criminal penalties, including imprisonment, fines and exclusion of the provider from future participation in the Medicare or Medicaid programs. Civil penalties for violation of the federal Anti-Kickback Law include assessments of $50,000 per improper claim for payment plus three times the amount of such claim, as well as suspension from future participation in Medicare and Medicaid. While the federal Anti-Kickback Law expressly prohibits transactions that have traditionally had criminal implications, such as kickbacks, rebates or bribes for patient referrals, its language has been construed broadly and has not been limited to such obviously wrongful transactions. Court decisions state that, under certain circumstances, the Anti-Kickback Law is also violated where any part of the purpose (as opposed to the "primary" or "material" purpose) of a payment is to induce referrals. Congress has frequently considered federal legislation that would expand the federal Anti-Kickback Law to include the same broad prohibitions to all situations involving the inducement of referrals, regardless of payor source.
In July 1991, November 1992 and January 1996, the Secretary of Health and Human Services ("HHS") published regulations that create exceptions or "safe harbors" for certain business transactions. Transactions that satisfy the criteria under applicable safe harbors will be deemed not to violate the federal Anti-Kickback Law. Transactions that do not satisfy all elements of a relevant safe harbor do not necessarily violate the statute, although such transactions may be subject to scrutiny by enforcement agencies. The Company seeks to structure its various business arrangements to satisfy as many safe harbor elements as possible under the
circumstances, although many of the Company's arrangements do not satisfy all of the elements of a safe harbor. Although the Company has never been challenged under the Anti-Kickback Law, and the Company believes that it complies in all material respects with the federal Anti-Kickback Law and all other applicable related laws and regulations, there can be no assurance that the Office of Inspector General or other governmental agency will not take a contrary position or that the Company will not be required to change its practices or will not experience a material adverse effect as a result of any such challenge or any sanction that might be imposed. In recent years, new legislation and amendments to the existing federal fraud and abuse laws have strengthened the government's enforcement powers, and there has been a significant increase in the number of health care fraud and abuse investigations and prosecutions. Some of these new investigations and prosecutions scrutinize practices that have been widely utilized by health care providers in the past. The Company is unable to predict whether the enforcement agencies will ultimately prevail in their stepped-up enforcement activities or what impact these enforcement activities may ultimately have on the interpretation of the federal fraud and abuse laws.
On July 21, 1994, the Secretary of HHS proposed a rule that would modify the original set of safe harbor provisions to give greater clarity to the rule's original intent. Those rules were published in final form on November 19, 1999. The final rule makes modifications to the safe harbors on personal services, management contracts, investment interests, and space rentals, among others. The Company does not believe that its current operations, as set forth above, are materially impacted by the final rule.
Physician Ownership. A significant portion of the Company's issued stock is presently owned or controlled by physicians. The Company has also issued stock options to various individuals, including many of its medical directors. Additionally, many of the Company's outpatient dialysis centers are owned on a joint-venture basis between the Company, or one of its wholly owned subsidiaries, and local physicians. Because many of these physicians refer patients to the Company's facilities, the federal Anti-Kickback Law could be found to apply to referrals by such physicians to the Company's facilities. However, the Company believes these ownership relationships are in material compliance with the federal Anti-Kickback Law. The Company believes that the value of stock issued and options granted to physicians has been consistent with the fair market value of assets transferred to, or services performed by such physicians for the Company, and there is no intent to induce referrals to the Company's facilities. There is a safe harbor for certain investments in non-publicly traded entities such as the Company, and the Company believes that its physician ownership and investment relationships meet some of the criteria for this safe harbor. However, these relationships do not satisfy all of the criteria for the safe harbor and there can be no assurance that these relationships will not subject the Company to investigation or prosecution by enforcement agencies.
Medical Director Relationships. The conditions for coverage under the Medicare ESRD program mandate that treatment at a dialysis center be under the general supervision of a medical director who is a licensed physician. Additionally, the medical director must be board certified or board eligible in internal medicine or pediatrics and have had at least 12 months of experience or training in the care of patients at ESRD centers. The medical directors engaged by the Company typically exceed the Medicare requirements and are generally board certified nephrologists. The Company has engaged medical directors at each of its centers under contracts with physicians or their group practices. The compensation of the medical directors and other physicians under contract with the Company is separately negotiated and generally depends upon competitive factors in the local market, the physician's professional qualifications and responsibilities and the size of the center. The aggregate compensation of the medical directors and other physicians under contract with the Company is generally fixed in advance for periods of one year or more by written agreement, is set to reflect the fair market value of the services rendered and does not take into account the volume or value of patients referred to the Company's facilities. Because in all cases the medical directors and the other physicians under contract with the Company refer patients to the Company's centers, the federal Anti-Kickback Law could be found to apply. However, the Company believes that its contractual arrangements with these physicians are in material compliance with the federal Anti-Kickback Law. The Company seeks to comply with the requirements of the personal services and
management contract safe harbor when entering into agreements with its medical directors and other physicians. See "Certain Relationships and Related Transactions--NANI-IL and NANI-IN."
Acute Inpatient Dialysis Services. Under the Company's acute inpatient dialysis service arrangements, the Company agrees to provide a hospital with supervised emergency and acute dialysis services, including qualified nursing and technical personnel, technical services, supplies, and, in many cases, equipment. Because physicians under contract with the Company, or who have an ownership interest in the Company and/or its affiliates, may refer patients to hospitals with which the Company has an acute dialysis service arrangement, the federal Anti-Kickback Law could be found to apply. However, the Company believes that its contractual arrangements with hospitals for acute inpatient dialysis services are in material compliance with the federal Anti-Kickback Law. In all instances, the Company seeks to comply with the requirements of the personal services and management contract and equipment lease safe harbors when entering into agreements or contracts for acute inpatient dialysis services.
The Health Insurance Portability and Accountability Act of 1996. The Health Insurance Portability and Accountability Act of 1996 ("HIPAA") was enacted in August 1996 and substantively changed federal fraud and abuse laws by expanding their reach to all federal health care programs, establishing new bases for exclusions and mandating minimum exclusion terms, creating an additional exception to the anti-kickback penalties for risk-sharing arrangements, requiring the Secretary of HHS to issue advisory opinions, increasing civil money penalties to $10,000 (formerly $2,000) per item or service and assessments to three times (formerly twice) the amount claimed, creating a specific health care offense and related health fraud crimes, and expanding investigative authority and sanctions applicable to health care fraud. It also prohibits provider payments which could be deemed an inducement to patient selection of a provider.
In addition to establishing minimum periods of exclusion from government health programs, the statute authorizes exclusion of an individual with a direct or indirect ownership or control interest in a sanctioned entity if the individual "knows or should know" of the activity leading to the conviction or exclusion of the entity or where the individual is an officer or managing employee of the entity. Significantly, the law expands criminal sanctions for health care fraud involving any governmental or private health benefit program, including freezing of assets and forfeiture of property traceable to commission of a health care offense.
Balanced Budget Act of 1997. In August 1997, President Clinton signed the Balanced Budget Act of 1997 ("BBA") which contains sweeping adjustments to both the Medicare and Medicaid programs, as well as further expansion of the fraud and abuse laws. Specifically, the BBA created a civil monetary penalty for violations of the federal anti-kickback statute whereby violations will result in damages equal to three times the amount involved as well as a penalty of $50,000 per violation. In addition, the new provisions expanded the exclusion requirements so that any person or entity convicted of three health care offenses is automatically excluded from federally funded health care programs for life. Individuals or entities convicted of two offenses are subject to mandatory exclusion of 10 years, while any provider or supplier convicted of any felony may be denied entry into the Medicare program by the Secretary of HHS if deemed to be detrimental to the best interests of the Medicare program or its beneficiaries.
The BBA also provides that any person or entity that arranges or contracts with an individual or entity that has been excluded from a federally funded health care program will be subject to civil monetary penalties if the individual or entity "knows or should have known" of the sanction. In addition, the BBA requires HCFA to issue advisory opinions in response to inquiries as to whether physician referrals for designated health services are prohibited by the Stark law (hereinafter described).
Finally, the BBA creates a Medicare+Choice Program that is designed to provide a variety of options to Medicare beneficiaries, almost all of whom may enroll in a Medicare+Choice Plan. The options include provider sponsored organizations, coordinated care plans, HMOs with and without point of service options involving out-of-network providers, and medical savings accounts offered as a demonstration project.
Stark Law
The federal prohibition against self-referral amendments to the Social Security Act (commonly known as the "Stark" provisions) restricts physician referrals for certain "designated health services" to entities with which a physician or an immediate family member has a "financial relationship." The Stark law was enacted by Congress in two parts, and is commonly referred to individually as "Stark I" and "Stark II." The Stark I legislation, which became effective in 1992, was only applicable to clinical laboratory services. The Stark II legislation, which became effective January 1, 1995, expanded the self-referral prohibition from only clinical laboratory services to all "designated health services." Under the Stark provisions, an entity is prohibited from claiming payment under the Medicare or Medicaid programs for services rendered pursuant to a prohibited referral and is liable for the refund of amounts received pursuant to prohibited claims. The Stark provisions also set forth certain reporting requirements that require entities providing services to Medicare beneficiaries to report certain ownership arrangements to the Secretary of HHS. In addition to being obligated to refund any payments received in violation of the Stark provisions, entities can also incur civil penalties of up to $15,000 per improper claim, $10,000 per day for each day that the entities fail to comply with the reporting obligations, and can be excluded from participation in the Medicare and Medicaid programs.
A "financial relationship" under Stark is defined as an ownership or investment interest in an entity by a physician (or an immediate family member), or a compensation arrangement between a physician (or an immediate family member) and an entity. The Company has entered into compensation agreements with its medical directors or their respective professional corporations for the services such physicians provide as medical directors. Additionally, a number of physicians own shares of the Company or its joint ventures, and options to purchase shares of stock in the Company. Accordingly, physicians that have entered into such arrangements with the Company, including its medical directors, may be deemed to have a "financial relationship" with the Company for purposes of Stark.
For purposes of Stark, "designated health services" include, among other things: clinical laboratory services; parenteral and enteral nutrients, equipment and supplies; prosthetics, orthotics, prosthetic devices and supplies; physical and occupational therapy services; outpatient prescription drugs; durable medical equipment and supplies; radiology services (including MRI, CAT scans and ultrasound services); radiation therapy services and supplies; home health services; and inpatient and outpatient hospital services. Dialysis is not a designated health service under Stark. However, the definition of "designated health services" includes items and services that are components of dialysis or that may be provided to a patient in connection with dialysis, if such items and services are considered separately rather than collectively as dialysis. Under the final Stark I regulations published in August 1995, HCFA provided an exception from Stark I for clinical laboratory services reimbursed under the Medicare "composite rate" for dialysis. The Company believes it likely that, when final Stark II regulations are published, they will contain a similar exception for the various dialysis related items that fall within the definition of "designated health services," but that are reimbursed under the composite rate for dialysis. However, there can be no assurance that HCFA will adopt such a position.
On January 9, 1998, HCFA issued proposed Stark II regulations (the "1998 Proposed Regulations"). The 1998 Proposed Regulations provide that EPO and other outpatient drugs used in connection with dialysis treatments, and home health services and supplies used in home dialysis services are not considered "designated health services" for purposes of Stark II. There can be no assurance, however, that final Stark II regulations will adopt such a position. With respect to the other items and services provided by the Company that are likely to be deemed to be "designated health services" subject to the Stark II prohibition, the language of the Stark II amendments and the Stark I final regulations suggest that the Company will not be permitted to offer, or seek reimbursement for, such services in the absence of a Stark II exception.
Because physicians under contract with the Company may refer patients to hospitals with which the Company has a Contract Services arrangement, Stark II may be interpreted to apply to the Company's Contract Services arrangements with hospitals. However, Stark II contains exceptions for certain equipment rental, personal services and fair market value arrangements and the Company believes that most of its Contract
Services arrangements are in material compliance with the requirements of such exceptions to Stark II. Moreover, the 1998 Proposed Regulations exclude from the definition of "inpatient hospital services" acute dialysis services furnished by a physician-owned contractor when the hospital is not certified to provide ESRD services. There can be no assurance, however, that final Stark II regulations will adopt such a position.
Stark II contains exceptions for ownership and compensation arrangements that meet certain specific criteria set forth in the statute or in forthcoming regulations. With respect to ownership, certain qualifying in-office physician and ancillary services provided by or under the supervision of physicians in a single group practice are exempt from both ownership and compensation arrangement restrictions. With respect to compensation arrangements, the exceptions available for certain qualifying arrangements include the following areas: (i) bona fide employment relationships; (ii) personal service arrangements; (iii) space and equipment leasing arrangements; (iv) certain group practice arrangements with a hospital that were in existence prior to December 1989; and (v) purchases by physicians of laboratory services, or other items and services at fair market value. In order to be exempt from the Stark II self-referral prohibition, it is necessary to meet all of the criteria of a particular exception for each financial relationship existing between an entity and a referring physician. Based on the existing regulations and the 1998 Proposed Regulations, the Company believes that many of its financial relationships with referring physicians will not be subject to the Stark self- referral prohibitions. Further, to the extent that some of the Company's financial arrangements are subject to Stark, the Company believes that all such financial arrangements meet the criteria for an exception under either the existing regulations or the 1998 Proposed Regulations.
However, because of its broad language, Stark II may be interpreted to apply to certain of the Company's operations. Consequently, Stark II may require the Company to restructure certain existing compensation agreements with its medical directors, or, in the alternative, to refuse to accept referrals for designated health services from certain physicians. Moreover, since Stark II prohibits Medicare or Medicaid reimbursement of items or services provided pursuant to a prohibited referral, and imposes substantial civil monetary penalties on entities which present or cause to be presented claims for reimbursement in such cases, the Company could be required to repay amounts reimbursed for items and services that HCFA determines to have been furnished in violation of Stark II, and could be subject to substantial civil monetary penalties, either or both of which could have a material adverse effect on the Company's operations and financial results and condition. The Company believes that if Stark II is interpreted to apply to the Company's operations, it is likely that the Company will be able on a prospective basis to bring its financial relationships with referring physicians into material compliance with the provisions of Stark II, including relevant exceptions. However, prospective compliance would not affect amounts or penalties determined to be owed for past conduct, and there can be no assurance that such prospective compliance, if possible, would not have a material adverse effect on the Company.
The Company's certificate of incorporation (the "Certificate") has certain provisions which are designed to comply with the requirements of the Stark Law. The Certificate provides that if the holder of the Company's stock or an immediate family member of the holder is a physician, then the stock will represent no investment or ownership interest in any entity to which such physician has made or is in a position to make referrals for designated health services. The Certificate also contains dividend and transfer policies which are designed to cure potential violations of the Stark Law which would occur should a physician with an investment or ownership interest in the Company make referrals to an entity and indirectly derive financial gain from such activities. The transfer policies have the additional function of subjecting future holders of the Company's stock to the same restrictions being imposed upon current holders.
