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American Renal Associates Holdings, Inc. – ‘10-Q’ for 3/31/17

On:  Tuesday, 5/9/17, at 4:50pm ET   ·   For:  3/31/17   ·   Accession #:  1498068-17-35   ·   File #:  1-37751

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  As Of                Filer                Filing    For·On·As Docs:Size

 5/09/17  American Renal Assocs Holdin… Inc 10-Q        3/31/17   73:5.0M

Quarterly Report   —   Form 10-Q
Filing Table of Contents

Document/Exhibit                   Description                      Pages   Size 

 1: 10-Q        Quarterly Report                                    HTML    479K 
 2: EX-10.1     Material Contract                                   HTML     40K 
 3: EX-10.2     Material Contract                                   HTML     38K 
 4: EX-10.3     Material Contract                                   HTML     37K 
 5: EX-10.4     Material Contract                                   HTML     39K 
 6: EX-31.1     Certification -- Sarbanes-Oxley Act - Sect. 302     HTML     24K 
 7: EX-31.2     Certification -- Sarbanes-Oxley Act - Sect. 302     HTML     24K 
 8: EX-32.1     Certification -- Sarbanes-Oxley Act - Sect. 906     HTML     21K 
 9: EX-32.2     Certification -- Sarbanes-Oxley Act - Sect. 906     HTML     21K 
16: R1          Document and Entity Information                     HTML     40K 
17: R2          Consolidated Balance Sheets                         HTML    107K 
18: R3          Consolidated Balance Sheets (Parenthetical)         HTML     42K 
19: R4          Consolidated Statements of Operations               HTML     76K 
20: R5          Consolidated Statements of Comprehensive (Loss)     HTML     33K 
                          Income                                                 
21: R6          Consolidated Statement of Changes in Equity         HTML     73K 
22: R7          Consolidated Statements of Cash Flows               HTML    108K 
23: R8          Basis of Presentation and Organization              HTML     34K 
24: R9          Initial Public Offering                             HTML     37K 
25: R10         Cash                                                HTML     28K 
26: R11         Accounts Receivable                                 HTML     26K 
27: R12         Fair Value Measurements                             HTML     89K 
28: R13         Accrued Expenses and Other Current Liabilities      HTML     36K 
29: R14         Variable Interest Entities                          HTML     27K 
30: R15         Noncontrolling Interests Subject to Put Provisions  HTML     37K 
31: R16         Debt                                                HTML     50K 
32: R17         Income Taxes                                        HTML     25K 
33: R18         Stock-Based Compensation                            HTML     61K 
34: R19         (Loss) Earnings Per Share                           HTML     54K 
35: R20         Related Party Transactions                          HTML     32K 
36: R21         Commitments and Contingencies                       HTML     26K 
37: R22         Certain Legal Matters                               HTML     29K 
38: R23         Changes in Ownership Interest in Consolidated       HTML     37K 
                          Subsidiaries                                           
39: R24         Basis of Presentation and Organization (Policies)   HTML     36K 
40: R25         Cash (Tables)                                       HTML     33K 
41: R26         Fair Value Measurements (Tables)                    HTML     83K 
42: R27         Accrued Expenses and Other Current Liabilities      HTML     37K 
                          (Tables)                                               
43: R28         Debt (Tables)                                       HTML     45K 
44: R29         Stock-Based Compensation (Tables)                   HTML     63K 
45: R30         (Loss) Earnings Per Share (Tables)                  HTML     52K 
46: R31         Changes in Ownership Interest in Consolidated       HTML     34K 
                          Subsidiaries (Tables)                                  
47: R32         Basis of Presentation and Organization (Details)    HTML     49K 
48: R33         Initial Public Offering (Details)                   HTML    104K 
49: R34         Cash (Details)                                      HTML     27K 
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51: R36         Fair Value Measurements (Details)                   HTML     28K 
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                          (Details)                                              
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                          for tax receivable agreement liability                 
                          (Details)                                              
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                          (Details)                                              
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                          (Details)                                              
57: R42         DEBT - Schedule of long-term debt (Details)         HTML     39K 
58: R43         DEBT - Scheduled maturities of long-term debt       HTML     37K 
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59: R44         DEBT - Narrative (Details)                          HTML     50K 
60: R45         Income Taxes (Details)                              HTML     26K 
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62: R47         STOCK-BASED COMPENSATION - Narrative (Details)      HTML     46K 
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10-Q   —   Quarterly Report
Document Table of Contents

Page (sequential) | (alphabetic) Top
 
11st Page   -   Filing Submission
"Table of Contents
"Part I. Financial Information
"Item 1
"Consolidated Balance Sheets as of March 31, 2017 (Unaudited) and December 31, 2016
"Consolidated Statements of Operations for the three months ended March 31, 2017 and March 31, 2016 (Unaudited)
"Consolidated Statements of Comprehensive (Loss) Income for the three months ended March 31, 2017 and March 31, 2016 (Unaudited)
"Consolidated Statement of Changes in Equity for the three months ended March 31, 2017 (Unaudited)
"Consolidated Statements of Cash Flows for the three months ended March 31, 2017 and March 31, 2016 (Unaudited)
"Notes to Consolidated Financial Statements (Unaudited)
"Item 2
"Management's Discussion and Analysis of Financial Condition and Results of Operations
"Item 3
"Quantitative and Qualitative Disclosures About Market Risk
"Item 4
"Controls and Procedures
"Part II. Other Information
"Legal Proceedings
"Item 1A
"Risk Factors
"Item 6
"Exhibits
"Signatures

This is an HTML Document rendered as filed.  [ Alternative Formats ]



  Document  

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 
FORM 10-Q
 
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2017
or
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                  to                 
Commission File Number 001-37751
 
ara20160930x10q001.jpg
American Renal Associates Holdings, Inc.
(Exact name of registrant as specified in its charter)
 
Delaware
27-2170749
(State or other jurisdiction of
incorporation or organization)
(IRS Employer
Identification Number)
 
 
500 Cummings Center
(Address of principal executive offices)
(Zip code)
 
(978) 922-3080
(Registrant’s telephone number, including area code)
 
Securities registered pursuant to Section 12(b) or 12(g) of the Act:
None
 
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.   Yes ☒ No ☐ 
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes ☒ No ☐
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company or an emerging growth company. See the definitions of "large accelerated filer," "accelerated filer", "smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer
Accelerated filer
Non-accelerated filer
☒ (Do not check if a smaller reporting company)
Smaller reporting company
 
 
Emerging growth company

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☒

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒

As of May 8, 2017 there were 31,151,569 shares of the registrant’s Common Stock outstanding.


Table of Contents

INDEX
 
 
 
PAGE
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


Table of Contents

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
 
This Form 10-Q contains certain “forward-looking statements” and information relating to us that are based on the beliefs of our management as well as assumptions made by, and information currently available to, us. Forward-looking statements include, but are not limited to, those statements that are based upon management's current plans and expectations as opposed to historical and current facts and are often identified in this report by use of words including but not limited to “estimates,” “expects,” “contemplates,” “anticipates,” “projects,” “plans,” “intends,” “believes,” “forecasts,” “may,” “should” and variations of such words or similar expressions. These statements are based upon estimates and assumptions made by our management that, although believed to be reasonable, are subject to numerous factors, risks and uncertainties that could cause actual outcomes and results to be materially different from those projected. These and other important factors, including those discussed in “Item 1A. Risk Factors” in the Company’s Form 10-K for the year ended December 31, 2017, and in “Part I, Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations” in this Form 10-Q, as such risk factors may be updated from time to time in our periodic filings with the SEC, may cause our actual results, performance or achievements to differ materially from any future results, performance or achievements expressed or implied by these forward-looking statements. Some of the factors that could cause actual results to differ materially from those expressed or implied by the forward-looking statements include, among others, the following:

decline in the number of patients with commercial insurance, including as a result of changes to the healthcare exchanges or changes in regulations or enforcement of regulations regarding the healthcare exchanges and challenges from commercial payors or any regulatory changes leading to changes in the ability of patients with commercial insurance coverage to receive charitable premium support;

decline in commercial payor reimbursement rates;

the ultimate resolution of the Centers for Medicare and Medicaid Services (“CMS”) Interim Final Rule published December 14, 2016 related to dialysis facilities Conditions for Coverage (CMS 3337-IFC);

reduction of government-based payor reimbursement rates or insufficient rate increases or adjustments that do not cover all of our operating costs;

our ability to successfully develop de novo clinics, acquire existing clinics and attract new physician partners;

our ability to compete effectively in the dialysis services industry;

the performance of our joint venture subsidiaries and their ability to make distributions to us;

changes to the Medicare ESRD program that could affect reimbursement rates and evaluation criteria, as well as changes in Medicaid or other non-Medicare government programs or payment rates, including the ESRD PPS final rule for 2017 issued  on October 28, 2016;

federal or state healthcare laws that could adversely affect us;

our ability to comply with all of the complex federal, state and local government regulations that apply to our business, including those in connection with federal and state anti-kickback laws and state laws prohibiting the corporate practice of medicine or fee-splitting;

heightened federal and state investigations and enforcement efforts;

the impact of the litigation by affiliates of UnitedHealth Group, Inc., the Department of Justice inquiry, securities litigation and related matters;

changes in the availability and cost of erythropoietin-stimulating agents (“ESAs”) and other pharmaceuticals used in our business;

development of new technologies that could decrease the need for dialysis services or decrease our in-center patient population;

our ability to timely and accurately bill for our services and meet payor billing requirements;


1

Table of Contents

claims and losses relating to malpractice, professional liability and other matters; the sufficiency of our insurance coverage for those claims and rising insurances costs; and any negative publicity or reputational damage arising from such matters;

loss of any members of our senior management;

damage to our reputation or our brand and our ability to maintain brand recognition;

our ability to maintain relationships with our medical directors and renew our medical director agreements;

shortages of qualified skilled clinical personnel, or higher than normal turnover rates;

competition and consolidation in the dialysis services industry;

deteriorations in economic conditions, particularly in states where we operate a large number of clinics, or disruptions in the financial markets;

the participation of our physician partners in material strategic and operating decisions and our ability to favorably resolve any disputes;

our ability to honor obligations under the joint venture operating agreements with our physician partners were they to exercise certain put rights and other rights;

unauthorized disclosure of personally identifiable, protected health or other sensitive or confidential information;

our ability to meet our obligations and comply with restrictions under our substantial level of indebtedness; and

the ability of our principal stockholder, whose interests may conflict with yours, to strongly influence or effectively control our corporate decisions.
 
You should evaluate all forward-looking statements made in this Form 10-Q in the context of these risks and uncertainties.
We caution you that the risks, uncertainties and other factors referenced above, many of which are beyond our control, may not contain all of the risks, uncertainties and other factors that are important to you. In addition, we cannot assure you that we will realize the results, benefits or developments that we expect or anticipate or, even if substantially realized, that they will result in the consequences or affect us or our business in the way expected. All forward-looking statements in this Form 10-Q apply only as of the date made and are expressly qualified in their entirety by the cautionary statements included in this Form 10-Q. We undertake no obligation to publicly update or revise any forward-looking statements to reflect subsequent events or circumstances.

All subsequent written and oral forward-looking statements attributable to us, or persons acting on our behalf, are expressly qualified in their entirety by these cautionary statements.

2


PART I.
FINANCIAL INFORMATION

ITEM 1.
FINANCIAL STATEMENTS

AMERICAN RENAL ASSOCIATES HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(dollars in thousands, except for share data) 
 
 
 
(Unaudited)
 
 
Assets
 
 
 
Cash
$
84,003

 
$
100,916

Accounts receivable, less allowance for doubtful accounts of $9,227 and $8,726, respectively
77,495

 
81,127

Inventories
4,648

 
4,676

Prepaid expenses and other current assets
18,217

 
18,498

Income tax receivable
9,415

 
5,163

Total current assets
193,778

 
210,380

Property and equipment, net of accumulated depreciation of $129,540 and $121,242, respectively
167,338

 
170,118

Intangible assets, net of accumulated depreciation of $23,005 and $23,489, respectively
25,681

 
25,626

Other long-term assets
7,472

 
6,753

Goodwill
573,147

 
573,147

Total assets
$
967,416

 
$
986,024

 
 
 
 
Liabilities and Equity
 
 
 
Accounts payable
$
24,605

 
$
31,127

Accrued compensation and benefits
26,092

 
29,103

Accrued expenses and other current liabilities
45,075

 
45,286

Current portion of long-term debt
45,559

 
48,274

Total current liabilities
141,331

 
153,790

Long-term debt, less current portion
520,364

 
522,058

Income tax receivable agreement payable
16,683

 
21,200

Other long-term liabilities
12,826

 
11,670

Deferred tax liabilities
1,522

 
1,278

Total liabilities
692,726

 
709,996

Commitments and contingencies (Note 14 and Note 15)

 

Noncontrolling interests subject to put provisions
132,465

 
130,365

Equity:
 
 
 
Preferred stock, $0.01 par value; 1,000,000 shares authorized; none issued

 

Common stock, $0.01 par value; 300,000,000 shares authorized; 31,143,998 and 30,894,962 issued and outstanding at March 31, 2017 and December 31, 2016, respectively
184

 
184

Additional paid-in capital
93,596

 
95,062

Receivable from noncontrolling interests
(747
)
 
(544
)
Accumulated deficit
(129,897
)
 
(128,646
)
Accumulated other comprehensive loss, net of tax
(744
)
 
(100
)
Total American Renal Associates Holdings, Inc. deficit
(37,608
)
 
(34,044
)
Noncontrolling interests not subject to put provisions
179,833

 
179,707

Total equity
142,225

 
145,663

Total liabilities and equity
$
967,416

 
$
986,024

See accompanying notes to consolidated financial statements.