Other Regulation
False Claims. The Company is also subject to federal and state laws prohibiting an individual or entity from knowingly and willfully presenting claims for payment (by Medicare, Medicaid and certain other third-party payors) that contain false or fraudulent information. These laws provide for both criminal and civil penalties. Furthermore, providers found to have submitted claims which they knew or should have known were false or fraudulent, or for items or services that were not provided, may be excluded from Medicare and
Medicaid participation, required to repay previously collected amounts, and/or subject to substantial civil monetary penalties, resulting in the possibility of substantial financial penalties for small billing errors repeated over a large number of claims, as each individual error may be deemed to be a separate violation of the False Claims Act. Although false claim violations are generally subject to investigation and prosecution by the applicable governmental agency, violations of the federal False Claim Act can also be the subject of Qui Tam (or whistle blower) litigation. In Qui Tam situations, certain individuals with knowledge of False Claim Act violations can bring suit, on behalf of the federal government, for such violations. As a "reward" for bringing successful Qui Tam cases, Qui Tam plaintiffs are entitled to a significant percentage of any penalties ultimately recovered by the federal government as a result of the violations prosecuted in the Qui Tam action. The number of health care Qui Tam cases is growing, and these cases increasingly involve arguments that a violation of the Anti-Kickback and Stark Laws could constitute a false claim under the federal False Claims Act, and thus subject health care providers to Qui Tam actions for alleged Anti-Kickback and Stark Law violations.
Although dialysis centers are generally reimbursed by Medicare based on prospective composite rates, the submission of Medicare cost reports and requests for payment by dialysis centers are covered by these laws. The Company believes that it has procedures to ensure the accurate completion of cost reports and requests for payment. However, there can be no assurance that cost reports or requests for payment filed by the Company will be materially accurate or will not be subject to challenge under these laws. Furthermore, there can be no assurance that cost reports or payment requests previously submitted by any of the entities that the Company has acquired will not be challenged under these laws. Any such challenges, including any related sanctions which might be assessed, could have a material adverse effect on the Company.
State Anti-Kickback Provisions. Many states have enacted statutes prohibiting health care providers from providing kickbacks or other forms of remuneration to individuals, including physicians, who induce, or refer patients, to the provider. Many of these laws have proscriptions similar to the Anti-Kickback Law, but apply more broadly to all patients, and not just those entitled to reimbursement under Medicare, Medicaid or other federal health care programs. The Company has no reason to believe that any of its arrangements with physicians are not in material compliance with such state laws. However, given the recent enactment of such state laws, there is an absence of definitive interpretive guidance in many areas and there can be no assurance that one or more of the practices of the Company or any of its acquired entities might not be subject to challenge under such state laws. If one or more of such state laws is interpreted to apply to the Company and the Company is determined to be liable for violations of such state laws, the application of such state laws could have a material adverse effect on the Company.
State Self-Referral Provisions. Numerous states have enacted statutes prohibiting physicians from holding financial interests in various types of medical centers or providers to which they refer patients. Many of these laws have proscriptions similar to the Stark law, but apply more broadly to all patients, and not just those entitled to reimbursement under the Medicare and Medicaid programs. The Company has no reason to believe that any of its arrangements with physicians are not in material compliance with such state laws. However, given the recent enactment of such state laws, there is an absence of definitive interpretive guidance in many areas and there can be no assurance that one or more of the practices of the Company or any of its acquired entities might not be subject to challenge under such state laws. If one or more of such state laws is interpreted to apply to the Company and the Company is determined to be liable for violations of such state laws, the application of such state laws could have a material adverse effect on the Company.
State Laws Regarding Provision of Medicine and Insurance. Although the Company currently has a number of arrangements with insurance companies and HMOs, these relationships do not account for a significant portion of the Company's revenues. Notwithstanding these current arrangements, as the managed care environment evolves, or if there is a legislative change requiring Medicare ESRD beneficiaries to obtain their care through a managed care arrangement, such as an HMO, the Company may be forced to revise its current operations, structure and/or practices to adapt to such an environment. Such changes may include the development of quasi-managed care entities that could deliver both dialysis treatment and related physician services through an integrated system that would share in the financial risk of the integrated services it
provides. However, because the laws of many states prohibit physicians from splitting fees with non-physicians and prohibit non-physician entities from practicing medicine, the Company's ability to structure such arrangements may be severely restricted, if not prohibited. Further, because most states also have laws regulating insurance companies and HMOs as well as the ability to enter into certain types of risk spreading and risk sharing arrangements, the Company may also be restricted in its ability to develop quasi-managed care entities and/or enter into risk sharing types of arrangements with payors. As a result of these regulatory constraints, the Company may not be able to quickly respond or adapt to a rapidly changing marketplace. If the Company is not able to quickly respond to such changes, it may have a material adverse effect on the Company. Further, if the Company is able to respond to such changes by restructuring its operations and/or practices, the Company may be subject to new intense regulatory oversight which may also have a material adverse effect on the Company.
Health Care Reform. Members of Congress from both parties and the executive branch are continuing to consider many health care proposals, some of which are comprehensive and far-reaching in nature. As noted above, the Medicare+Choice Program was developed as part of the amendments in the BBA. This program is designed to expand the options for Medicare beneficiaries and may have a significant impact on the manner in which health care is delivered in the future. Several states are also currently considering health care proposals. The Company is unable to predict what additional action, if any, the federal government or any state may ultimately take with respect to health care reform or when any such action will be taken. Health care reform may bring radical changes in the financing and regulation of the health care industry, which could have a material adverse effect on the Company.
Other Regulations. The Company's operations are subject to various state hazardous waste disposal laws. Those laws, as currently in effect, do not classify most of the waste produced during the provision of dialysis services to be hazardous, although disposal of non-hazardous medical waste is also subject to regulation. OSHA regulations require employers of workers who are occupationally subject to blood or other potentially infectious materials to provide those workers with certain prescribed protections against blood-borne pathogens. These regulatory requirements apply to all health care centers, including dialysis centers, and require employers to make a determination as to which employees may be exposed to blood or other potentially infectious materials and to have in effect a written exposure control plan. In addition, employers are required to provide hepatitis B vaccinations, personal protective equipment, infection control training, post-exposure evaluation and follow-up, waste disposal techniques and procedures, and engineering and work practice controls. Employers are also required to comply with certain record-keeping requirements. The Company believes that it is in material compliance with the foregoing laws and regulations.
Some states have established certificate of need ("CON") programs regulating the establishment or expansion of health care centers, including dialysis centers. In those states where CON laws apply to dialysis centers, the Company is required to go through a regulatory process that generally requires the identification and documentation of "need" for dialysis services, prior to being able to establish or expand its dialysis operations. The existence of CON laws and their application by regulatory agencies could have a material impact on the Company's ability to expand its dialysis operations in those states with CON requirements.
There can be no assurance that in the future the Company's business arrangements, past or present, will not be the subject of an investigation or prosecution by a federal or state governmental authority. Such investigation could result in any, or any combination, of the penalties discussed above depending upon the agency involved and such investigation and prosecution. None of the Company's business arrangements with physicians, vendors, patients or others have been the subject of investigation by any governmental authority. The Company monitors legislative developments and would seek to restructure a business arrangement if the Company determined that one or more of its business relationships placed it in material noncompliance with applicable law. The Company believes that in the near future the health care service industry will continue to be subject to substantial regulation at the federal and state levels, the scope and effect of which cannot be predicted by the Company. Any loss by the Company of its various federal certifications, its authorization to participate in the Medicare and Medicaid programs or its licenses under the laws of any state or other
governmental authority from which a substantial portion of its revenues are derived would have a material adverse effect on its operating and financial results.
ITEM 2.
ITEM 2. PROPERTIES
The Company operates 74 dialysis centers, five of which are located in owned facilities and the remainder of which are located in leased facilities. Such facilities range from approximately 2,000 to 17,000 square feet. These leases generally have terms of 10 years and typically contain renewal options. The Company owned 13,800 square feet of office space in Oak Park, Illinois as of September 2000. In October 2000, the Company sold such property to the Oak Park School District. Currently, the Company leases the property which is used for its corporate headquarters. In addition, the Company leases approximately 28,000 square feet of space in Bellwood, Illinois which houses corporate training, purchasing, biomedical, billing, facilities management and medical records and the Company leases approximately 6,000 square feet of space in Westbrook, Illinois, which houses dialysis accounting. The Company also leases space for its regional offices in Tucson, Arizona; Panama City, Florida; Dearborn, Michigan; and Westchester, Illinois. The regional offices range in size from 230 square feet to approximately 4,600 square feet under leases with expiration dates through March 31, 2003.
The Company considers its physical properties to be in good operating condition and suitable for the purposes for which they are being used.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
The Company is subject to claims and suits in the ordinary course of business, including those arising from patient treatment. The Company believes it will be covered by malpractice insurance with respect to these claims and does not believe that the ultimate resolution of pending proceedings will have a material adverse effect on the Company. However, claims against the Company, regardless of their merit or eventual outcome, could require management to devote time to matters unrelated to the operation of the Company's business, and may also have a material adverse effect on the Company's ability to attract patients or expand its business.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth quarter of fiscal 2000. Subsequent to the reporting period, on November 1, 2000, a majority-in-interest of the holders of common stock of the Company approved, by written consent, the execution of the Merger Agreement by the Company as well as certain other documents and matters related to the Merger Agreement. See "Management's Discussion and Analysis of Financial Condition and Results of Operations--Recent Developments."
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ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
There is no established public trading market for the common stock of the Company.
During fiscal 2000, the Company granted options to purchase 60,000 shares of common stock pursuant to the Company's stock option plan, in reliance on Rule 701 promulgated under the Securities Act. The Company also issued shares of common stock of the Company to the following former employees as a result of the exercise of stock options at an exercise price of $9.10: John Bourke received 17,625 shares on January 3, 2000, Nicki Norris received 3,603 shares on February 3, 2000 and Donna Raasch received 600 shares on September 14, 2000.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
These financial data should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the Consolidated Financial Statements and notes thereto included elsewhere in this Report.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis of the financial condition and results of operations of the Company should be read in conjunction with the more detailed information contained in the Consolidated Financial Statements and notes thereto appearing elsewhere in this Report.
Overview
Everest is a leading provider of dialysis and other blood treatment services. Founded in 1968 and principally owned by nephrologists, the Company has a long- standing focus on developing strong relationships with physicians to provide high-quality patient care. The Company is the nation's sixth-largest provider of chronic dialysis outpatient services and serves over 6,700 patients through 74 facilities in 11 states. In addition to its outpatient dialysis center operations, the Company provides acute dialysis services through contractual relationships with 34 hospitals in five states. Everest also contracts with 67 hospitals in 13 states to provide a broad range of other extracorporeal blood treatment services, including inpatient acute dialysis, perfusion, apheresis and auto-transfusion (together, "Contract Services"). Pursuant to management contracts, Everest provides management services to (i) a physician practice group comprised of 31 nephrologists, primarily in the Chicago and northwest Indiana areas, and (ii) certain minority-owned or unaffiliated dialysis facilities. For fiscal 2000, the Company derived 88.8% of its net revenues from chronic and acute dialysis services, 10.1% from Contract Services and 1.1% from management services.
Sources of Revenues
The Company's net revenues from chronic and acute dialysis services are derived from: (i) in-center dialysis and home dialysis services including drugs and supplies and acute dialysis services performed in hospitals; and (ii) contracts with hospital-based programs. The majority of the Company's in-center and home dialysis services are paid for under the Medicare ESRD program in accordance with rates established by HCFA. Additional payments are provided by other third-party payors (particularly by employer group health plans during the first thirty months of treatment), generally at rates higher than those reimbursed by Medicare. Everest is currently seeking to expand the portion of its revenues attributable to non-government payors by entering into contracts with managed care companies and other private payors. Because dialysis is an ongoing, life-sustaining therapy used to treat a chronic condition, utilization of the Company's chronic dialysis services is generally predictable and not subject to seasonal or economic fluctuations. ESRD patients may receive up to 156 dialysis treatments per year; however, due to hospitalization and no shows the Company's average number of treatments per patient per year is 140. Unless the patient moves to another dialysis facility, receives a kidney transplant or dies, the revenues generated per patient per year can be estimated with reasonable accuracy. See "Business--Sources of Revenue Reimbursement."
The Company's Contract Services revenues are derived from perfusion, apheresis and auto-transfusion services provided to hospitalized patients pursuant to contracts with hospitals. Rates paid for such services are negotiated with individual hospitals. Because extracorporeal blood treatment services are required for patients undergoing major surgical procedures, utilization of the Company's Contract Services is not subject to seasonal or economic fluctuations.
The Company's revenues also include fees paid under management services contracts. Management service fee revenue is recognized when earned. Management service fees are based on contracted rates. The contracted rates are estimates based upon the cost of services provided such as billing, accounting, technical support, cash management and facilities management.
Acquisitions
Pursuant to a Management Agreement with Montefiore Medical Center ("MMC"), New York Dialysis Management, Inc., a wholly-owned subsidiary of the Company ("NYDM"), managed four dialysis
facilities located in the Bronx, New York (the "Facilities") during fiscal 2000. Under the original Management Agreement, NYDM had a right of first refusal to purchase the Facilities and the right to operate them (and in effect terminate the Management Agreement) in the event that MMC received and proposed to accept a bona fide offer for the purchase of one or all of the Facilities. After having been informed by MMC of the receipt of such an offer in 1998, NYDM exercised its right of first refusal and, as a result, in July 1998, the parties entered into an Agreement to Amend and Not-to-Compete (the "Agreement to Amend") and Amendment No. 3 to the Management Agreement (the "Amendment"). Pursuant to the Agreement to Amend, NYDM paid an amount equal to $19,216,000 to MMC in consideration for MMC's covenant not-to-compete and other undertakings, including MMC's agreement to enter into the Agreement. Contemporaneously with the execution of the Agreement to Amend and the Amendment, MMC entered into a Medical Asset Purchase Agreement (the "Purchase Agreement") pursuant to which it agreed to sell the Facilities' medical assets to Everest Dialysis Services, Inc. ("EDS"), a corporation formed for this purpose under the laws of the State of New York, and which is owned by Craig Moore and Paul Balter, M.D., owners of the Company. The sale of the medical assets to EDS occurred in November 2000.
During Fiscal 1999, the Company acquired additional equity in five entities in which it previously held a minority interest: (i) Dialysis Specialists of Topeka, Inc., which owns one outpatient and home dialysis facility in Topeka, Kansas (the Company's interest was increased from 25% to 75%); (ii) Dialysis Specialists of Central Cincinnati, Ltd. ("DSCCL"), which owns one outpatient and home dialysis facility in Norwood, Ohio (the Company's interest was increased from 37.9% to 100.0%); (iii) Home Dialysis of Fairfield, Inc. ("Fairfield"), which owns one outpatient and home dialysis facility in Fairfield, Ohio (the Company's interest was increased from 50.0% to 100.0%); (iv) Home Dialysis of Columbus, Inc ("Columbus"), which owns two outpatient and home dialysis facilities in Columbus, Ohio (the Company's interest was increased from 49.0% to 100.0%); (v) Dialysis Specialists of Tulsa, Inc., which owns one outpatient and home dialysis facility in Tulsa, Oklahoma (the Company's interest was increased from 33.33% to 100.0%). Additionally, during Fiscal 1999 the Company acquired a 100.0% interest in Englewood Dialysis Facility L.L.C., which owns one outpatient and home dialysis facility in Englewood, New Jersey (the Company previously had no equity interest in this facility). These acquisitions represented 120 stations and approximately 639 patients in the aggregate.
In November 1999, the Company acquired a 100.0% interest in the non-medical assets of Western New York Artificial Kidney Center, Inc. ("WAKC") through NYDM, and entered into an agreement with WAKC whereby EDS would acquire the medical assets of WAKC. This acquisition relates to three outpatient dialysis facilities in the Buffalo, New York area (the Company previously had no equity interest in these facilities). This acquisition represented 45 stations and approximately 241 patients in the aggregate. The parties have obtained the approval of the New York Public Health Council required for the consummation of the transactions contemplated under the purchase agreement with WAKC and the subsequent operation of the Facilities by EDS.
In December 1999, the Company acquired a 100.0% interest in St. Clare Dialysis Center located in Dover, New Jersey (the Company previously had no equity interests in these facilities). This acquisition represented 12 stations and approximately 65 patients.
Acquisitions of dialysis and Contract Services providers have been recorded under purchase accounting with the purchase price being principally allocated to fixed assets, accounts receivable and inventory based on respective estimated fair market values at the date of acquisition. Any excess of the purchase price over the fair value of identifiable assets (including identifiable intangible assets) is allocated to goodwill, which is amortized over 25 years. The results of these acquisitions have been included in the results of operations from their respective acquisition dates. The Company regularly evaluates the potential acquisition of, and holds discussions with, various potential acquisition candidates; as a general rule, the Company does not intend to publicly announce such acquisitions until a definitive agreement has been reached.
De Novos
During Fiscal 2000, the Company commenced operations in four De Novo facilities: (1) Greenwood Avenue Dialysis Center which is comprised of one outpatient dialysis facility in Chicago, Illinois, (2) North Avenue Dialysis Center which is comprised of one outpatient dialysis facility in Melrose Park, Illinois, (3) East Chicago Dialysis Center which is comprised of one outpatient dialysis facility in East Chicago, Indiana, and (4) Portage Dialysis Center which is comprised of one outpatient dialysis facility in Portage, Indiana. These De Novos represent 61 stations and approximately 200 patients in the aggregate.
Reorganization
In November 1997, in order to simplify its ownership structure and better position the Company for future growth, the shareholders of the Company entered into a series of related transactions. Prior to such transactions, the Founding Directors, who collectively owned approximately 70% of the equity in the Company, held their equity interest through a limited liability company. Following these transactions, the Founding Directors now directly hold approximately 55% of the equity in the Company, and collectively own all of the membership interests in Peak Liquidating, which in turn owns approximately 15% of the equity in the Company. See "Certain Relationships and Related Transactions" and "Security Ownership of Certain Beneficial Owners and Management."
Consolidations
Effective as of June 30, 1999, in a transaction consummated by the Company to simplify tax reporting, Northwest Indiana Dialysis Center, Inc. and Lake Avenue Dialysis Center, Inc., were merged with and into Ohio Valley Dialysis Center, Inc. ("Ohio Valley"), in a statutory merger with Ohio Valley being the surviving entity, and the name of Ohio Valley was changed to Everest Healthcare Indiana, Inc.
Effective as of September 30, 1999, in a transaction consummated by the Company to simplify tax reporting, Dialysis Specialists of Central Cincinnati, Ltd., Home Dialysis of Columbus, Inc., and Home Dialysis of Dayton, Inc. were merged with and into Home Dialysis of Fairfield, Inc. ("Fairfield"), in a statutory merger with Fairfield being the surviving entity, and the name of Fairfield was changed to Everest Healthcare Ohio, Inc.
Effective as of October 31, 1999, in a series of transactions consummated by the Company to simplify tax reporting, Dialysis Specialists of South Texas, L.L.C., Hemo Dialysis of Amarillo, L.L.C., Amarillo Acute Dialysis Specialists, L.L.C. and Dialysis Specialists of Corpus Christi, L.L.C., were merged with and into North Buckner Dialysis Center Inc. ("North Buckner") in a statutory merger with North Buckner being the surviving entity, and the assets of North Buckner were contributed to Everest Healthcare Texas, L.P. ("New LP"), a newly formed limited partnership. New LP is owned by North Buckner (its 1% general partner) and Everest Healthcare Texas Holding Corp. (its 99% limited partner) a newly formed, wholly-owned subsidiary of North Buckner.
Results of Operations
The following table sets forth for the periods indicated the Company's results of operations:
The following table sets forth for the periods indicated certain statement of operations items expressed as a percentage of net revenues for such periods:
Fiscal Year Ended September 30, 2000 Compared to Fiscal Year Ended September 30, 1999
Net Revenues. Net revenues increased $48.7 million or 26.3% to $233.6 million for fiscal 2000 from $184.9 million for fiscal 1999. Approximately $18.7 million of the increase was attributable to an increase in
the number of treatments at existing dialysis facilities, a shift in revenues by payor and an increase in the average net revenue per treatment to approximately $253 for fiscal 2000 from $236 for fiscal 1999. Of the remaining $30.0 million of the increase, approximately $21.7 million resulted from the increase in ownership of five dialysis facilities and the acquisition of five dialysis facilities in fiscal 2000 and fiscal 1999. Approximately $5.7 million was attributable to revenues generated pursuant to de novo facilities opened by the Company in fiscal 2000 and 1999 and approximately $2.6 million was attributable to same store growth in the Contract Services business.
Patient Care Costs. Patient care costs consist of costs directly related to the care of patients, including direct and indirect labor, drugs and other medical supplies and operational costs of the facilities. Patient care costs also reflect the indirect costs of supporting the facilities such as bio-med and staff education. Patient care costs increased $36.1 million or 27.4% to $167.7 million for fiscal 2000 from $131.6 million for fiscal 1999. Approximately $9.8 million of the increase was attributable to the increase in the number of treatments at the existing dialysis facilities. Of the remaining increase, $23.0 million is from opening de novo facilities, the increase in ownership of five dialysis facilities and the acquisition of five dialysis facilities in fiscal 2000 and 1999. Approximately $2.3 million was attributable to the patient care costs incurred by the Contract Services businesses.
General and Administrative Expenses. General and administrative expenses increased $3.6 million or 14.9% to $27.9 million for fiscal 2000 from $24.3 million for fiscal 1999. The increase was attributable to the growth of the corporate infrastructure, including the expansion of information systems and increased professional fees.
Special Charges. Approximately $23.0 million of charges were recognized during fiscal 1999. These amounts included $22.4 million in impairment of long- lived assets and $600 in severance costs to two executives of the Company related to amounts that were due under the individuals' employment contract upon separating from the Company. No special charges were incurred during fiscal 2000. Exclusive of special charges, income from operations increased approximately $8.3 million or 74.6% to $19.4 million for fiscal 2000 from $11.1 million for fiscal 1999.
Provision for Bad Debts. Provision for bad debts decreased $1.1 million or 14.9% to $6.3 million for fiscal 2000 from $7.4 for fiscal 1999. The decrease was due primarily to improvements in the Company's days sales outstanding of patient receivables by approximately 20 days.
Depreciation and Amortization. Depreciation and amortization increased approximately $1.8 million or 17.1% to $12.3 million for fiscal 2000 from $10.5 million for fiscal 1999. The increase was due to increased amortization of goodwill as a result of business acquisitions and to increased depreciation expense as a result of fixed asset purchases and denovo developments.
Income from Operations. Income from operations increased $31.2 million or 264.4% to income of $19.4 million for fiscal 2000 from a loss of $11.8 million for fiscal 1999. Accordingly, income from operations as a percentage of net revenues increased to 8.3% for fiscal 2000 as compared to (6.4)% for fiscal 1999 due primarily to the effect of the special charges recorded in fiscal 1999 and the factors discussed above.
Interest Expense, Net. Interest expense, net increased $2.2 million or 19.8% to $13.3 million for fiscal 2000 from $11.1 million for fiscal 1999. The increase was primarily attributable to an increase of approximately $6.0 million in the acquisition line under the Credit Facility, increase in interest rates over prior year and increased amortization of deferred financing costs over prior years.
Equity in Earnings of Affiliates. Equity in earnings of affiliates represents the Company's portion of earnings in unconsolidated joint ventures. The Company recognized equity in earnings of affiliates of approximately $472 in fiscal 2000, and $586 in fiscal 1999. This decrease is primarily due to the Company's acquisition of the interest not previously owned in the minority joint ventures over the last several years.
Minority Interests in Earnings. Minority interests in earnings represents the proportionate equity interests of other partners in the Company's entities that are not wholly owned. The minority interests in earnings increased approximately $27 to $870 in fiscal 2000 as compared to $843 in fiscal 1999.
Income Taxes. Income taxes increased approximately $10.1 million to a tax expense of $3.3 million in fiscal 2000 from a tax benefit of $6.8 million in fiscal 1999 as a result of the factors discussed above.
Fiscal Year Ended September 30, 1999 Compared to Fiscal Year Ended September 30, 1998
Net Revenues. Net revenues increased $37.4 million or 25.4% to $184.9 million for fiscal 1999 from $147.5 million for fiscal 1998. Approximately $11.8 million of the increase was attributable to an increase in the number of treatments at existing dialysis facilities, a shift in revenues by payor and an increase in the average net revenue per treatment to approximately $236 for fiscal 1999 from $229 for fiscal 1998. Of the remaining $25.6 million of the increase, approximately $20.6 million resulted from the acquisition of 12 dialysis facilities in fiscal 1999 and fiscal 1998 and the acquisition of Contract Services businesses in fiscal 1998. Approximately $3.2 million was attributable to revenues generated pursuant to de novo facilities opened by the Company in fiscal 1998 and 1999 and approximately $2.4 million was attributable to same store growth in the contract services business.
Patient Care Costs. Patient care costs consist of costs directly related to the care of patients, including direct and indirect labor, drugs and other medical supplies and operational costs of the facilities. Patient care costs have been adjusted to also reflect the indirect costs of supporting the facilities such as bio-med and staff education. Patient care costs increased $29.0 million or 28.3% to $131.6 million for fiscal 1999 from $102.6 million for fiscal 1998. Approximately $9.7 million of the increase was attributable to the increase in the number of treatments at the existing dialysis facilities. Of the remaining increase, $15.5 million is from the opening of de novo facilities in fiscal 1998 and 1999 and the acquisition of 12 facilities in fiscal 1999 and fiscal 1998, and approximately $2.5 million was attributable to the acquisition of Contract Services businesses in fiscal 1998.
General and Administrative Expenses. General and administrative expenses increased $1.0 million or 4.3% to $24.3 million for fiscal 1999 from $23.3 million for fiscal 1998. The increase was attributable to the growth of the corporative infrastructure, including the expansion of information systems, increased professional fees and increased administrative labor costs.
Special Charges. The Company recorded approximately $23.0 million of charges during fiscal 1999. These amounts have been expensed as special charges and include $22.4 million in impairment of long-lived assets and $600 in severance costs.
The impairment of long-lived assets included (i) a $20.5 million write down of goodwill and other intangible assets, (ii) a $1.4 million write-off of advances to, and other assets of, certain of the Company's joint ventures and (iii) the write-down of $500 of fixed assets to fair value. The write-off of goodwill and other intangible assets was the result of a deterioration in the profitability and cash flows of certain acquired operations. The deterioration was due, in part, to continued contractual adjustments and other reductions in anticipated revenues. As a result of this deterioration, the Company evaluated the long-lived assets of effected businesses for impairment to determine the amount of the assets that were not recoverable. As a result of this evaluation, the Company recorded a write-down of these assets based upon the amount by which the carrying value of the assets exceeded their fair values as determined on a discounted cash flows basis. Certain of the Company's joint ventures encountered similar deterioration in the current fiscal year. As a result, the Company recorded a write-off of certain advances to and other assets of these companies.
The severance costs to two executives of the Company related to amounts that were due under the individuals' employment contract upon separating from the Company.
Provision for Bad Debts. Provision for bad debts increased $4.7 million or 174.1% to $7.4 million for fiscal 1999 from $2.7 for fiscal 1998. The increase was due to a deterioration of the Company's days sales outstanding of patient receivables as well as an overall increase in patient receivables due to increased treatments.
Depreciation and Amortization. Depreciation and amortization increased approximately $3.6 million or 52.2% to $10.5 million for fiscal 1999 from $6.9 million for fiscal 1998. The increase was due to increased amortization of goodwill as a result of business acquisitions (including the purchase of minority interests) and to increased depreciation expense as a result of fixed asset purchases and denovo developments.
Income from Operations. Income from operations decreased $23.7 million or 199.2% to a loss of $11.8 million for fiscal 1999 from income of $11.9 million for fiscal 1998. Accordingly, income from operations as a percentage of net revenues decreased to (6.4)% for fiscal 1999 as compared to 8.0% for fiscal 1998 due to the factors discussed above.
Interest Expense, Net. Interest expense, net increased $5.2 million or 88.1% to $11.1 million for fiscal 1999 from $5.9 million for fiscal 1998. The increase was primarily attributable to a full year of interest expense recognized on the Senior Subordinated Notes in fiscal 1999 versus only five months of interest expense recognized in fiscal 1998.
Equity in Earnings of Affiliates. Equity in earnings of affiliates represents the Company's portion of earnings in unconsolidated joint ventures. The Company recognized equity in earnings of affiliates of approximately $586 in fiscal 1999, and $1.8 million in fiscal 1998. This decrease is primarily due to the Company's acquisition of the interest not previously owned in four joint ventures during fiscal 1999, which were previously minority owned, and the increase from minority ownership (25%) to majority ownership (75%) in one other entity.
Minority Interests in Earnings. Minority interests in earnings represents the proportionate equity interests of other partners in the Company's entities that are not wholly owned. The minority interests in earnings increased approximately $327 to $843 in fiscal 1999 as compared to $516 in fiscal 1998.
Income Taxes. Income taxes decreased approximately $10.3 million to a tax benefit of $6.8 million in fiscal 1999 from a tax expense of $3.5 million in fiscal 1998 as a result of the factors discussed above.
Liquidity and Capital Resources
The Company requires capital primarily for the acquisition and development of dialysis centers and Contract Services businesses, the purchase of property and equipment for existing centers and to finance working capital requirements. At September 30, 2000, the Company's working capital was $30.5 million as compared to $34.6 million at September 30, 1999.
The Company's net cash provided by operating activities was $17.4 million for the twelve months ended September 30, 2000. Cash provided by operating activities consists of net income increased by non-cash expenses such as depreciation, amortization and the provision for bad debts and adjusted by the changes in components of working capital, primarily receivables, payables and accrued expenses. The Company's net cash used in investing activities was $19.5 million for the twelve months ended September 30, 2000. The
Company's principal sources and uses of cash consist of investing activities related to the development of five facilities and the expansion of four existing facilities and the purchase of new equipment and leasehold improvements for existing dialysis centers and the purchase of four independent dialysis facilities. Net cash provided by financing activities was approximately $2.9 million for the twelve months ended September 30, 2000. The primary sources and uses of cash from financing activities were net borrowings or repayments under the Credit Facility.
The Company does not have any current material commitments for capital expenditures.