3

Table of Contents


AMERICAN RENAL ASSOCIATES HOLDINGS, INC. AND SUBSIDIARIES  
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(dollars in thousands, except for share data)
 
 
Three Months Ended March 31,
 
 
2017
 
2016
 
Patient service operating revenues
$
178,632

 
$
173,554

 
Provision for uncollectible accounts
(1,607
)
 
(1,423
)
 
Net patient service operating revenues
177,025

 
172,131

 
Operating expenses:
 
 
 
 
Patient care costs
120,301

 
105,455

 
General and administrative
31,244

 
21,499

 
Transaction-related costs (Note 1)

 
24

 
Depreciation and amortization
9,074

 
7,677

 
Certain legal matters (Note 15)
3,936

 

 
Total operating expenses
164,555

 
134,655

 
Operating income
12,470

 
37,476

 
Interest expense, net
(7,609
)
 
(12,258
)
 
Income tax receivable agreement income
4,517

 

 
Income before income taxes
9,378

 
25,218

 
Income tax (benefit) expense
(3,524
)
 
2,661

 
Net income
12,902

 
22,557

 
Less: Net income attributable to noncontrolling interests
(14,153
)
 
(18,801
)
 
Net (loss) income attributable to American Renal Associates Holdings, Inc.
$
(1,251
)
 
$
3,756

 
 
 
 
 
 
(Loss) earnings per share (Note 12):
 
 
 
 
Basic
$
(0.40
)
 
$
0.17

 
Diluted
$
(0.40
)
 
$
0.16

 
Weighted-average number of common shares outstanding
 
 
 
 
Basic
30,907,482

 
22,213,967

 
Diluted
30,907,482

 
22,785,670

 
 
See accompanying notes to consolidated financial statements.

4

Table of Contents

AMERICAN RENAL ASSOCIATES HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS) INCOME
(Unaudited)
(dollars in thousands)
 
 
Three Months Ended March 31,
 
 
2017
 
2016
 
Net income
$
12,902

 
$
22,557

 
Unrealized (loss) gain on derivative agreements, net of tax
(644
)
 
100

 
Total comprehensive income
12,258

 
22,657

 
Less: Comprehensive income attributable to noncontrolling interests
(14,153
)
 
(18,801
)
 
Total comprehensive (loss) income attributable to American Renal Associates Holdings, Inc.
$
(1,895
)
 
$
3,856

 
 
See accompanying notes to consolidated financial statements.

5

Table of Contents

AMERICAN RENAL ASSOCIATES HOLDINGS, INC. AND SUBSIDIARIES  
CONSOLIDATED STATEMENT OF CHANGES IN EQUITY
(Unaudited)
(dollars in thousands, except share data)
 
 
 
 
Total American Renal Associates Holdings, Inc. Equity (Deficit)
 
 
 
Noncontrolling
Interests
subject to put provisions
 
Common Stock
 
Additional
Paid-in
Capital
 
Receivable
from
Noncontrolling
Interest
Holders
 
Retained Earnings (Deficit)
 
Accumulated
Other
Comprehensive Income (loss)
 
 
 
Noncontrolling
Interests not
subject to put provisions
 
 
Shares
 
Par Value
 
 
 
 
 
Total
 
$
130,365

 
30,894,962

 
$
184

 
$
95,062

 
$
(544
)
 
$
(128,646
)
 
$
(100
)
 
$
(34,044
)
 
$
179,707

Net income (loss)
4,354

 

 

 

 

 
$
(1,251
)
 

 
(1,251
)
 
9,799

Stock-based compensation

 

 

 
10,088

 

 

 

 
10,088

 

Exercise of stock options

 
28,786

 

 
30

 

 

 

 
30

 

Issuance of restricted stock

 
220,250

 

 

 

 

 

 

 

Cash dividend equivalents paid on share-based payments

 

 

 
(271
)
 

 

 

 
(271
)
 

Cash dividend equivalents accrued on share-based payments

 

 

 
(1,563
)
 

 

 

 
(1,563
)
 

Distributions to noncontrolling interests
(6,889
)
 

 

 

 

 

 

 

 
(12,155
)
Contributions from noncontrolling interests
565

 

 

 

 
(203
)
 

 

 
(203
)
 
1,348

Purchases of noncontrolling interests
(3,274
)
 

 

 
(1,272
)
 

 

 

 
(1,272
)
 

Reclassification/other adjustments
(1,134
)
 

 

 

 

 

 

 

 
1,134

Change in fair value of derivative agreements, net of tax

 

 

 

 

 

 
(644
)
 
(644
)
 

Change in fair value of noncontrolling interests
8,478

 

 

 
(8,478
)
 

 

 

 
(8,478
)
 

Balance at March 31, 2017
$
132,465

 
31,143,998

 
$
184

 
$
93,596

 
$
(747
)
 
$
(129,897
)
 
$
(744
)
 
$
(37,608
)
 
$
179,833

 
See accompanying notes to consolidated financial statements.


6

Table of Contents

AMERICAN RENAL ASSOCIATES HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)  
(dollars in thousands) 

 
Three Months Ended March 31,
Operating activities
2017
 
2016
Net income
$
12,902

 
$
22,557

Adjustments to reconcile net income to cash provided by operating activities:
 
 
 
Depreciation and amortization
9,074

 
7,677

Amortization of discounts, fees and deferred financing costs
530

 
797

Stock-based compensation
10,088

 
386

Premium paid for interest rate cap agreements
(1,186
)
 

Deferred taxes
673

 
67

Income tax receivable agreement income
(4,517
)
 

Non-cash charge related to derivative agreements
173

 
623

Non-cash rent charges
289

 
512

Loss on disposal of assets
57

 

Change in operating assets and liabilities, net of acquisitions:
 
 
 
Accounts receivable
3,632

 
1,088

Inventories
28

 
(1,224
)
Prepaid expenses and other current assets
(3,870
)
 
(152
)
Other assets
(63
)
 
(18
)
Accounts payable
(6,522
)
 
1,286

Accrued compensation and benefits
(3,011
)
 
(1,008
)
Accrued expenses and other liabilities
(1,755
)
 
3,985

Cash provided by operating activities
16,522

 
36,576

Investing activities
 

 
 
Purchases of property, equipment and intangible assets
(6,406
)
 
(16,396
)
Cash used in investing activities
(6,406
)
 
(16,396
)
 
 
 
 
Financing activities
 

 
 
Proceeds from term loans, net of deferred financing costs
4,881

 
12,282

Payments on long-term debt
(9,689
)
 
(7,462
)
Dividends and dividend equivalents paid
(271
)
 

Proceeds from exercise of stock options
30

 

Payments of deferred offering costs

 
(467
)
Distributions to noncontrolling interests
(19,044
)
 
(21,440
)
Contributions from noncontrolling interests
1,710

 
1,884

Purchases of noncontrolling interests
(4,546
)
 

Cash used in financing activities
(26,929
)
 
(15,203
)
 
 
 
 
(Decrease) increase in cash and restricted cash
(16,813
)
 
4,977

Cash and restricted cash at beginning of period
100,916

 
90,988

Cash and restricted cash at end of period
$
84,103

 
$
95,965

 
 
 
 
Supplemental Disclosure of Cash Flow Information
 

 
 
Cash paid for income taxes
$
127

 
$
193

Cash paid for interest
6,832

 
10,581

 
 
 
 
Supplemental Disclosure of Non-Cash Financing Activities
 

 
 
Accrued offering expense

 
680

Liability for accrued dividend equivalent payments
1,563

 

See accompanying notes to consolidated financial statements.
 

7

Table of Contents

AMERICAN RENAL ASSOCIATES HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(dollars in thousands, except per share amounts)

1. BASIS OF PRESENTATION AND ORGANIZATION
 
Business
 
American Renal Associates Holdings, Inc. (“ARAH” or the Company) owns 100% of the membership units of its subsidiary American Renal Holdings Intermediate Company, LLC, which itself has no assets other than 100% of the shares of capital stock of American Renal Holdings Inc. All of our operating activities are conducted through American Renal Holdings Inc. and its operating subsidiaries (“ARH”).
 
The Company is a national provider of kidney dialysis services for patients suffering from chronic kidney failure, also known as end stage renal disease, or ESRD. As of March 31, 2017, the Company owned and operated 217 dialysis clinics treating 14,735 patients in 25 states and the District of Columbia. The Company’s operating model is based on shared ownership of its facilities with physicians, known as nephrologists, who specialize in treating kidney-related diseases in the local market served by the clinic. Each clinic is maintained as a separate joint venture, or JV, in which the Company has a controlling interest and its local nephrologist partners have noncontrolling interests.
 
Basis of Presentation and Consolidation
 
The accompanying unaudited consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”) regarding interim financial reporting. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America (“U.S.”) for complete financial statements. Our consolidated financial statements include the accounts of the Company, its wholly owned subsidiaries and variable interest entities that operate its clinics (“joint ventures”). All significant intercompany balances and transactions of our wholly owned subsidiaries and joint ventures, including management fees from subsidiaries, are eliminated in consolidation. Refer to Note 6 – Variable Interest Entities.
 
In the opinion of management, the Company has prepared the accompanying unaudited consolidated financial statements on the same basis as its audited financial statements, and these financial statements include all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of the results of the interim periods presented.  These unaudited consolidated financial statements should be read in conjunction with the Consolidated Financial Statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2016.  Prior year balances and amounts have been reclassified to conform to the current year presentation. Operating results for the interim periods are not necessarily indicative of the results that may be expected for the full year.
 
Segment Information
 
Operating segments are identified as components of an enterprise about which separate discrete financial information is available for evaluation by the chief operating decision-maker as of March 31, 2017, or decision-making group, in making decisions how to allocate resources and assess performance. The Company’s chief decision-maker is a combination of the Chief Executive Officer and the President. The Company views its operations and manages its business as one reportable business segment, the ownership and operation of dialysis clinics, all of which are located in the United States.
 
Recent Accounting Pronouncements
 
In August 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2016-18, Statement of Cash Flows (Topic 230). The objective of this update is to provide additional guidance and reduce diversity in practice when classifying certain transactions within the statement of cash flows. In November 2016, the FASB issued ASU 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash. The new standard requires that the statement of cash flows explain the change during the period in the total of cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. These standards are effective for financial statements issued for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. Early application is permitted for all organizations. The Company adopted the provisions of ASU 2016-18 as of January 1, 2017 and applied it retrospectively for all periods presented, which did not have a material impact on the Company's financial statements.

8


AMERICAN RENAL ASSOCIATES HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)
(Unaudited)
(dollars in thousands, except per share amounts)



In March 2016, the FASB issued ASU 2016-09, Compensation – Stock Compensation (Topic 718) – Improvements to Employee Share-Based Payment Accounting. The ASU identifies areas for simplification involving several aspects of share-based payment transactions, including the income tax consequences, classification of awards as equity or liabilities, an option to recognize gross stock compensation expense with actual forfeitures recognized as they occur, as well as certain classifications on the statement of cash flows. ASU 2016-09 is effective for annual periods beginning after December 15, 2016, and interim periods within those annual periods. Early application is permitted for all organizations, and the Company adopted the provisions of ASU 2016-09 as of July 1, 2016.   Upon early adoption, the Company elected to change its accounting policy to account for forfeitures as they occur.  The change was applied on a modified retrospective basis resulting in an increase to stock compensation expense for the six months ended June 30, 2016 of $354.  Amendments related to accounting for excess tax benefits have been adopted prospectively, resulting in recognition of excess tax benefits against income tax expenses rather than additional paid-in capital of $225 for the six months ended June 30, 2016.  Excess tax benefits for share-based payments are included in net operating cash rather than net financing cash, which is consistent with the Company’s current policy.
 
In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842) – Leases: Amendments to the FASB Accounting Standards Codification. The amendments are expected to increase transparency and comparability by recognizing lease assets and liabilities from lessees on the balance sheet and disclosing key information about leasing arrangements in the financial statements. ASU 2016-02 is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early application is permitted for all organizations. The Company expects a balance sheet extension due to the “on balance sheet” recognition of right of use assets and liabilities for agreed lease payment obligations related to certain leased clinics and buildings which are currently classified as operating leases. The impact on the Company will depend on the contract portfolio at the effective date, as well as the transition method. The Company expects to apply the modified retrospective method after review of the analysis is performed. We are currently assessing the impact the adoption of ASU 2016-02 will have on our consolidated financial statements.
 
In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606), which requires companies to recognize revenue when a customer obtains control rather than when companies have transferred substantially all risks and rewards of a good or service. The new standard also requires entities to enhance disclosures about the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers. The new standard allows for either a full retrospective or a modified retrospective transition method and is effective for fiscal years beginning after December 15, 2016. In July 2015 the FASB issued ASU 2015-14, which defers the effective date of ASU 2014-09 for one year, making ASU 2014-09 effective for annual reporting periods beginning on or after December 15, 2017 while also providing for early adoption but not before the original effective date. The FASB has issued additional updates to serve as clarification to the original standard update. The Company is currently assessing the impact the adoption of ASU 2014-09 will have on our consolidated financial statements.
 
2. INITIAL PUBLIC OFFERING

On April 26, 2016, the Company completed an initial public offering (the “IPO”) pursuant to which the Company sold an aggregate of 8,625,000 shares of common stock at a public offering price of $22.00 per share. The net proceeds to the Company from its sale of shares of Common Stock in the IPO, after deducting underwriting discounts and before deducting offering expenses, amounted to $176,942. The Company applied $165,635 of the net proceeds from the IPO toward repayment of outstanding amounts under its second lien credit facility, and funded the repayment in full of the outstanding balance with borrowings from its first lien credit facility, as amended, and cash on hand.

Amendment of Certificate of Incorporation

On April 7, 2016, the Company’s board of directors authorized the amendment of its certificate of incorporation to increase the number of shares that the Company is authorized to issue to 300,000,000 shares of common stock, par value $0.01 per share. In addition, the amendment of the certificate of incorporation authorized the Company to effect a 2.29-for-one stock split of its outstanding common stock. The amendment became effective on April 26, 2016. Accordingly, all common share and per share amounts in these condensed consolidated financial statements have been adjusted to reflect the 2.29-for-one stock split as though it had occurred at the beginning of the initial period presented.