On June 30, 1999, the Company refinanced its Credit Facility with Harris Trust and Savings Bank as agent bank, the same commercial bank that provided the Prior Credit Facility. The new Credit Facility consists of three separate facilities: (i) the $35.0 million Revolving Credit Facility maturing on June 30, 2002; (ii) $65.0 million Acquisition Credit Facility maturing on June 15, 2005, which includes the requirement to convert all of the borrowings outstanding thereunder on each of June 30, 2000, 2001 and 2002 to one or more seven-year term loans with balloon payments due on June 15, 2005 (the "Term Loans"); and (iii) the $40.0 million Year 2000 Credit Facility, available from January 1, 2000 through June 30, 2000, to finance government related accounts receivable which are unpaid due to difficulties related to the year 2000. The total amount drawn under the Credit Facility may not exceed $140.0 million. The Credit Facility contains operating and financial covenants, including, without limitation, requirements to maintain leverage and debt service coverage ratios and minimum tangible net worth. In addition, the Credit Facility includes customary covenants relating to the delivery of financial statements, reports, notices and other information, access to information and properties, maintenance of insurance, payment of taxes, maintenance of assets, nature of business, corporate existence and rights, compliance with applicable laws, including environmental laws, transactions with affiliates, use of proceeds, limitation on indebtedness, limitations on liens, limitations on certain mergers and sales of assets, limitations on stock repurchases, and limitation on debt payments and other distributions including prepayment or redemption of the Company's Senior Subordinated Notes due 2008. The Credit Facility contains certain events of default after expiration of applicable grace periods, including defaults relating to: (i) nonpayment of principal, interest, fees or other amounts; (ii) violation of covenants; (iii) material inaccuracy of representations and warranties; (iv) bankruptcy; (v) material judgments; (vi) certain ERISA liabilities; and (vii) actual or asserted invalidity of any loan documents.
Effective as of October 8, 1999, December 21, 1999 and March 1, 2000 the new Credit Facility was amended. In addition to approving certain acquisitions by the Company, the October amendment permits the Company to capitalize and provide working capital to certain affiliates of the Company which own or operate a segment of the business in jurisdictions where, pursuant to the laws of such jurisdictions, the Company itself is not qualified to own or operate such segments of the business. The December amendment modified the cash leverage ratio, fixed charge coverage ratio and definition of EBITDA under the Credit Facility in connection with the charge recognized by the Company in fiscal 1999 of approximately $23 million, which charge was taken in connection with the write down by the Company of goodwill and other intangible assets. The March amendment adjusted the net worth and rescinded the Y2K Revolving Credit Commitment. See, "--Results of Operations--Special Charges." In connection with the December amendment, the Company paid Harris Trust and Savings Bank a fee of $525,000.
In November 1996, the Company issued notes in the aggregate principal amount of $7.0 million as part of the purchase price for its acquisition of The Extracorporeal Alliance. The notes bear interest at a variable rate equal to the five-year Treasury note rate plus three percent and mature on October 31, 2002.
A significant component of the Company's growth strategy is the acquisition and development of dialysis centers and the acquisition of Contract Services businesses. The Company believes that the existing cash and funds from operations, together with funds available under the Credit Facility, will be sufficient to meet the Company's acquisition, development, expansion, capital expenditure and working capital needs for at least the
next twelve months. In order to finance certain strategic acquisition opportunities, the Company may from time to time incur additional short and long-term bank indebtedness and may issue equity or debt securities, the availability and terms of which will depend on market and other conditions. There can be no assurance that the Company will be successful in implementing its growth strategy or that adequate sources of capital will be available in the future as needed on terms acceptable to the Company.
Impact of Inflation
A substantial portion of the Company's net revenues is subject to reimbursement rates that are regulated by the federal government and do not automatically adjust for inflation. The Company is unable to increase the amount it receives for the services provided by its dialysis businesses that are reimbursed under the Medicare composite rate. Increased operating costs due to inflation, such as labor and supply costs, without a corresponding increase in reimbursement rates, may adversely affect the Company's earnings in the future. However, part of the Company's growth strategy is to acquire additional Contract Services businesses which are not directly dependent on reimbursement from government agencies. The Company believes that the effect of inflation is further mitigated by a recent change in current governmental health care laws that extends the coordination of benefits period for ESRD patients who are covered by an employer group health plan from 18 to 21 months to 30 to 33 months before Medicare becomes the primary payor. In addition, the Balanced Budget Refinement Act of 1999 updated the composite rate for payment by 1.2% for renal dialysis services furnished in 2000 and an additional 1.2% for such services furnished in 2001.
Recent Developments
On November 2, 2000, the Company announced that it had entered into an Agreement and Plan of Merger, dated November 1, 2000, by and among the Company, Fresenius Medical Care AG, ("FMC"), Edmund Acquisition Sub, Inc. and certain stockholders of the Company (the "Merger Agreement"). The Merger Agreement provides for a merger of the Company with and into Edmund Acquisition Sub, Inc. While the merger is anticipated by management to be completed in the first calendar quarter of 2001, because all the conditions of the Merger Agreement have not been met, the exact timing for consummation of the merger is uncertain at this time. Therefore, the Company's Form 10-K has been prepared so as to describe its business in an ongoing manner, thus providing an understanding of the Company's strategies, business and ongoing obligations as they existed at the end of its fiscal year ended September 30, 2000 for which this report is filed. Further information can be found in the Form 8-K filed by the Company with respect to the Merger Agreement on November 14, 2000.
On November 15, 2000, in connection with the Merger Agreement, FMC announced a tender offer and consent solicitation for the Company's 9 3/4% Senior Subordinated Notes due 2008 (the "Notes"). On December 1, 2000, following the tender by holders possessing a majority of the Notes, the Company and its subsidiaries which are guarantors under the Indenture, dated May 5, 1998 by and among the Company, the Subsidiary Guarantors and American National Bank and Trust Company of Chicago, as trustee (the "Subsidiary Guarantors") executed a Supplemental Indenture which implements amendments to the Indenture. These amendments to the Indenture shall be effective upon the later of the consummation of the transactions under the Merger Agreement or the expiration of the tender offer.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is exposed to market risk from changes in interest rates. To reduce such risk, the Company selectively uses financial instruments. All hedging transactions are authorized and executed pursuant to regularly reviewed policies and procedures, which prohibit the use of financial instruments for trading purposes.
A discussion of the Company's accounting policies for derivative financial instruments is included in Note 3, Summary of Significant Accounting Policies, in the notes to the consolidated financial statements, and further disclosure is included in Note 11, Long-Term Debt.
The Company's earnings are affected by changes in interest rates as a result of its variable rate borrowings under the Credit Facility. In August 2000, the Company entered into an interest rate cap to reduce the impact of increases in interest rates on its floating rate debt. The differential received under the agreement is recognized as an adjustment to interest expense. Based on 2000 and 1999 year-end balances, it is estimated that a 1% increase in interest rates would not have a material impact on interest expense or income before taxes. This analysis does not take into effect other changes that might occur in the economic environment as a whole due to such changes in short-term interest rates.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements and schedule of the Company are annexed to this Report. An index to such materials appears on page.
ITEM 9.
ITEM 9. CHANGE IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable.
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ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The directors and executive officers of the Company are as follows:
Mr. Moore is Chairman of the Board of Directors and Chief Executive Officer of the Company. He has served in those capacities since 1995. Mr. Moore joined Everest in 1986 as an Executive Vice President. He holds a Bachelor of Arts in Business and Finance from Adrian College and completed the Institute for Management at Northwestern University in 1976. He has worked for U.S. Steel Corporation, American Hospital Supply Corporation and Baxter Healthcare Corporation in a variety of management assignments including Division President of American Micro-Surgery Specialties. He served four years in the U.S. Navy as a line officer. Mr. Moore is a member of the Board of Directors of Biologic Systems Corporation.
Dr. Morris is the President and a director of the Company. Dr. Morris joined Everest in 1971. He received his medical degree from the State University of New York at Buffalo in 1965 and completed a Fellowship in Renal Disease at Rush-Presbyterian-St. Luke's Hospital in Chicago in 1971. Dr. Morris was board certified in Internal Medicine in 1971 and in Nephrology in 1972. He has been on the Board of Directors of the National Kidney Foundation of Illinois since 1973. From 1979 to 1981, he served as Chairman of the ESRD Network 15. In 1984 Dr. Morris was appointed by Governor Thompson to serve on the State of Illinois Renal Disease Advisory Council, on which he continues to serve. Dr. Morris is a Fellow in the American College of Physicians, has been a member of the board of trustees at West Suburban Hospital Medical Center since 1990. He has been in private practice since 1971.
Mr. Fox is the Senior Vice President of Strategic Development and a director of the Company. Mr. Fox joined Everest in 1996. He is a graduate of Northern Arizona University where he earned a Bachelor of Science in Accounting and is a Certified Public Accountant. Mr. Fox has over ten years of management experience in the dialysis industry. He began his career in the dialysis industry as the Chief Financial Officer of Southwest Kidney Institute and later, beginning in 1992, was named Chief Executive Officer of HDA. Mr. Fox is a former treasurer of the National Renal Administrators Association.
Dr. Carbon is the Senior Vice President and a director of the Company. Dr. Carbon joined Everest in 1979. Dr. Carbon received his M.D. from the University of Illinois in 1965. He completed his fellowship in both Internal Medicine in 1970 and Nephrology in 1971 from the University of Miami, Miami, Florida. Dr. Carbon served in the U.S. Army Medical Corps from 1966 to 1968. Dr. Carbon has been in private practice since 1971 specializing in nephrology and hypertensive disease. Dr. Carbon has been a board member of
Central DuPage Hospital since 1994 and formerly served as president of the hospital's medical staff. He is chief operating officer of NANI-IL and NANI-IN and medical director of the Company's Contract Services business.
Dr. Zabetakis is the Executive Vice President and Chief Operating Officer of the Company's Dialysis Services business with responsibility for operations of the chronic dialysis centers. Dr. Zabetakis joined Everest in this capacity in November of 1999. Previously, he had served various other roles with the Company including Vice-Chairman--Quality Improvement Committee, Medical Director--Peritoneal Dialysis, and Medical Director for Renal Disease Management Services. Dr. Zabetakis received his undergraduate degree from Washington and Jefferson College in Washington, Pennsylvania and received his Doctorate of Medicine from the University of Tennessee College of Medicine in Memphis. Dr. Zabetakis completed his Fellowship in Nephrology at Yale University School of Medicine and is a graduate of the Kellogg Graduate School of Management's Advanced Executive Program. Dr. Zabetakis also has been a practicing physician in Nephrology at Lenox Hill Hospital in New York City where he was also the Associate Chief of Nephrology and the Director of Home Peritoneal Dialysis.
Mr. Becks is Chief Executive Officer of the Company's Contract Services business and has served in that capacity since 1996. Mr. Becks joined Everest in 1989. Mr. Becks is a registered nurse and a graduate of Northwestern University where he earned a Bachelor of Science Degree. Mr. Becks served in the U.S. Navy following which he worked for American V. Mueller, a division of American Hospital Supply Corp., in a variety of sales, marketing, and management assignments including Vice President of Business Development. Mr. Becks was previously (from 1989 to 1996) a General Manager of the Company's Continental Healthcare affiliate.
Mr. Damron is the Chief Financial Officer of the Company. Mr. Damron joined the Company in June 1999. Mr. Damron received his Bachelor of Arts degree in economics from the University of Cincinnati and his Masters of Arts degree in international relations from University of Southern California. Mr. Damron received his Masters of Business Administration from Harvard University and is also a Certified Public Accountant. Mr. Damron served as senior accountant at Price Waterhouse from 1975 to 1980 when he left to join American Hospital Supply Corporation. Mr. Damron had a number of successively more responsible positions at American Hospital Supply Corporation, which was acquired by Baxter International in 1985. Mr. Damron spent 12 years in a number of key management positions at Baxter International including his last position as Treasurer of Baxter. Mr. Damron most recently held the position of Senior Vice President, Finance and Treasurer at Evanston Northwestern Healthcare.
Dr. Balter is the Chief Medical Officer, Secretary/Treasurer and a director of the Company. He also serves as chairman of the Company's Corporate Quality Improvement Committee. Dr. Balter joined Everest in 1971. Dr. Balter received his M.D. from Yale University in 1965 and completed his renal fellowship there in 1969. He served as a nephrologist in the U.S. Army from 1969 to 1971, and served in the only hemodialysis unit in Vietnam from 1970 to 1971. Dr. Balter was board certified in Internal Medicine in 1972 and in Nephrology in 1974. Dr. Balter specializes in systems applications of quality assurance. He has been in private practice since 1971.
Mr. Creel has been a member of the board of directors of Everest since 1997. Mr. Creel received his Bachelor of Arts degree from the University of South Florida. Following two years in the U.S. Army, Mr. Creel began his sales career in health care with Parke-Davis Pharmaceutical Co. He later joined Baxter Healthcare Renal Division where he became Vice President of Sales and Service-- U.S. He was one of the founders of Home Dialysis of America, Inc., where he served since 1992 as Managing Director of Business Development and Operations. Since June of 1996, Mr. Creel has been the Vice President of Business Development--North for Everest.
Mr. Berry has been a member of the board of directors of Everest since 1996. Mr. Berry received his Bachelor of Science degree in 1966 from the University of Wisconsin and a Juris Doctor degree in 1969 from Boston University. Mr. Berry is a Partner in the law firm of Katten Muchin Zavis in Chicago, Illinois, which he joined in 1974. He currently serves on the Board of Directors of the National Kidney Foundation of Illinois.
Mr. Berry also serves on the board of directors of each of Abrix Group, Health Care Management Consultants and MedOpSys.
Dr. Dunea has been a member of the board of directors of Everest since 1990. He received his medical degree from University of Sydney Medical School in 1957 and completed nephrology fellowships at the Cleveland Clinic in 1965 and at Presbyterian St. Luke's and University of Illinois Hospitals in 1966. Dr. Dunea was board certified in Internal Medicine in 1973 and in Nephrology in 1974. Since 1969 he has served as the Chairman of the Department of Nephrology- Hypertension at the Cook County Hospital, a Professor of Clinical Medicine at the Chicago campus of the University of Illinois College of Medicine and the Scientific Director of the Hektoen Institute. In addition to an extensive background of scientific publications including articles, book chapters and books, Dr. Dunea serves as the editor of Kidney and the coordinating editor of International Journal of Artificial Organs. Dr. Dunea is a Fellow in the Royal College of Physicians (London and Edinburgh) and the Royal Society of Medicine (London).
Dr. Gupta has been a member of the Board of Directors of the Company since 1987. Dr. Gupta received his medical degree at the University of Delhi in Delhi, India in 1970, and completed his nephrology fellowship at the University of Chicago in 1978. Dr. Gupta was board certified in Internal Medicine in 1981 and in Nephrology in 1988. His professional memberships include the American Society of Nephrology, the International Society of Nephrology and the American Medical Association. He has been in private practice in Internal Medicine and Nephrology since 1978. Dr. Gupta is a fellow of the American College of Physicians and serves as an associate editor of Kidney.
Dr. Mufuka has been a member of the board of directors of Everest since 1987. He received his medical degree from the State University of New York in Syracuse, New York in 1973 and completed his Nephrology Fellowship at Northwestern University Medical Center in 1978. Dr. Mufuka is board certified in Internal Medicine. His professional memberships include the American Society of Nephrology, International Society of Nephrology, the American Medical Association and the American College of Physicians. In addition, Dr. Mufuka is a current director of WSKC Dialysis Services, Inc. He has been in private practice since 1978.
There is no family relationship among any of the officers and directors.
Messrs. Creel and Fox are each entitled to a seat on the Board of Directors pursuant to a Shareholders Agreement. See "Certain Relationships and Related Transactions--Shareholders Agreements."
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The following table sets forth information with respect to the cash compensation paid by the Company for services rendered during the fiscal years ended September 30, 2000, 1999 and 1998 to the chief executive officer and the four other most highly compensated executive officers (the "Named Executive Officers") of the Company:
Summary Compensation Table for the Fiscal Years Ended September 30
- -------- (1) Does not include compensation for service as a director of the Company. Director compensation is set forth below. (2) Includes profit sharing contributions of $0, $8,104 and $15,533 in fiscal 2000, 1999 and 1998, respectively and 401(k) plan matching contributions of $6,935, $5,000 and $4,007 in fiscal 2000, 1999 and 1998, respectively. (3) Includes profit sharing contributions of $0 in fiscal 2000 and 401(k) plan matching contributions of $1,661 in fiscal 2000. (4) Mr. Damron was hired by the Company as its Chief Financial Officer, effective June 28, 1999. (5) Includes profit sharing contributions of $0 $8,104 and $15,533 in fiscal 2000, 1999 and 1998, respectively and 401(k) plan matching contributions of $7,067, $5,000 and $5,709 in fiscal 2000, 1999 and 1998, respectively. (6) Includes profit sharing contributions of $0, $8,104 and $15,533 in fiscal 2000, 1999 and 1998, respectively and 401(k) plan matching contributions of $7,434, $4,952 and $2,050 in fiscal 2000, 1999 and 1998, respectively. (7) Includes profit sharing contributions of $0 in fiscal 2000, 1999 and 1998, and 401(k) plan matching contributions of $4,881, $0 and $0 in fiscal 2000, 1999 and 1998 respectively.
Certain executive officers of the Company, including Drs. Morris, Carbon and Balter, are compensated by NANI. The Company pays fees to NANI for medical director and other services provided by these physicians and other NANI employees. See "Certain Relationships and Related Transactions--NANI-IL and NANI-IN."
Director Compensation
The Company has quarterly directors' meetings and pays each of its 10 directors $8,000 per year. Certain directors also provide consulting services to the Company through NANI. See "Certain Relationships and Related Transactions--NANI-IL and NANI-IN."
Employment Agreements
The Company and Mr. Moore entered into an employment agreement effective January 1, 1997 and continuing on a year-to-year basis thereafter, subject to termination by either party on 48 hours' notice. The agreement provides for an annual salary of $440,000 in addition to health insurance, disability insurance and other standard benefits. If the agreement is terminated by the Company for any reason or by Mr. Moore for any reason upon at least 45 days' prior notice, Mr. Moore will be entitled to severance pay in the amount of $598,833, as well as life, health and disability insurance and other benefits for nine months after the termination date. The agreement contains restrictive covenants that prohibit Mr. Moore from competing with the Company for a period of two years following his termination of employment. Pursuant to Company policy, Mr. Moore is entitled to a personal expense account, funded from a portion of his salary, to be used for legitimate business expenses, provided that all monies not used in the account at each year end will be returned to Mr. Moore.
The Company and Mr. Damron entered into an employment agreement dated June 28, 1999. The contract covers a five-year period from the effective date, subject to prior termination upon the employee's resignation or death (or, at the option of the Company, upon the employee's permanent disability). The agreement calls for a base salary at the rate of $235,000 per year (or a greater amount as determined by the Board in its discretion), in addition to bonus compensation, insurance and certain other benefits including a possible success bonus of $400,000 if the Company is sold before September 30, 2002, and if Mr. Damron is employed by the Company at such time. In connection with his employment Mr. Damron also received options to purchase 70,000 shares of common stock of the Company at an exercise price of $13.05 per share. The agreement also provides for a two-year post termination covenant not to compete.
In connection with the acquisition of Home Dialysis of America, Inc. ("HDA"), the Company entered into employment agreements with Messrs. Fox and Creel. Each of these agreements was effective June 20, 1996 and provides for an initial term of three years, subject to (i) an automatic two-year extension if certain revenue goals are achieved, and (ii) two-year extensions from time to time at the option of the Company. Messrs. Fox and Creel are each entitled to receive an annual salary of $205,000 for the first five years. Mssr. Fox's annual salary was increased to $230,000 effective March 2000 to compensate for additional management responsibilities. The agreements provide for a 10% salary increase if the agreement is extended on the fifth anniversary of its effective date and a 6% salary increase if the agreement is extended on the seventh or any later anniversary of the effective date. The agreements also provide that Messrs. Fox and Creel are entitled to participate in Everest's general bonus plan as well as a special incentive plan pursuant to which the former shareholders of HDA (including Messrs. Fox and Creel) in the aggregate may be entitled to receive up to 2% of Everest's common stock. The agreements provide for insurance and other benefits commensurate with those generally provided to officers of the Company. If either of these agreements is terminated: (i) by the Company without cause (as defined); (ii) due to the employee's permanent disability; or (iii) by the employee for good reason (as defined), the employee will be entitled to receive as severance (A) his base salary for the greater of one year or the then remaining employment period and (B) if the employment agreement is terminated after the sixth month of any fiscal year, his prorated bonus for such partial fiscal year; provided, however, that if the agreement is terminated prior to June 20, 1999 by the Company without cause or by the employee for good reason, the employee will be entitled to receive his base salary through June 19, 2001 as
well as the amount, if any, payable pursuant to clause (A) above. If an agreement expires on the fifth anniversary of the effective date and the Company has not offered the employee an extension, the employee will be entitled to his base salary for one year following the expiration date, in addition to any bonus payable in accordance with the preceding sentence. The agreements contain restrictive covenants that prohibit Messrs. Fox and Creel from competing with the Company for at least two years following termination of employment.
The Company and Mr. Becks entered into an employment agreement dated August 10, 1998, covering an employment term extending until November 1, 2001. The agreement provides for an annual salary of $126,500 (or a greater amount as determined by the Board), in addition to potential bonus compensation, insurance and certain other benefits including a possible success bonus of $150,000 if the Company is sold. In December 2000, the Company amended Mr. Becks' employment agreement to clarify that the success bonus will be payable regarding of the closing date if such sale is pursuant to the Merger Agreement. The agreement also provides for a two-year post termination covenant not to complete.
The Company and Dr. Zabetakis entered into an employment agreement dated November 15, 1999, covering an employment term extending until November 15, 2004, subject to prior termination upon the employee's resignation or death (or, at the option of the Company, upon the employee's permanent disability). The agreement calls for a base salary at the rate of $225,000 per year (or a greater amount as determined by the Board in its sole discretion), in addition to bonus compensation, insurance and other benefits including a possible success bonus of $200,000 if the Company is sold before September 30, 2002, and if Dr. Zabetakis is employed by the Company at such time. In connection with his employment, Dr Zabetakis also received options to purchase 60,000 shares of common stock of the Company at an exercise price of $13.05 per share. The agreement also provides for a covenant not to compete extending until two years from the termination of employment. In November 2000, the Company and Dr. Zabetakis amended this employment agreement to narrow the scope of activities covered by the covenant not to compete.
Stock Option Plans
Pursuant to the Company's 1998 Stock Award Plan (the "Plan"), the Company has granted to certain employees and medical directors options to purchase shares of the Company's common stock. As of September 30, 2000, options to purchase a total of 526,500 shares of common stock had been granted and are outstanding under the Plan at an exercise price of $7.50 per share, options to purchase a total of 1,111,800 shares of common stock had been granted and are outstanding under the Plan at an exercise price of $9.10 per share, and options to purchase a total of 315,119 shares of common stock had been granted under the Plan at an exercise price of $13.05 per share. Such options vest in four equal increments on each of the first four anniversaries of their respective grant dates. Such options expire after a ten-year period, or earlier if an employee is terminated for cause or voluntarily terminates employment other than through retirement. The options will become fully exercisable upon termination of employment by reason of death, disability or retirement or upon a change of control of the Company. In the case of an employee whose employment is terminated for a reason other than cause, the Company may in its sole discretion purchase the option for an amount equal to the aggregate per share fair market value minus the aggregate per share exercise price.
Option Grants in Last Fiscal Year
There were 60,000 stock options granted by the Company to the Named Executive Officers during the fiscal year ended September 30, 2000.
Fiscal Year-End Option Values
The following table contains information regarding the Named Executive Officers' unexercised options as of September 30, 2000. None of the Named Executive Officers exercised any options during the fiscal year ended September 30, 2000:
- -------- (1) These options were originally issued in February 1997 and were subsequently terminated and replaced by options with identical terms on February 5, 1998 pursuant to the reorganization of the Company. See "Management's Discussion and Analysis of Financial Condition and Results of Operation-- Reorganization" and "Certain Relationships and Related Transactions--Peak." (2) The options shown for Mr. Moore represent the maximum number of options indirectly granted to him through Peak Liquidating. The actual number of options Mr. Moore is entitled to receive will vary depending on the valuation of certain assets of Peak Liquidating or Peak. (3) Dr. Zabetakis was hired by the Company as its Executive Vice President and Chief Operating Officer, Dialysis Services effective November 15, 1999. (4) Everest is a privately held company. There is no market for its securities, and no valuation of Everest for the purpose of determining its value as of September 30, 2000 has been undertaken.
Compensation Committee Interlocks and Insider Participation
The Compensation Committee of the Board of Directors, consisting of Craig Moore, Martin Fox and Doctors Morris, Carbon and Balter, recommends to the Board the policies that govern the annual and long-term compensation of the executive officers of the Company. Mr. Moore and Mr. Fox do not participate in decisions affecting their own compensation.
Compensation Policies Toward Executive Officers. The Compensation Committee aims to provide competitive levels of compensation that relate compensation with the Company's annual and long-term performance goals, reward above average corporate performance, recognize individual initiative and achievements, and assist the Company in attracting and retaining qualified executives. The Compensation Committee attempts to achieve these objectives through a combination of base salary, stock options, and cash bonus awards. In making its determination, the Compensation Committee utilizes outside information to obtain compensation information concerning comparable companies in the dialysis and blood services industry.
Base Salary. The base salaries for the Named Executive Officers were governed by the terms of their respective employment agreements with the Company.
Incentive Stock Options. Stock options are granted to executive officers and other employees of the Company as a means of providing long-term incentives. The Compensation Committee believes that stock options encourage increased performance by the Company's employees, including its officers, and align the interests of the Company's employees with the interests of the Company's stockholders. Dr. Paul Zabetakis received 60,000 stock options in fiscal 2000.
Cash Bonus Awards. The Compensation Committee considers on an annual basis whether to pay cash bonuses to some or all of the Company's employees, including the Company's executive officers.
Chief Executive Officer's Compensation. The base salary for Mr. Moore ($430,000) for fiscal 2000 was governed by the terms of an employment agreement effective January 1, 1997. See "--Employment Agreements." Mr. Moore received no stock options or cash bonus during fiscal 2000.
COMPENSATION COMMITTEE
Arthur M. Morris, M.D. Paul Balter, M.D. Michael J. Carbon, M.D. Craig W. Moore Martin Fox
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth the number of shares of common stock beneficially owned as of December 27, 2000 by: (i) each person who is known by the Company to beneficially own more than 5% of the outstanding common stock; (ii) each director of the Company; (iii) each Named Executive Officer; and (iv) all directors and executive officers of the Company as a group. Beneficial ownership is determined in accordance with the rules of the Securities and Exchange Commission. The number of shares beneficially owned by a person and the percentage ownership of that person includes shares of common stock subject to options held by that person that are currently exercisable or exercisable within 60 days of December 27, 2000.
- -------- * Less than 1.0%. (1) The members of Peak Liquidating are Arthur M. Morris, M.D., Paul Balter, M.D., Michael J. Carbon, M.D., George Dunea, M.D. Revocable Trust, Ashutosh Gupta, M.D., Douglas Mufuka, M.D., and Craig W. Moore. (2) Includes options to purchase 880,600 shares which are exercisable within 60 days of December 27, 2000. (3) Subject to the Shareholders Agreement dated as of November 30, 1997 and the Restricted Stock Agreement dated as of November 30, 1997. See "Certain Relationships and Related Transactions--Shareholders Agreements." (4) Does not include shares beneficially owned by Peak Liquidating, of which shares the members of Peak Liquidating share voting and dispositive control and may be deemed to be beneficial owners. (5) Does not include options to purchase shares indirectly granted through Peak Liquidating. (6) Includes 1,000,000 shares held by KC Partners, a nominee of Dr. Morris and 966,901 shares held by the Arthur M. Morris, M.D. Revocable Trust.
(7) Subject to the Shareholders Agreement dated as of November 30, 1997. See "Certain Relationships and Related Transactions--Shareholders Agreements." (8) The Fox Revocable Trust (the "Fox Trust") is the general partner of Fox- McCarthy Family Limited Partnership, L.L.P. Martin P. Fox is a trustee of the Fox Trust. (9)AJ BCA, Ltd. is a Partnership of which Anthony Unruh is the general partner. (10) Includes 1,532 shares held by each of (i) Lauren Moore and (ii) Jeffrey Moore, and 612,137 shares held by Moore Investments, LLC. (11) Includes options to purchase 47,100 shares which are exercisable within 60 days of December 27, 2000. (12) Excludes participations in value of Peak Liquidating to which such person may be entitled pursuant to an agreement with members of Peak Liquidating. (13) Includes options to purchase 15,000 shares which are exercisable within 60 days of December 27, 2000. (14) Includes shares held indirectly through Peak Liquidating. (15) Includes options to purchase 960,200 shares which are exercisable within 60 days of December 27, 2000.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The Company is subject to various actual and potential conflicts of interest arising out of its relationships and related transactions with the Company's directors and officers and other entities controlled by them. While the Company believes these transactions generally provide for financial terms that would be obtainable from an unaffiliated third party, the agreements and transactions described below were not the result of arm's-length negotiations.
Peak. In November 1997, in order to simplify its ownership structure and better position the Company for future growth, the shareholders of the Company entered into a series of related transactions. See "Management's Discussion and Analysis--Reorganization" and "Security Ownership of Certain Beneficial Owners and Management." Peak sold Continental Healthcare, Ltd. ("Continental") to the Company. See "--Continental Healthcare." The members of Peak (Arthur Morris, Paul Balter, Michael Carbon, Douglas Mufuka, Ashutosh Gupta, George Dunea and Craig W. Moore, referred to herein as the "Founding Directors") contributed their membership interests in Peak to a new limited liability company, Peak Liquidating, in exchange for all of its outstanding membership interests. Peak Liquidating contributed all of its interest in Peak to a newly formed corporation, Everest Healthcare II, Inc. ("EHII"), in exchange for common stock of EHII. The shareholders of Everest Healthcare Services Corporation other than Peak exchanged all of their shares for shares of EHII, and Peak Liquidating distributed to its members approximately 55% of the outstanding common stock of EHII. Peak was then liquidated. In March 1998, Everest Healthcare Services Corporation was merged with and into EHII, which changed its name to "Everest Healthcare Services Corporation."