9


AMERICAN RENAL ASSOCIATES HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)
(Unaudited)
(dollars in thousands, except per share amounts)


Clinic Loan Assignment and Term Loan Holdings LLC Distribution

We partly finance the de novo clinic development costs of some of our joint venture subsidiaries by providing intercompany term loans and revolving loans through our wholly owned operating subsidiary American Renal Associates LLC (“ARA OpCo”). On April 26, 2016, the Company transferred substantially all of the then existing intercompany term loans (“assigned clinic loans”) provided to our joint venture subsidiaries by ARA OpCo to a newly formed entity, Term Loan Holdings LLC (“Term Loan Holdings”), which ownership interest was distributed to our pre- IPO stockholders pro rata in accordance with their ownership in the Company. As a result of the distribution of membership interests in Term Loan Holdings, the balance of such assigned clinic loans is reflected on our consolidated balance sheet beginning in the current reporting period. The balance of such assigned clinic loans was $17,335 as of March 31, 2017. Each assigned clinic loan is and will continue to be guaranteed by us and the applicable joint venture partner or partners in proportion to our respective ownership interests in the applicable joint venture. We guaranteed $9,134 of such assigned clinic loans as of March 31, 2017.

Amendments to and Repayment of Credit Facility

On April 26, 2016, the Company entered into the first amendment (the “Amendment”) to the First Lien Credit Agreement. The Amendment increased the borrowing capacity under the first lien revolving credit facility by $50,000 to an aggregate amount of $100,000, increased the interest rate margin by 0.25% on the first lien term loans, and provided for additional borrowings of $60,000 of incremental first lien term loans. The Company incurred $2,700 of costs associated with these refinancing activities, of which $1,350 were charged as transaction costs and $1,350 were deferred upon execution of the Amendment.

The Company also applied $165,635 of the net proceeds from the IPO and cash on hand to repay the outstanding balance on the second lien term loans. The write-off of deferred financing fees and discounts in the amount of $4,708 were charged as early extinguishment of debt upon repayment.

Income Tax Receivable Agreement

On April 26, 2016, the Company entered into the Income Tax Receivable Agreement (“TRA”) for the benefit of our pre-IPO stockholders, including Centerbridge and our executive officers. The TRA provides for the payment by us to our pre-IPO stockholders on a pro rata basis of 85% of the amount of cash savings, if any, in U.S. federal, state and local income tax that we actually realize as a result of any deductions (including net operating losses resulting from such deductions) attributable to the exercise of (or any payment, including any dividend equivalent right or payment, in respect of ) any compensatory stock option issued by us that is outstanding (whether vested or unvested) as of April 20, 2016, which is the record date set by the board of directors of the Company for this distribution. The Company recorded an estimated liability of $23,400 based on the fair value of the TRA as of April 20, 2016. As of March 31, 2017, the Company’s total liability under the TRA is estimated to be $17,597, of which $914 is included as a component of other accrued expenses on the condensed consolidated balance sheet.

Special Dividends and Stock Option Modification

On April 26, 2016, the Company declared and paid a cash dividend to our pre-IPO stockholders equal to $1.30 per share, or $28,886 in the aggregate. In connection with the dividend, all employees with outstanding options had their option exercise price reduced and in some cases were awarded a future dividend equivalent payment, which were paid on vested options and become due upon vesting for unvested options. This resulted in a modification. Additionally, in connection with the cash dividend, as of March 31, 2017 the Company has made payments equal to $1.30 per share, or $1,445 in the aggregate, to option holders, and, in the case of some performance and market options, a future payment will be due upon vesting totaling $5,405.

In connection with the Term Loan Holdings Distribution, as described above, the Company also equitably adjusted the outstanding stock options by reducing exercise prices and making cash dividend equivalent payments, of which $176 was paid to vested option holders as of March 31, 2017 and $2,349 is payable to unvested option holders only if such unvested options become vested. Options were also equitably adjusted for the TRA, as described above. Options were adjusted by reducing exercise prices and, if necessary, increasing the number of shares subject to such stock options.


10


AMERICAN RENAL ASSOCIATES HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)
(Unaudited)
(dollars in thousands, except per share amounts)


In connection with these dividends, equitable adjustments are required by the terms of some of our equity incentive plans and for other plans were modified at the discretion of our Board of Directors. The Company also elected to modify the vesting conditions of certain market and performance-based stock options. These modifications are treated as an option modification and the Company accounted for the option modification under ASC Topic 718, Compensation – Stock Compensation. As a result of these modifications made to our outstanding market and performance-based stock options at the time of the IPO, the amount of the unrecognized non-cash compensation costs increased by approximately $38,877. These compensation costs, after giving effect to the modifications, will be recognized over a period of approximately 12 months from the time of the IPO. As a result, the Company recognized $9,105 in incremental compensation expense during the three months ended March 31, 2017. As of March 31, 2017, the Company had $12,349 of unrecognized compensation costs related to unvested share-based compensation arrangements.

3. CASH

The following table provides a reconciliation of cash and restricted cash reported within the balance sheet that sum to the total of the same such amounts shown in the statement of cash flows.
 
 
Cash
$
84,003

 
Restricted cash included in prepaid expenses and other current assets
100

 
Total cash and restricted cash shown in the statement of cash flows
$
84,103

 

Restricted cash included in prepaid expenses and other current assets on the balance sheet represent those amounts required to be set aside by contractual agreement with a financial institution.

4. ACCOUNTS RECEIVABLE
 
Accounts receivable are reduced by an allowance for doubtful accounts. In evaluating the ultimate collectability and net realizable value of the Company’s accounts receivable, the Company analyzes its historical cash collection experience and trends for each of its government payors and commercial payors to estimate the adequacy of the allowance for doubtful accounts and the amount of the provision for bad debts. Management regularly updates its analysis based upon the most recent information available to it to determine its current provision for bad debts and the adequacy of its allowance for doubtful accounts. For receivables associated with services provided to patients covered by government payors, like Medicare, the Company receives 80% of the payment directly from Medicare as established under the government’s bundled payment system and determines an appropriate allowance for doubtful accounts and provision for bad debts on the remaining balance due depending upon the Company’s estimate of the amounts ultimately collectible from other secondary coverage sources or from the patients. For receivables associated with services to patients covered by commercial payors that are either based upon contractual terms or for non-contracted health plan coverage, the Company provides an allowance for doubtful accounts and a provision for bad debts based upon its historical collection experience, potential inefficiencies in its billing processes and for which collectability is determined to be unlikely. Receivables where the patient is primary payor make up less than 1% of the Company’s accounts receivable. It is the Company’s policy to reserve for a portion of these outstanding accounts receivable balances based on historical collection experience and for which collectability is determined to be unlikely.

5. FAIR VALUE MEASUREMENTS
 
The Company’s interest rate swap agreements, Tax Receivable Agreement (“TRA”) and noncontrolling interests subject to put provisions are accounted for at fair value on a recurring basis and are classified and disclosed in one of the following three categories:
 
Level 1:  Financial instruments with unadjusted, quoted prices listed on active market exchanges.
 