Peak Notes. Through 1995, the Founding Directors advanced funds to the Company's predecessor evidenced by promissory notes which the Founding Directors contributed to Peak in 1995. The Founding Directors also contributed funds to Peak which were advanced to Everest. The aggregate principal amount of these advances (the "Peak Notes") was $5,118,809. In connection with the 1997 reorganization, the Peak Notes (together with the note issued in connection with the purchase of Continental described below) were distributed by Peak to the Founding Directors individually (in the principal amount of (i) $767,822 each to Drs. Morris, Balter, Carbon, Dunea, Gupta and Mufuka, and (ii) $511,877 to Mr. Moore). The Peak Notes bore interest at the prime rate plus 1% per annum and matured at various times throughout 1998. The Company repaid the Peak Notes with a portion of the net proceeds of the Initial Offering. See "Market for Registrant's Common Equity and Related Stockholder Matters."
NANI-IL and NANI-IN. Nephrology Associates of Northern Indiana, P.C. ("NANI- IN") and Nephrology Associates of Northern Illinois, Ltd. ("NANI-IL" and, together with NANI-IN, "NANI") are medical service corporations which employ physicians and personnel to engage in the business of providing dialysis and
dialysis related services. The shareholders of NANI are the Founding Directors, excluding Mr. Moore. On January 1, 1997, Mr. Moore, who was previously an employee of NANI, became an employee of the Company.
The Company and NANI-IL have entered into a medical director and administrative services agreement (the "Administrative Services Agreement"). Under the terms of the Administrative Services Agreement, NANI-IL provides services to the Company relating to the development and implementation of medical policies and procedures, as well as medical director services to certain chronic dialysis facilities operated by the Company and its subsidiaries. The Company pays NANI-IL an annual consulting fee of $1,284,920, plus an incentive amount for medical director services not greater than $80,080 (25% of the calculated value of the medical director component) in any year in the event the medical directors cause the facilities for which they provide medical director services to meet certain quality, utilization and other performance measurements. Additionally, individual NANI physicians have their Everest medical director fees paid directly to NANI. In fiscal 2000, the total of the above fees paid to NANI-IL was $2,535,716.
Pursuant to a management service agreement (the "Management Agreement"), the Company provides certain administrative and accounting services to NANI-IL, including services related to billing and collections. Under the terms of the Management Agreement, NANI-IL pays the Company an annual fee of $825,000, plus a fixed fee for each acute treatment billed and administered by the Company on behalf of NANI-IL. In fiscal 2000, NANI-IL paid the Company $1,600,000 pursuant to the terms of the Management Agreement.
Each of the above-described agreements between the Company and NANI-IL is for a period of five years, renewable for consecutive one-year periods thereafter. After the initial five-year period which will end on October 1, 2002, the agreements may be terminated upon 90 days' notice by either party. NANI-IL also has an outstanding loan payable to the Company of approximately $6,811,000 plus short-term working capital advances of approximately $929,000 outstanding as of September 30, 2000. The loan payable bears interest at prime plus 1% and is due on demand.
Pursuant to a lease assigned to the Company in June 1998, the Company leases 2,284 square feet of office space to NANI-IL at an annual rent of $38,348, payable monthly. The lease term expires in October 2002.
Pursuant to a letter agreement originally dated October 1, 1995, as amended and restated as of November 30, 1997, the Founding Directors have agreed that as soon as practicable and as permitted by law, they will cause the business of providing dialysis services to hospital patients to be sold by NANI-IL to the Company at fair market value.
Continental Healthcare. On November 30, 1997 Peak, which was wholly owned by the Founding Directors, sold all of the stock of Continental to the Company for a promissory note in the amount of $2,090,000 and cash in the amount of $110,000. The Note was to mature on November 29, 2000 with interest to be paid at the prime rate plus 1% per annum. The Company repaid such note with a portion of the net proceeds of the Initial Offering. See "Market for Registrant's Common Equity and Related Stockholder Matters." Continental owns and leases dialysis equipment to the Company.
ARE Partnership. The Founding Directors, together with Sandra Gadson and Thomas Golubski, two shareholders of the Company, are also partners in ARE Partnership, an Illinois general partnership ("ARE"). Prior to June 1998, ARE owned real property and improvements which it leased to the Company and certain of its subsidiaries, and which are used primarily for the corporate headquarters and certain dialysis facilities. In fiscal 1998 the Company and its subsidiaries paid ARE $491,519 under the leases. In June 1998, the Company and its Subsidiaries purchased substantially all of ARE's assets, for an aggregate purchase price of approximately $4,800,000. In July 1999, one of the parcels of real property was sold by the Company for a loss of approximately $70,000.
Three M&L Partnership. Three M&L Partnership, an Illinois general partnership ("3M&L"), owns various properties on which certain dialysis facilities of the Company and its subsidiaries are located. The
partners of 3M&L are Arthur Morris, the President and a director of the Company, and Robert Muehrcke, a shareholder of the Company. Pursuant to the terms of the lease arrangements with 3M&L, the Company and its subsidiaries, in fiscal 2000, collectively paid 3M&L $132,000. All leases are currently in month-to-month renewal periods.
Security General. An Illinois general partnership, Security General Partnership ("Security General") is owned collectively by the Founding Directors and John Bourke, the Company's former Chief Financial Officer. Security General owns a 6.67% interest in Infinity Insurance, Ltd., ("Infinity") an entity which provides property and casualty and workers compensation insurance to the Company and its subsidiaries. The annual premiums paid by the Company and its subsidiaries to Infinity in the last policy year were approximately $2,206,000.
Shareholders Agreements. The Shareholders Agreement, dated as of November 30, 1997, by and among EHII, Peak Liquidating, the Founding Directors and Martin Fox, individually, and as agent for the HDA shareholders, Thomas Creel, Paul Zabetakis, M.D. and Anthony Unruh (collectively, the "HDA Shareholders"), established certain rights and restrictions with respect to the management of the Company and the voting and transfer of the Company's common stock. A five member voting committee was established consisting of Craig Moore, Arthur Morris, M.D., Michael Carbon, M.D. and Paul Balter, M.D., and one designee of the HDA Shareholders, Martin Fox. The members of the Voting Committee, aside from the designee of the HDA Shareholders, are obligated to vote in accordance with any other agreements among the Founding Directors, including the Operating Agreement of Peak Liquidating described below. Decisions of the Voting Committee are binding upon the remaining shareholders signatory to the agreement. The agreement also sets forth various share transfer restrictions. Upon the termination of an HDA Shareholder's employment with the Company, each share held by such HDA Shareholder is subject to repurchase by, in order of priority, the other HDA Shareholders, Peak Liquidating, the Founding Directors and the Company.
Under a Restricted Stock Agreement dated as of November 30, 1997 by and among the Founding Directors and the Company, and the Operating Agreement of Peak Liquidating, the Founding Directors have agreed to vote their shares together with respect to certain corporate transactions or events including mergers, dispositions, a public offering, other issuances of securities, distributions, indebtedness and liens, liquidation and related party transactions. The approval of Dr. Morris is required for any sale of Peak Liquidating to a third party, or any sale of the Company to a third party for consideration less than a specified amount. In addition, the approval of Dr. Morris and two other voting members is required for a merger or consolidation of the Company, a disposition of more than 10% of its stock, a public offering and certain other specified events.
All shareholders of the Company, other than Paul Zabetakis, Anthony Unruh and the Company's directors, are party to one or more restricted stock agreements which grant the Company a right of first refusal with respect to any proposed transfer of Company shares by such shareholders. Such restricted stock agreements also grant the Company a repurchase right upon the occurrence of certain events. Such restricted stock agreements also contain provisions requiring the shareholder to cooperate and consent to any sale of the Company to a third party.
Thomas D. Creel. Pursuant to a redemption agreement effective as of October 19, 1999, the Company redeemed 65,134 shares of common stock formerly held by Mr. Creel for an aggregate redemption price of approximately $850,000.
Dialysis Specialists of Central Cincinnati, Ltd. Effective February 18, 1999, the Company's wholly-owned subsidiary, Home Dialysis of America, Inc. ("HDA") purchased 62.1% of the membership units of Dialysis Specialists of Central Cincinnati, Ltd. ("DSCCL") for an aggregate purchase price of approximately $5.5 million. The transaction increased HDA's percentage ownership in DSCCL from 37.9% to 100%. In connection with the transaction, 9.5% of the membership units of DSCCL were purchased from S-F Holdings, Inc., which entity is wholly- owned by a grantor trust, with Sandy Fritzsch as trustee and as sole beneficiary, for an aggregate purchase price of approximately $845,400. Ms. Fritzsch is an employee of the Company.
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ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) The financial statements and schedule (Schedule II; Valuation & Qualifying Accounts) filed as part of this report are listed in the accompanying Index to Financial Statements and Schedule.
All other schedules for which provision is made in the applicable accounting regulation of the Securities and Exchange Commission are not required under the related instructions or are inapplicable and therefore have been omitted.
(b) The exhibits filed as a part of this report are listed in the accompanying Index to Exhibits.
(c) In November 2000, the Company filed Form 8-K announcing the Company's proposed merger with Fresenius.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized, on the 27th day of December, 2000.
Everest Healthcare Services Corporation
/s/ Craig W. Moore By: _________________________________ Craig W. Moore Chairman and Chief Executive Officer
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.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized, on the 27th day of December, 2000.
Con-Med Supply Company, Inc. Continental Health Care, Ltd. Dialysis Specialists of Tulsa, Inc. Dupage Dialysis, Ltd. Everest Healthcare Indiana, Inc. Everest Healthcare Ohio, Inc. Everest Healthcare Texas Holding Corp. Everest Management, Inc. Everest New York Holdings, Inc. Everest One IPA, Inc. Everest Three IPA, Inc. Everest Two IPA, Inc. Home Dialysis of America, Inc. Mercy Dialysis Center, Inc. New York Dialysis Management, Inc. North Buckner Dialysis Center, Inc. WSKC Dialysis Services, Inc.
/s/ Craig W. Moore By: ________________________________ Craig W. Moore Chairman and Chief Executive Officer
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.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized, on the 27th day of December, 2000.
Acute Extracorporeal Services, L.L.C.
/s/ Craig W. Moore By: _________________________________ Craig W. Moore Chief Executive Officer
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.
/s/ Craig W. Moore Sole Member December 27, By:____________________________ 2000 Craig W. Moore Chairman and Chief Executive Officer
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized, on the 27th day of December, 2000.
Everest Healthcare Texas, L.P.
/s/ Craig W. Moore By: _____________________________ Craig W. Moore Chief Executive Officer
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.
/s/ Craig W. Moore General Partner December 27, By:____________________________ 2000 Craig W. Moore Chairman and Chief Executive Officer
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized, on the 27th day of December, 2000.
Northern New Jersey Dialysis, L.L.C.
/s/ Craig W. Moore By: _________________________________ Craig W. Moore Chief Executive Officer
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.
Everest Healthcare Services Corporation
/s/ Craig W. Moore Sole Member December 27, By: ___________________________ 2000 Craig W. Moore Chairman and Chief Executive Officer
EXHIBIT INDEX
- -------- *Previously filed with the Securities and Exchange Commission as an Exhibit incorporated herein by reference. (1) The name of Ohio Valley Dialysis Center, Inc. was changed to Everest Healthcare Indiana, Inc. (2) The name of Home Dialysis of Fairfield, Inc. was changed to Everest Healthcare Ohio, Inc.
EVEREST HEALTHCARE SERVICES CORPORATION
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended September 30, 1998, 1999 and 2000
REPORT OF INDEPENDENT AUDITORS
Board of Directors Everest Healthcare Services Corporation
We have audited the accompanying consolidated balance sheets of Everest Healthcare Services Corporation and subsidiaries (the Company) as of September 30, 1999 and 2000, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the three years in the period ended September 30, 2000. Our audits also included the financial statement schedule listed in the Index at Item 14(a). These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Everest Healthcare Services Corporation and subsidiaries at September 30, 1999 and 2000, and the consolidated results of their operations and their cash flows for each of the three years in the period ended September 30, 2000, in conformity with accounting principles generally accepted in the United States. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
Chicago, Illinois December 8, 2000
EVEREST HEALTHCARE SERVICES CORPORATION
CONSOLIDATED BALANCE SHEETS
(in thousands except share and per share data)
See notes to consolidated financial statements.
EVEREST HEALTHCARE SERVICES CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS (in thousands except share and per share data)
See notes to consolidated financial statements.
EVEREST HEALTHCARE SERVICES CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (in thousands except share and per share data)
See notes to consolidated financial statements.
EVEREST HEALTHCARE SERVICES CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands except share and per share data)
See notes to consolidated financial statements.
EVEREST HEALTHCARE SERVICES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 1998, 1999 and 2000 (in thousands, except for share and per share data)
1. Organization
Peak Healthcare, L.L.C. (Peak) was formed, as a limited liability company, on October 1, 1995. Effective November 30, 1997, Peak was reorganized whereby the following transactions occurred simultaneously. The members of Peak contributed all of their interests in Peak for an equal number of membership interests in Peak Liquidating, L.L.C. (Peak Liquidating), a newly formed limited liability company. The operating agreement and number and classes of interests of Peak Liquidating were identical to Peak. Upon the exchange, Peak Liquidating, the sole member of Peak, contributed its interests in Peak for shares of common stock of Everest Healthcare II, Inc, (Everest II) a newly-formed subchapter C Corporation. The number of shares of common stock of Everest II received by Peak Liquidating was equal to the number of shares of Everest held by Peak. The number and class of authorized shares of Everest II upon formation was identical to that of Everest. Following the exchange, Peak was liquidated. Upon the consummation of these transactions, Everest II issued shares of common stock, representing approximately 30% of the shares of the Company, to the minority interest holders in Everest in exchange for their shares of Everest common stock. The acquisition of minority interest was treated as a purchase in accordance with generally accepted accounting principles and goodwill of approximately $12,400 was recognized. Upon the consummation of these transactions, Everest became a wholly owned subsidiary of Everest II. In March 1998, Everest was merged into Everest II. Upon the merger, Everest II (the surviving entity) changed its name to Everest Healthcare Services Corporation. All references hereinafter to Everest or the Company refer to Everest Healthcare Services Corporation, its subsidiaries and its predecessors.
2. Nature of Business
The Company provides dialysis services to patients with chronic kidney failure, also known as end-stage renal disease ("ESRD"). As of September 30, 2000, the Company provided dialysis and ancillary services to approximately 6,700 patients through 74 outpatient dialysis centers in 11 states. In addition to its outpatient dialysis center operations, the Company provides acute dialysis services through contractual relationships with 34 hospitals in five states. The Company also operates a business providing extracorporeal services through contractual relationships with 67 hospitals in 13 states.
3. Significant Accounting Policies
Basis of Consolidation
The consolidated financial statements include the accounts and transactions of Everest Healthcare Services Corporation and its subsidiaries. All intercompany accounts and transactions are eliminated in consolidation. The Company also performs certain administrative services under management agreements with affiliated and unaffiliated entities. The Company does not have a controlling financial interest in the entities for which it has management contracts and, as such, the Company does not consolidate these entities.
Cash and Cash Equivalents
The Company considers all highly liquid investments with original maturities of three months or less to be cash equivalents.
Medical Supplies Inventories
Medical supplies inventories consist of drugs, supplies, and parts used in treatments and are stated at the lower of cost or market. Cost is determined principally on a first in, first out (FIFO) basis.
EVEREST HEALTHCARE SERVICES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Property and Equipment
Property and equipment are stated at cost. Depreciation is calculated on the straight-line method over the estimated useful lives of the assets. Medical equipment and furniture and fixtures are depreciated over five to ten years. Buildings are depreciated over 40 years. Leasehold improvements are amortized over the respective lease terms or the service lives of the improvements, whichever is shorter. Depreciation expense was $4,213, $6,610 and $8,463 for the years ended September 30, 1998, 1999 and 2000, respectively.
Goodwill
Goodwill represents the excess of the purchase price over the estimated fair value of the net assets acquired in the Company's business combinations. The amounts are being amortized over the estimated remaining economic lives of 25 years. Accumulated amortization of goodwill amounted to approximately $7,032 and $10,487 at September 30, 1999 and 2000, respectively.
Other Intangible Assets
Other intangible assets is comprised primarily of covenants not to compete. The covenants not to compete are being amortized over the periods of the agreements (See Note 9). Accumulated amortization of other intangible assets was approximately $224 and $727 at September 30, 1999 and 2000, respectively.
Deferred Financing Costs
The costs of obtaining financing are capitalized and are being amortized as interest expense over the term of the related financing using a method which approximates the interest method. Accumulated amortization was $893 and $2,210 as of September 30, 1999 and 2000, respectively.
Income Taxes
Deferred taxes have been recognized for the tax consequences of temporary differences by applying the enacted statutory income tax rates applicable to future years of differences between the financial statement carrying amounts and the tax basis of the existing assets and liabilities. A valuation allowance is provided for any deferred tax asset for which it is more likely than not that the asset will not be realized. Changes in the valuation allowance are recognized as a component of income.
Stock Options
The Company accounts for stock options in accordance with Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" (APB 25). In accordance with APB 25, compensation expense is recognized based upon the excess of fair value of the underlying stock over the option exercise price on the measurement date, the date at which both the exercise price and the number of shares to be issued are known. The Company has elected to continue to measure compensation expense under the provisions of APB 25; however, in accordance with Statement of Financial Accounting Standards No. 123, "Accounting for Stock Based Compensation" (SFAS 123), an estimate of the fair value of the stock options has been made by the Company to determine the pro forma effect on earnings had the provisions of SFAS 123 been applied in the financial statements (see Note 14).
Revenue Recognition
Net revenue is recorded at the estimated net realizable amount from Medicare, Medicaid, commercial insurers and other third-party payors for services rendered and includes estimated revenue adjustments due to
EVEREST HEALTHCARE SERVICES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
future audits, reviews and investigations. Estimated revenue adjustments are recorded in the period the related services are rendered and such amounts are adjusted in future periods as adjustments become known or as years are no longer subject to audits, reviews and investigations. The Medicare and Medicaid programs reimburse the Company at amounts that are different from the Company's established rates. Contractual adjustments are recorded under these programs for the difference between the amounts billed for these services and the amounts that are reimbursable by third-party payors. A summary of the basis for reimbursement with these payors follows:
Medicare. The Company is reimbursed by the Medicare program predominantly on a prospective payment system for dialysis services. Under the prospective payment system, each facility receives a composite rate per treatment that is adjusted to account for geographic differences in the cost of labor. Drugs and other ancillary services are reimbursed on a fee for service basis.
Medicaid. Medicaid is a state administered program with reimbursements varying by state. The Medicaid programs administered in each state, in which the Company operates, reimburse the Company predominantly on a prospective payment system for dialysis services rendered.
Other Payors. Other payments from patients, commercial insurers and other third-party payors are received pursuant to a variety of reimbursement arrangements, which are generally higher than those payments received from the Medicare and Medicaid programs.
Reimbursements from Medicare and Medicaid at established rates approximated 55.1%, 57.2% and 56.4% of net revenues for the years ended September 30, 1998, 1999 and 2000, respectively.
Use of Estimates
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Laws & regulations covering the Medicare and Medicaid programs, are extremely complex. Accordingly, there is at least a reasonable possibility that recorded estimates will change by a material amount in the near term. Actual results could differ from those estimates.
Fair Value of Financial Instruments
The carrying amounts reported in the consolidated balance sheets for cash and cash equivalents approximates fair value. The carrying amounts reported in the Company's balance sheets for variable-rate long-term debt approximate fair value, as the underlying long-term debt instruments are comprised of notes that are repriced on a short-term basis. The carrying amounts of the amounts due to and from affiliated companies bear interest at prime plus 1% and approximate fair value. The fair value of the Company's 9 3/4% Senior Subordinated Notes, Series B was $86 million at September 30, 2000 based upon trading in the public debt market.
Long-Lived Assets
The Company evaluates its long-lived assets (including goodwill) on an ongoing basis. Identifiable intangibles are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of the related asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of the asset to future undiscounted cash flows expected to be generated by the asset. If the asset is determined to be impaired, the impairment recognized is measured by the amount by which the carrying value of the asset exceeds its fair value as determined on a discounted cash flows basis.
EVEREST HEALTHCARE SERVICES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Concentration of Credit Risk
The Company derives a significant portion of its revenues from Medicare and Medicaid (or comparable state benefits) and as such, a significant portion of patient accounts receivable is from those payors. The Company is reimbursed for dialysis services primarily at fixed rates established in advance under the Medicare End-Stage Renal Disease Program. All of the states in which the Company operates provide Medicaid or comparable benefits to qualified recipients. The Medicare and Medicaid programs are subject to statutory and regulatory changes, administrative rulings, interpretation of policy and government funding restrictions, all of which may have the effect of decreasing program payments. The Company believes that risks associated with the Medicare and Medicaid programs are related to future revenues and that the concentration of credit risk within current patient accounts receivable is limited.
At September 30, 1999 and 2000, the Company maintained cash deposits with certain financial institutions which were in excess of federally insured limits.
Retrospectively Rated Insurance Policy
The Company is insured under a retrospectively rated policy of a multiemployer captive insurance company for property, casualty, workers compensation and professional liability coverage. Future claims are accrued based on the captive insurance company's experience to date.
New Accounting Standards
Effective October 1, 1998, the Company adopted Statement of Position 98-5, "Reporting on the Costs of Start-Up Activities (SOP 98-5)." SOP 98-5 requires that costs related to start up activities be expensed as incurred. Prior to adoption of SOP 98-5, the Company capitalized certain external costs related to the establishment of new dialysis facilities. The effect of adoption of SOP 98- 5 was to record a charge for the cumulative effect of an accounting change of $615 in fiscal 1999, to expense costs that had been previously capitalized. There were no income tax implications to the write-off as these amounts are not deductible for income tax purposes.
In March, 1998, the AICPA issued SOP 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use". The provisions of SOP 98-1 establish guidance on accounting for the costs incurred related to internal use software. The provisions of SOP 98-1 specifically address the accounting for the costs related to designing, developing, obtaining and modifying and/or implementing internal use software. SOP 98-1 requires that companies capitalize qualifying costs incurred during the application development stage. All other costs incurred in connection with an internal use software project are to be expensed as incurred. As a result of adopting SOP 98-1, $1.66 million of software costs were capitalized in the year ended September 30, 2000, resulting in an increase of net income of $687.
Pending Accounting Standards
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities (as amended by Statement No. 137, Accounting for Derivative Instruments and Hedging Activities - -- Deferral of the Effective Date of FASB Statement No. 133 issued June 1999, and amended by Statement No. 138, Accounting for certain Derivative Instruments and certain Hedging Activities-- An amendment to FASB Statement 133 issued June 2000), effective for periods beginning after June 15, 2000. SFAS No. 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 a part of a hedge and, if it is, the type of hedge transaction. Adoption of SFAS No. 133 will not have a significant effect on the Company's results of operations or its financial position. The Company is required to adopt SFAS No. 133 on October 1, 2000.
EVEREST HEALTHCARE SERVICES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Interest Rate Cap Agreement
The Company purchased an interest-rate cap agreement in August 2000 that is designed to limit its exposure to increasing interest rates on a portion of its term loan under the Credit Facility through August 2003. The interest rate cap entitles the Company to receive a payment from the counterparty equal to the excess, if any, of the hypothetical interest expense (strike price) on the specified notional amount ($10 million) at a current market interest rate over an amount specified in the agreement (7.0%). The only amount the Company is obligated to pay to the counterparty is a yearly premium. The interest rate index specified by the agreement has been and is expected to be highly correlated with the interest rate the Company incurs on the term loan. Payments to be received as a result of the specified interest rate index exceeding the strike price are accrued in other assets and are recognized as a reduction of interest expense (the accrual accounting method). The cost of these agreements is included in other assets and amortized to interest expense ratably during the life of the agreement. The fair value of the interest rate cap, if the Company were to terminate the agreements, was not material at September 30, 2000.
Reclassifications
Certain reclassifications have been made to prior years' financial statements to conform to the 2000 presentation.
4. Net Revenues
The Company provides dialysis and perfusion services to certain patients under government-sponsored programs such as Medicare and Medicaid, as well as other insurance reimbursement arrangements. Provision has been made in the financial statements for the estimated contractual adjustment, representing the difference between the Company's standard charges for services and the estimated payments from the various third-party payors. Gross and net patient service revenues for the years ended September 30 include the following:
5. Investments In and Advances to Affiliated Companies
The Company uses the equity method of accounting for its investments in the common stock of various companies. Investments in these companies at September 30, 1999, and 2000, amounted to approximately $868 and $625, respectively. Additionally, the Company had approximately $8,034 and $8,148 of advances due from affiliates as of September 30, 1999 and 2000, respectively (see Note 15). The percentages of ownership in these companies range from 10% to 50%. Aggregate balance sheet information of these companies at September 30 is as follows:
EVEREST HEALTHCARE SERVICES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Aggregate statement of income information of these companies is as follows for the year ended September 30:
6. Business Combinations
In January 1998, the Company acquired the remaining outstanding equity interests in Hemo Dialysis of Amarillo, LLC (Amarillo), an outpatient and home dialysis facility located in Amarillo, Texas. Prior to the acquisition, the Company owned a 30% interest in Amarillo and accounted for the investment under the equity method of accounting. The purchase price of the acquisition, including costs of the transaction, was approximately $2,900. Goodwill recognized in the acquisition was approximately $2,500.
In January 1998, the Company increased its investment in Home Dialysis of Mount Auburn, Inc. (Mount Auburn), a home dialysis facility located in Cincinnati, Ohio, in exchange for the issuance of 52,399 shares of common stock of Everest Healthcare Services Corporation with a fair value of approximately $377. Through the purchase, the Company increased its investment in Mount Auburn from 50% to 80.5% and recognized goodwill of $266. Prior to the acquisition, the Mount Auburn investment was accounted for under the equity method of accounting.
In February 1998, the Company acquired the remaining outstanding equity interests in Dialysis Specialist of South Texas, LLC (South Texas), which owns and operates three outpatient and home dialysis facilities in Corpus Christi, Texas. Prior to the acquisition, the Company owned a 33% interest in South Texas and accounted for the investment under the equity method of accounting. The purchase price of the acquisition was $7,600, including costs of the transaction. The consideration for the purchase was financed through the issuance of 179,300 shares of common stock of Everest Healthcare Services Corporation with a fair value of approximately $1,300 and cash of approximately $6,300. Goodwill recognized in the acquisition was approximately $7,100.
In March 1998 Alliance acquired a 70% interest in Perfusion Resource Association LLC (PRA), a contract services provider located in Tampa, Florida. The purchase price of the acquisition, including costs of the transaction, was approximately $1,400. Goodwill recognized in the acquisition was approximately $1,300.
In April 1998, the Company acquired North Buckner Dialysis Center, a dialysis service provider located in Dallas, Texas. The purchase price of the acquisition was approximately $5,100, including costs of the transaction. The consideration for the purchase price of the acquisition was financed through the issuance of 153,021 shares of common stock of Everest Healthcare Services Corporation with a fair value of approximately $1,100 and cash of $4,000. Goodwill recognized in the acquisition was approximately $4,100.
In February 1999, the Company acquired the remaining outstanding equity interest in Dialysis Specialists of Central Cincinnati, Ltd. (Central Cincinnati), an outpatient dialysis facility located in Norwood, Ohio. Prior to the acquisition, the Company owned a 37.9% interest in Central Cincinnati and accounted for the investment under the equity method of accounting. The purchase price, including costs of the transaction, was approximately $5,600. Goodwill recognized in the acquisition was approximately $4,800.
In February 1999, the Company increased its investment in Dialysis Specialists of Topeka, Inc. (Topeka) from 25% to 75%. Topeka is an outpatient dialysis facility located in Topeka, Kansas. Prior to the acquisition, the Topeka investment was accounted for under the equity method of accounting. The purchase price, including costs of the transaction, was approximately $1,300. Goodwill recognized in the acquisition was approximately $600.
EVEREST HEALTHCARE SERVICES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
In March 1999, the Company acquired the remaining outstanding equity interest in Home Dialysis of Fairfield, Inc. (Fairfield), a home dialysis facility located in Fairfield, Ohio. Prior to the acquisition, the Company owned a 50% interest in Fairfield and accounted for the investment under the equity method of accounting. The purchase price, including costs of the transaction, was approximately $2,800. Goodwill recognized in the acquisition was approximately $1,900.
In March 1999, the Company acquired the remaining outstanding equity interest in Home Dialysis of Columbus, Inc. (Columbus), an outpatient dialysis facility and a home dialysis facility located in Columbus, Ohio. Prior to the acquisition, the Company owned a 49% interest in Columbus and accounted for the investment under the equity method of accounting. The purchase price, including costs of the transaction, was approximately $500. Goodwill recognized in the acquisition was approximately $500.
In May 1999, the Company acquired the remaining outstanding equity interest in the Dialysis Specialists of Tulsa, Inc. (Tulsa), an outpatient dialysis facility located in Tulsa, Oklahoma. Prior to this transaction, the Company owned a 33% interest in Tulsa, and accounted for the investment under the equity method of accounting. The purchase price, including the costs of the transaction, was approximately $4,400. Goodwill recognized in the acquisition was approximately $3,600.
In July 1999, the Company purchased certain assets and operations of Englewood Dialysis Facility, LLC an outpatient dialysis facility located in Englewood, New Jersey. The purchase price, including costs of the transaction, was approximately $10,000. This transaction was accounted for as a purchase which resulted in the recording of goodwill of approximately $7,000 and covenant not to compete of $931.
In November 1999, the Company acquired a 100% interest in the non-medical assets of Western New York Artificial Kidney Centers, which consists of three outpatient dialysis facilities located in the Buffalo, New York area. The purchase price, including costs of the transaction, was approximately $6,400. Goodwill of approximately $5,100 and a covenant not to compete of $600 were recognized in the acquisition.