Level 2:  Financial instruments determined using prices for recently traded financial instruments with similar underlying terms, as well as directly or indirectly observable inputs, such as interest rates and yield curves that are observable at commonly quoted intervals.
 

11


AMERICAN RENAL ASSOCIATES HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)
(Unaudited)
(dollars in thousands, except per share amounts)


Level 3:  Financial instruments not actively traded on a market exchange. This category includes situations where there is little, if any, market activity for the financial instrument. The prices are determined using significant unobservable inputs or valuation techniques.
 
The asset or liability fair value measurement level within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement. There were no changes in the methodologies used at March 31, 2017.

Noncontrolling interests subject to put provisions—See Note 8 for a discussion of the Company’s methodology for estimating fair value of noncontrolling interest subject to put provisions.
 
Derivative agreements—See Note 9 for a discussion of the Company’s methodology for estimating fair value of interest rate swaps agreements.
 
Tax Receivable Agreement—The fair value of the TRA relied upon both Level 2 data and Level 3 data.  The liability is remeasured at fair value each reporting period with the change in fair value recognized as Income tax receivable agreement income or expense in the Company’s Consolidated Statements of Operations.  The fair value is calculated using a Monte Carlo simulation-based approach that relies on significant assumptions about our stock price, stock volatility and risk-free rate as well as the timing and amounts of options exercised.  Changes in assumptions based on future events, including the price of our common stock, will impact the fair value for the TRA.  See Note 2 – Initial Public Offering for further discussion of the Tax Receivable Agreement.
 
Transfers among levels are calculated on values as of the transfer date. There were no transfers between Levels 1, 2 and 3 during the three months ended March 31, 2017 and the year ended December 31, 2016.
 
 
 
Total
 
Level 1
 
Level 2
 
Level 3
Assets
 
 
 
 
 
 
 
Interest rate derivative agreements (included in Prepaid expenses and other current assets)
$
1

 
$

 
$
1

 
$

Interest rate derivative agreements (included in Other long-term assets)
795

 

 
795

 

Total Assets
$
796

 
$

 
$
796

 
$

Liabilities
 
 
 
 
 

 
 

Tax Receivable Agreement Liability (included in Income tax receivable agreement payable)
$
16,500

 
$

 
$

 
$
16,500

Interest rate swap agreement (included in Other long-term liabilities)
849

 

 
849

 

Total Liabilities
$
17,349

 
$

 
$
849

 
$
16,500

Temporary Equity
 
 
 
 
 

 
 

Noncontrolling interests subject to put provisions
$
132,465

 
$

 
$

 
$
132,465

 

12


AMERICAN RENAL ASSOCIATES HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)
(Unaudited)
(dollars in thousands, except per share amounts)


 
 
Total
 
Level 1
 
Level 2
 
Level 3
Assets
 
 
 
 
 
 
 
Interest rate swap agreements (included in Prepaid expenses and other current assets)
$
7

 
$

 
$
7

 
$

Liabilities
 
 
 
 
 
 
 

Tax Receivable Agreement Liability
$
21,200

 
$

 
$

 
$
21,200

Temporary Equity
 
 
 
 
 
 
 

Noncontrolling interests subject to put provisions
$
130,365

 
$

 
$

 
$
130,365

 
The following table provides the fair value rollforward for the three months ended March 31, 2017 for the Tax receivable agreement liability, which is classified as a Level 3 financial instrument. 
 
Three Months Ended March 31, 2017
 
$
21,200

Options exercised and dividend equivalent payment vesting
(183
)
Total realized/unrealized gains:
 
Included in earnings and reported as Income tax receivable agreement income
(4,517
)
Balance at March 31, 2017
$
16,500


The carrying amounts reported in the accompanying consolidated balance sheets for cash, accounts receivable, accounts payable and accrued liabilities approximate fair value because of their short-term nature. The fair value of the Company’s debt is estimated using Level 2 inputs based on the quoted market prices for the same or similar issues or on the current rates offered to the Company for debt of the same remaining maturities. The Company estimates the fair value of the first lien term loans at $433,140 as of March 31, 2017 as compared to the carrying amount of $432,599. The Company estimates the fair value of the first lien term loans approximates the carrying value at $433,758 as of December 31, 2016.  See Note 2 – Initial Public Offering for a discussion of the Company’s repayment of the second lien term loans.
 
6. ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES
 
Accrued compensation and benefits consist of the following:
 
 
 
Accrued compensation
$
13,509

 
$
18,077

Accrued vacation pay
12,583

 
11,026

 
$
26,092

 
$
29,103

 
Accrued expenses and other current liabilities consist of the following:
 
 
 
Payor refunds and retractions
$
30,578

 
$
32,902

Dividend equivalent payments
7,909

 
6,438

Other
6,588

 
5,946

 
$
45,075

 
$
45,286

 

13


AMERICAN RENAL ASSOCIATES HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)
(Unaudited)
(dollars in thousands, except per share amounts)


7. VARIABLE INTEREST ENTITIES
 
The Company relies on the operating activities of certain entities that it does not have the majority voting interest, but over which it has indirect influence and of which it is considered the primary beneficiary. These entities are subject to the consolidation guidance applicable to variable interest entities (VIEs).
 
Under U.S. generally accepted accounting principles (GAAP), VIEs typically include entities for which (i) the entity’s equity is not sufficient to finance its activities without additional subordinated financial support; (ii) the equity holders as a group lack the power to direct the activities that most significantly influence the entity’s economic performance, the obligation to absorb the entity’s expected losses, or the right to receive the entity’s expected returns; or (iii) the voting rights of some investors are not proportional to their obligations to absorb the entity’s losses.
 
The Company has determined that substantially all of the entities it is associated with that qualify as VIEs must be included in its consolidated financial statements. For its joint ventures, the Company has determined that contractual rights granted to it provide the Company with the ability to direct the most significant activities of these entities, including development, administrative and management services.  In some cases, the contractual agreements include financial terms that may result in the Company absorbing more than an insignificant amount of the entities expected losses. Therefore, the Company has determined that it is the primary beneficiary of these entities.  Accordingly, the financial results of these joint ventures are fully consolidated into the Company’s operating results. The equity interests of the outside investors in the equity and results of operations of these consolidated entities are accounted for and presented as noncontrolling interests.

The analyses upon which these consolidation determinations rest are complex, involve uncertainties, and require significant judgment on various matters, some of which could be subject to different interpretations. As of March 31, 2017, these condensed consolidated financial statements include total assets of VIEs of $16,231 and total liabilities of VIEs of $12,287.
 
Term Loan Holdings
 
The Company has determined that we are not the primary beneficiary under VIE accounting guidance for Term Loan Holdings, as discussed in “Note 2—Initial Public Offering.”  Based on our involvement with Term Loan Holdings, we do not have the power to direct the activities which most significantly impact Term Loan Holding’s economic performance, and therefore this entity is not included in our consolidated financials.  The Company’s financial responsibility to repay the loans under its guarantee of a proportionate share of each clinic’s borrowing was not a factor in the Company’s assessment of the power criterion.  The maximum exposure to loss with respect to Term Loan Holdings is limited to the proportion of the assigned clinic loans which we guarantee.  See “Note 13—Related Party Transactions.”
 