In December 1999, the Company acquired St. Clare's Dialysis Facility, an outpatient dialysis facility located in Dover, New Jersey. The purchase price, including costs of the transaction, was approximately $1,500. Goodwill of approximately $1,300 and a covenant not to compete of $135 were recognized in the acquisition.
These acquisitions have been accounted for under the purchase method of accounting. Accordingly, the excess of the purchase price over the fair value of identifiable assets (including identifiable intangible assets) is allocated to goodwill and other identifiable intangibles. The consolidated financial statements include the operating results of each business from the respective dates of acquisition.
7. Leases and Related Party Transactions
Capital Leases
Property under capital leases included within property and equipment at September 30 are as follows:
EVEREST HEALTHCARE SERVICES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Interest rates on the capital lease obligations ranged from 8.0% to 14.0%. Future minimum lease payments under capital leases with initial or remaining terms of one year or more consisted of the following at September 30, 2000:
Operating Leases
Prior to June 1998, the Company leased land and building space under operating leases for some of its dialysis centers and its corporate offices from ARE Partnership and Three M&L Partnership, related parties with common ownership. In June 1998, the Company purchased the land and buildings from ARE Partnership. For the year ended September 30, 1998, rents of approximately $616 were paid to these related parties. For the years ended September 30, 1999 and 2000, rents of approximately $149 and $132, respectively were paid to Three M&L Partnership, which leases are in month-to-month renewal periods.
Additionally, the Company leases land and building space under operating leases from unaffiliated entities for certain of its dialysis facilities. For the years ended September 30, 1998, 1999, and 2000, approximately $4,451, $4,137, and $5,898, respectively, were recorded as rent expense for such leases. Expiration dates for these leases continue through 2009.
Future minimum rental commitments under non-cancelable operating leases with terms in excess of one year are as follows:
8. Property and Equipment
Property and equipment consist of the following at September 30:
EVEREST HEALTHCARE SERVICES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
9. Other Intangible Assets
Other intangibles consist of the following at September 30:
10. Accrued Expenses
Accrued expenses consist of the following at September 30:
11. Long-Term Debt
Long-term debt consists of the following at September 30:
9 3/4% Senior Subordinated Notes due 2008, Series B
On May 5, 1998, the Company completed a private placement issuance of $100,000 in principal amount of 9 3/4% Senior Subordinated Notes due 2008 (the Offering). The Offering was made to qualified institutional buyers pursuant to Rule 144A of the Securities and Exchange Commission (SEC). Effective September 2, 1998 the Company registered the senior subordinated notes with the SEC. Upon the effectiveness of the registration, the Company exchanged the 9 3/4% Senior Subordinated Notes due 2008, Series B for the notes sold in the Offering.
The 9 3/4% Senior Subordinated Notes, Series B (the Notes) mature on May 1, 2008. Interest is payable semi-annually in arrears each November 1 and May 1, commencing November 1, 1998. On or after May 1,
EVEREST HEALTHCARE SERVICES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
2003, the Notes may be redeemed at the option of the Company, in whole or in part, at specified redemption prices plus accrued and unpaid interest:
In addition, at any time on or prior to May 1, 2001, the Company may, subject to certain requirements, redeem up to $35,000 aggregate principal amount of the Notes with the net cash proceeds of one or more public equity offerings, at a price equal to 109.75% of the principal amount to be redeemed plus accrued and unpaid interest. In the event of a change in control, the Company is required to offer to repurchase the Notes at a price equal to 101.0% of the principal amount plus accrued and unpaid interest (see Note 20).
The Notes are general obligations of the Company, subordinated in right of payment to all existing and future senior debt and are guaranteed by the Company's wholly-owned subsidiaries (the Guarantor Subsidiaries). Each of the Guarantor Subsidiaries' guarantees of the Notes are full, unconditional, and joint and several. The Company may incur additional indebtedness, including borrowings under its Credit Facility (see below), subject to certain limitations. See Note 19 for guarantor financial information as of September 30, 1998, 1999 and 2000.
The indenture under which the Notes were issued contains certain covenants that were met at September 30, 2000.
Credit Facilities
The Company has a Credit Facility consisting of two separate facilities; a revolving credit facility and an acquisition credit facility.
The revolving credit facility of $35,000, including letters of credit of up to $858, matures on June 30, 2002 (the "Revolving Credit Facility"). The borrowings on the Revolving Credit Facility are limited to 75% of eligible accounts receivable and up to 50% of eligible inventory. Interest is payable at the Company's option of either the higher of the bank's prime rate (9.50% at September 30, 2000) or the Federal Funds rate plus 1/2 of 1%, plus 0.00%-1.00%, or the London Interbank Offered Rate (LIBOR) (6.80% at September 30, 2000) plus 2.00-2.75%. Commitment fees of 0.50% of the unused portion of the Revolving Credit Facility are payable quarterly. No amounts were drawn on the revolving credit facility at September 30, 2000.
The acquisition credit facility of $65,000 matures on June 15, 2005 (the "Acquisition Credit Facility"). Under the Acquisition Credit Facility, all of the borrowings outstanding thereunder on each of June 30, 2000, 2001 and 2002 must be converted to one or more seven-year term loans with balloon payments due on June 15, 2005. On June 30, 2000, the Company converted $20,908 to a seven-year term loan, principal and interest payments due quarterly, 10.75% annual interest rate. Interest is payable at the Company's option of either the higher of the bank's prime rate or the Federal Funds rate plus 1/2 of 1%, plus 0.25%-1.25%, or LIBOR plus 2.25%-3.00%. Commitment fees of 0.75% of the unused portion of the Acquisition Credit Facility are payable quarterly. Excluding the term loan, no amounts were drawn on the acquisition credit facility at September 30, 2000.
EVEREST HEALTHCARE SERVICES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The Company purchased an interest-rate cap agreement in August 2000 to limit its exposure to increasing interest rates on $10.0 million of its Acquisition Credit Facility.
Acquisition Term Notes
In connection with the acquisition of the Extracorporeal Alliance, LLC (the "Alliance"), the Company incurred $7,000 in notes payable to the former owners of Alliance. These notes mature on October 31, 2002, and bear interest at the 5-year Treasury Note rate (5.9% as of September 30, 2000) (as determined on November 1 of each year) plus 3.0%. Interest is payable monthly.
Installment Notes Payable
The Company has entered into various installment notes payable which are payable to a vendor of medical equipment through September 2004, and bear interest at 9.0% to 9.5% per annum. The notes are collateralized by medical equipment.
Annual Maturities
Maturities of long term debt at September 30, 2000, are as follows:
12. Special Charges
The Company recorded approximately $23,000 of charges during fiscal 1999. These amounts have been expensed as special charges and include $22,400 in impairment of long-lived assets and $600 in severance costs.
The impairment of long-lived assets included (i) a $20,500 writedown of goodwill and other intangible assets, (ii) a $1,400 write-off of advances to, and other assets of, certain of the Company's joint ventures and (iii) the writedown of $500 of fixed assets to fair value. The write-off of goodwill and other intangible assets was the result of a deterioration in the profitability and cash flows of certain acquired operations. The deterioration was due, in part, to continued contractual adjustments and other reductions in anticipated revenues. As a result of this deterioration, the Company evaluated the long- lived assets that were not recoverable. As a result of this evaluation, the Company recorded a write down of these assets based upon the amount by which the carrying value of the assets exceeded their fair values as determined on a discounted cash flow basis. Certain of the Company's joint ventures encountered similar deterioration. As a result, the Company recorded a write-off of certain advances to and other assets of these companies in fiscal 1999.
The severance costs to two executives of the Company related to amounts that were due under the individuals' employment contract upon separating from the Company. At September 30, 2000, the remaining liability under the employment contracts is $128.
EVEREST HEALTHCARE SERVICES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
13. Income Taxes
Deferred income taxes reflect the net effects of temporary differences between carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of deferred income taxes at September 30 were as follows:
The Company has net operating loss carryforwards at approximately $5.1 million which may be used to reduce future New York state income taxes, which expire through 2010.
Income taxes consist of the following at September 30:
Federal income taxes at the statutory rate are reconciled with the Company's income tax provision at September 30 as follows:
EVEREST HEALTHCARE SERVICES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
14. Stock Options
The Company has stock options outstanding as follows:
Included in the stock options outstanding are 526,500 stock options issued on October 1, 1995 and 354,100 stock options issued in 1997 to the CEO of the Company. In connection with the reorganization on November 30, 1997, these 880,600 stock options were assigned to Peak Liquidating, LLC (a shareholder of the Company) and, as such, have been reflected as outstanding in all periods subsequent to their original grant. The 526,500 options were issued upon the formation of the Company and are currently exercisable. The remaining 1,426,919 options outstanding were issued under the Everest Healthcare Services Corporation 1996 Stock Award Plan (the 1996 Plan). The 1996 Plan permits the granting of stock options to certain key executive, managerial, and administrative employees of the Company to purchase shares of the Company's common stock. The stock options awarded vest ratably over a four year period in 25% increments. The stock options awarded expire ten years from the date of grant. Of the stock options outstanding under the 1996 Plan, 930,000 are exercisable at September 30, 2000.
In connection with the Company's reorganization, the Company cancelled all stock options outstanding and subsequently reissued them under the Everest Healthcare Services Corporation 1998 Stock Award Plan (the 1998 Plan). The 1998 Plan contains the same provisions as the 1996 Plan and the reissuance of stock options had no effect on the options previously issued.
The Company accounts for its stock options in accordance with Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" (APB25), as permitted in accordance with Statement of Financial Accounting Standards No. 123, "Accounting for Stock Based Compensation" (SFAS 123). Had the provisions of SFAS 123 been used in the calculation of compensation expense (calculated using the minimum value method for nonpublic companies), pro forma net income would have been approximately $254 and $281 lower than the net income reported in the statement of operations for the years ended September 30, 1999 and 2000, respectively.
15. Related Party Transactions
The Company provides administrative and purchasing services to several of its unconsolidated affiliates, all of which are owned, or substantially owned, by the majority equity holders of the Company. Fees charged to affiliates for services were approximately $1,939, $998 and $984 during the years ended September 30, 1998, 1999, and 2000, respectively, and are included in the accompanying consolidated statement of operations.
EVEREST HEALTHCARE SERVICES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
In addition, the Company provides advances to certain affiliates. Amounts due from unconsolidated affiliates at September 30 were as follows:
Nephrology Associates of Northern Illinois, Ltd., an unconsolidated affiliate substantially owned by the majority equity holders of the Company, provides management and physician supervisory services to the Company's outpatient maintenance dialysis operations. Total fees incurred for such services amounted to approximately $1,536, $1,536 and $1,600 during the years ended September 30, 1998, 1999, and 2000, respectively, and are included in the accompanying consolidated statement of operations.
The Company earned interest on outstanding balances due from unconsolidated affiliates of approximately $1,261, $904 and $776 during the years ended September 30, 1998, 1999 and 2000, respectively.
Insurance premiums totalling approximately $480, $1,233, and $2,206 were paid during the years ended September 30, 1998, 1999 and 2000, respectively to a multiemployer captive insurance company. Certain stockholders of the Company own a 6.67% interest in the multiemployer insurance company.
16. Significant Vendor
For the years ended September 30, 1998 and 1999, purchases from two vendors accounted for 46% and 40% of total purchases, respectively. For the year ended September 30, 2000, purchases from one vendor accounted for 54% of total purchases.
17. Supplemental Cash Flow Information
The following table provides supplemental cash flow data in addition to the information provided in the consolidated statements of cash flows for the years ended September 30:
18. Reportable Segments
The Company has two reportable segments: Dialysis Services and Contract Services. The Company's Dialysis Services segment consists of 74 outpatient dialysis treatment centers in 11 states, which primarily provide outpatient chronic dialysis treatments and 34 hospital based treatment centers that provide acute dialysis treatments. The Company's Contract Services segment provides perfusion, apheresis, and autotransfusion treatments in 67 hospitals in 13 states.
The Company evaluates performance and allocates resources based upon profit or loss before income taxes and extraordinary items. The reportable segment's accounting policies are the same as those described in the
EVEREST HEALTHCARE SERVICES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
summary of significant accounting policies (see Note 3). The Company's reportable segments are independent operating divisions that are managed separately. All intercompany costs are eliminated.
EVEREST HEALTHCARE SERVICES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
A reconciliation of the reportable segments to consolidated income (loss) before income taxes and cumulative effect of change in accounting and consolidated assets are as follows:
Other significant items as disclosed within the reportable segments are reconciled to the consolidated totals as follows:
EVEREST HEALTHCARE SERVICES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
19. Other Financial Information
The Company is a holding company with no independent assets or operations. Therefore, the Company relies primarily upon payment from its subsidiaries for the funds necessary to meet its obligations, including the payment of interest. The ability of the subsidiaries to fund the obligations is subject to significant restrictions, will be dependent upon the earnings of the subsidiaries, and will be subject to applicable laws and approval by the subsidiaries. Full separate statements of the Guarantor Subsidiaries have not been presented as the guarantors are wholly owned subsidiaries of the Company. Management does not believe that inclusion of such financial statements would be material to investors. The guarantees of the Guarantor Subsidiaries are full, unconditional, and joint and several.
The following sets forth the financial data at September 30, 2000 and for the year then ended:
EVEREST HEALTHCARE SERVICES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
EVEREST HEALTHCARE SERVICES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The following sets forth the financial data at September 30, 1999 and for the year then ended:
EVEREST HEALTHCARE SERVICES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
EVEREST HEALTHCARE SERVICES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The following sets forth the financial data at September 30, 1998 and for the year then ended:
EVEREST HEALTHCARE SERVICES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
20. Subsequent Events
Sale of Company
On November 2, 2000, the Company announced that it had entered into an Agreement and Plan of Merger, dated November 1, 2000, by and among the Company, Fresenius Medical Care AG ("FMC"), Edmund Acquisition Sub, Inc. and certain stockholders of the Company (the "Merger Agreement"). The Merger Agreement provides for a merger of the Company with and into Edmund Acquisition Sub, Inc. While the merger is anticipated by management to be completed in the first calendar quarter of 2001, because all the conditions of the Merger Agreement have not been met, the exact timing for consummation of the merger is uncertain at this time. The purchase price of $343 million will be comprised of $240 million cash and 2.25
EVEREST HEALTHCARE SERVICES CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
million Fresenius Medical Care AG preference shares. The cash portion of the purchase price is subject to increase or decrease if the net worth of the company is above or below a specified target.
Tender Offer of the 9 3/4% Senior Subordinated Notes due 2008
On November 15, 2000, in connection with the Merger Agreement, FMC announced a tender offer and consent solicitation for the Company's 9 3/4% Senior Subordinated Notes due 2008 (the "Notes"). On December 1, 2000, following the tender by holders possessing a majority of the Notes, the Company and its subsidiaries which are guarantors under the Indenture, dated May 5, 1998 by and among the Company, the Subsidiary Guarantors and American National Bank and Trust Company of Chicago, as trustee (the "Subsidiary Guarantors") executed a Supplemental Indenture which implements amendments to the Indenture. These amendments to the Indenture shall be effective upon the later of the consummation of the transactions under the Merger Agreement or the expiration of the tender offer on December 22, 2000.
21. Selected Quarterly Data
SCHEDULE II
Valuation & Qualifying Accounts Everest Healthcare Services Corporation
(in thousands)