14


AMERICAN RENAL ASSOCIATES HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)
(Unaudited)
(dollars in thousands, except per share amounts)


8. NONCONTROLLING INTERESTS SUBJECT TO PUT PROVISIONS
 
The Company has potential obligations to purchase a portion or all of the noncontrolling interests held by third parties in certain of its consolidated subsidiaries. These obligations are in the form of put provisions and are exercisable at the third-party owners’ discretion within specified periods as outlined in each specific put provision. Additionally, the Company has certain put agreements which are exercisable upon the occurrence of specific events, including third-party members’ death, disability, bankruptcy, retirement, or if third-party members are dissolved. Some of these puts accelerated as a result of the Company’s initial public offering, of which some were exercised during the three months ended March 31, 2017. If these put provisions were exercised, the Company would be required to purchase all or a portion of the third-party owners’ noncontrolling interests at the estimated fair value as defined within the put provisions. The majority of the put provisions are reported at the estimated fair value for accounting purposes, while some put provisions are stated at the contractual estimated fair value, as outlined in each specific put provision.  The put options of such noncontrolling interest holders were determined based on inputs that were not readily available in public markets or able to be derived from information available in publicly quoted markets. As such, the Company categorized the put options of the noncontrolling interest holders as Level 3. The fair value of noncontrolling interests subject to puts is arrived at based on the respective merits of the Income, Market and Asset Based Approaches. The primary inputs associated with these valuation methods are Clinic forecasts, Weighted Average Cost of Capital (13.50% - 19.00%) and EBITDA multiples. The estimated fair values of the noncontrolling interests subject to put provisions can also fluctuate and the implicit multiple of earnings at which these noncontrolling interest obligations may ultimately be settled could vary significantly from our current estimates depending upon market conditions including potential purchasers’ access to the credit and capital markets, which can impact the level of competition for dialysis and non-dialysis related businesses, the economic performance of these businesses and the restricted marketability of the third-party owners’ noncontrolling interests.

9. DEBT
 
Long-term debt consists of the following:
 
 
    
First Lien Credit Agreement
$
432,599

 
$
433,758

Term Loans (1)
126,991


118,503

Lines of Credit
7,301

 
19,360

Other
2,962

 
3,041

 
569,853

 
574,662

Less: discounts and fees, net of accumulated amortization
(3,930
)
 
(4,330
)
Less: current maturities
(45,559
)
 
(48,274
)
 
$
520,364

 
$
522,058

_____________________________
(1)    Includes assigned clinic loans
 
Scheduled maturities of long-term debt as of March 31, 2017 are as follows: 
 
2017 (remainder)
$
36,431

2018
38,263

2019
455,425

2020
19,859

2021
12,159

Thereafter
7,716

 
$
569,853


15


AMERICAN RENAL ASSOCIATES HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)
(Unaudited)
(dollars in thousands, except per share amounts)


 
During the three months ended March 31, 2017, the Company made mandatory principal payments of $1,159 under the First Lien Credit Agreement.
 
As of March 31, 2017, there were no borrowings outstanding under the Revolving Credit Facility as provided for under our First Lien Credit Agreement.
 
Interest Rate Swap Agreements
 
In May 2013, the Company entered into two interest rate swap agreements (the ‘‘2013 Swaps’’) with notional amounts totaling $320,000, as a means of fixing the floating interest rate component on $400,000 of its variable-rate debt under the Term B Loans. The 2013 Swaps were designated as a cash flow hedge, and terminated on March 31, 2017.

In March 2017, the Company entered into a forward starting interest rate swap agreement (the “2017 Swap”) with a notional amount of $133,000, as a means of fixing the floating interest rate component on $460,000 of its variable-rate debt under the Term B Loans, with an effective date of March 31, 2018. The forward starting 2017 Swap is designated as a cash flow hedge, with a termination date of March 31, 2021.

As a result of the application of hedge accounting treatment, to the extent the 2013 Swaps and 2017 Swap are effective, the unrealized gains and losses related to the derivative instrument are recorded in accumulated other comprehensive income (loss) and are reclassified into operations in the same period in which the hedged transaction affects earnings and to the extent the Swaps are ineffective and produces gains and losses differently from the losses or gains being hedged, the ineffectiveness portion is recognized in earnings immediately. Hedge effectiveness is tested quarterly. We do not use derivative instruments for trading or speculative purposes.
 
During the period ended March 31, 2017 the 2013 Swaps continue to be ineffective, which was determined as of March 31, 2016.  Amounts previously recorded in accumulated other comprehensive loss related to the 2013 Swaps, totaling $501, have been reclassified into earnings over the term of the previously hedged borrowing using the swaplet method.  The Company reclassified $100 previously recorded in accumulated other comprehensive loss into interest expense during the three months ended March 31, 2017. As of March 31, 2017, the 2017 Swaps are effective.

Interest Rate Cap Agreements

In March 2017, the Company entered into two interest rate cap agreements (the “Caps”) with notional amounts totaling $147,000, as a means of capping the floating interest rate component on $460,000 of its variable‑rate debt under the Term B Loans. The Caps are designated as a cash flow hedge, with a termination date of March 31, 2021. As a result of the application of hedge accounting treatment, to the extent the Caps are effective, the unrealized gains and losses related to the derivative instrument are recorded in accumulated other comprehensive income (loss) and are reclassified into operations in the same period in which the hedged transaction affects earnings and to the extent the Caps are ineffective and produces gains and losses differently from the losses or gains being hedged, the ineffective portion is recognized in earnings immediately. Hedge effectiveness is tested quarterly. The Company does not use derivative instruments for trading or speculative purposes.
 
As more fully described within Note 5 - Fair Value Measurements, the Company uses a three‑level fair value hierarchy that prioritizes the inputs used to measure fair value. The fair value of the interest rate swap agreements and Caps are recorded at fair value based upon valuation models utilizing the income approach and commonly accepted valuation techniques that use inputs from closing prices for similar assets and liabilities in active markets as well as other relevant observable market inputs at quoted intervals such as current interest rates, forward yield curves, and implied volatility. The Company does not believe the ultimate amount that could be realized upon settlement of these interest rate swaps would be materially different from the fair values currently reported.


16

Table of Contents
AMERICAN RENAL ASSOCIATES HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(dollars in thousands, except per share amounts)


10. INCOME TAXES
 
The income tax expense included in the accompanying consolidated statements of operations principally relates to the Company’s proportionate share of the pre-tax income of its joint venture subsidiaries. The determination of income tax expense for interim reporting purposes is based upon the estimated effective tax rate for the year adjusted for the impact of any discrete items which are accounted for in the period in which they occur.
 
The Company’s effective income tax rate for the three months ended March 31, 2017 and 2016 was (37.58)% and 10.55%, respectively. These rates differ from the federal statutory rate of 35% principally due to the portion of pre-tax income that is allocable to noncontrolling interests from our joint venture subsidiaries which are pass-through entities for income tax purposes, the valuation allowance recorded on a discrete basis, as well as the change in fair value of the TRA liability, which is not deductible for income tax purposes.

The Company has established a $673 valuation allowance for its charitable contributions that are expiring in 2017. The Company believes that future taxable income levels would be sufficient to realize the tax benefits and has not established any additional valuation on the remaining deferred tax assets.  Should the Company determine that future realization of these tax benefits is not more likely than not, a valuation allowance would be established, which would increase our tax provision in the period of such determination.

 
11. STOCK-BASED COMPENSATION
 
For the three months ended March 31, 2017 and 2016, stock-based compensation expense was reflected in the accompanying consolidated statements of operations as follows:
 
 
Three Months Ended March 31,
 
 
2017
 
2016
 
Patient care costs
$
1,828

 
$
93

 
General and administrative
8,260

 
293

 
Total stock-based compensation before tax
$
10,088

 
$
386

 
Income tax benefit
(4,035
)
 
(154
)
 
 
As of March 31, 2017, the Company has 5,988,294 options outstanding.
 
2016 Omnibus Plan
 
On April 7, 2016, the Company approved the 2016 Omnibus Incentive Plan (the “2016 Plan”). The 2016 Plan authorized the Company to issue options and other awards to directors, officers, employees, consultants and advisors to purchase up to a total of 4,000,000 shares of common stock. As of March 31, 2017, options to purchase an aggregate of 3,102,577 shares of common stock are available for future grants under the 2016 Plan. 
 
The assumptions used for options granted to acquire Common Stock and the fair value at the date of grant under the 2016 Plan is noted in the following table:
 
Three months ended March 31, 2017
Expected volatility
30.00%
Weighted average expected term in years
6.00
Weighted average risk-free interest rate
2.26%
Expected annual dividend yield
—%
Weighted average grant-date fair value
$5.85


17


AMERICAN RENAL ASSOCIATES HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)
(Unaudited)
(dollars in thousands, except per share amounts)


Information concerning options activity under the 2016 Plan for options to acquire Common Shares is summarized as follows:

 
Three months ended March 31, 2017
 
Number
of Options
 
Weighted-Average
Exercise Price
Outstanding, beginning of period
318,877

 
$
21.90

Granted (1)
422,529

 
17.39

Forfeited
(13,625
)
 
19.40

Outstanding, end of period
727,781

 
$
19.33

Options vested and expected to vest, end of period
727,781

 
$
19.33

Options exercisable, end of period
22,131

 
$
22.87

_____________________________
(1)    Subject to vesting terms of three years.
 

Restricted Stock Awards

Employees and directors are eligible to receive grants of restricted stock, which entitle the holder to shares of common stock as the awards vest over time. The Company determines stock-based compensation expense using the fair value method. The fair value of restricted stock is equal to the closing sale price of the Company’s common stock on the date of grant.

During the three months ended March 31, 2017, the Company granted 220,250 restricted stock awards to employees and directors, respectively, at a weighted average grant date fair value of $17.39. These restricted stock awards vest over a weighted average period of 2.4 year from grant date.

As of March 31, 2017, a total of 194,946 shares of restricted stock were unvested and outstanding, which results in unamortized stock-based compensation of $3,305 to be recognized as stock-based compensation expense over the remaining weighted average vesting period of 1.8 years.

A summary of restricted stock award activity is as follows: 
 
Three Months Ended March 31, 2017
 
Number Outstanding
 
Weighted Average Grant Date Fair Value per Award

 

Granted
220,250

 
$
17.39

Vested
25,304

 
$
17.39

Balance at March 31, 2017
194,946

 
$
17.39

 

18


AMERICAN RENAL ASSOCIATES HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)
(Unaudited)
(dollars in thousands, except per share amounts)


12. (LOSS) EARNINGS PER SHARE
 
Basic earnings (loss) per share is computed by dividing net income (loss) attributable to American Renal Associates Holdings, Inc., net of the change in the difference between the estimated fair values of contractual noncontrolling interest put provisions and estimated fair values for accounting purposes of the related noncontrolling interests, by the weighted-average number of common shares outstanding during the applicable period, less unvested restricted stock. Diluted earnings (loss) per share is computed using the weighted-average number of common shares outstanding during the applicable period, plus the dilutive effect of outstanding options, using the treasury stock method and the average market price of the Company’s common stock during the applicable period. Certain shares related to some of the Company’s outstanding stock options were excluded from the computation of diluted earnings per share because they were anti-dilutive in the periods presented, but could be dilutive in the future.
 
 
Three Months Ended March 31,
 
 
2017
 
2016
 
Basic
 

 
 

 
Net (loss) income attributable to American Renal Associates Holdings, Inc.
$
(1,251
)
 
$
3,756

 
Change in the difference between the estimated fair values of contractual noncontrolling interest put provisions and estimated fair values for accounting purposes of the related noncontrolling interests
(11,083
)
 

 
Net (loss) income attributable to American Renal Associates Holdings, Inc. for basic earnings per share calculation
$
(12,334
)
 
$
3,756

 
Weighted-average common shares outstanding used to calculate basic net income (loss) per share
30,907,482

 
22,213,967

 
(Loss) earnings per share, basic
$
(0.40
)
 
$
0.17

 
Diluted
 

 
 

 
Net (loss) income attributable to American Renal Associates Holdings, Inc.
$
(1,251
)
 
$
3,756

 
Change in the difference between the estimated fair values of contractual noncontrolling interest put provisions and estimated fair values for accounting purposes of the related noncontrolling interests
(11,083
)
 

 
Net (loss) income attributable to American Renal Associates Holdings, Inc. for diluted earnings per share calculation
$
(12,334
)
 
$
3,756

 
Weighted-average common shares outstanding, basic
30,907,482

 
22,213,967

 
Weighted-average effect of dilutive securities:
 

 
 

 
Effect of assumed exercise of stock options

 
571,703

 
Weighted-average common shares outstanding used to calculate diluted net income (loss) per share
30,907,482

 
22,785,670

 
(Loss) earnings per share, diluted
$
(0.40
)
 
$
0.16

 
Outstanding options excluded as impact would be anti-dilutive
1,315,091

 
116,937

 
 
13. RELATED PARTY TRANSACTIONS
 
Term Loan Holdings
 
In 2016, the Company transferred substantially all of the assigned clinic loans provided to our joint venture subsidiaries to Term Loan Holdings, as described in Note 2 – Initial Public Offering and Note 7 – Variable Interest Entities. A Centerbridge entity, which does not hold any economic interest in Term Loan Holdings, is the manager of Term Loan Holdings, and affiliates of Centerbridge and our executive officers own economic interests in Term Loan Holdings.  As of March 31, 2017, such assigned clinic loans aggregated $17,335, had maturities ranging from June 2017 to July 2020, with a weighted average maturity of approximately 2.42 years (September 2019), and interest rates ranging from 3.46% to 8.08%, with a weighted average interest rate of 5.09%. Fixed principal and interest payments with respect to such assigned clinic loans are payable monthly. The Company will continue to administer and manage the assigned clinic loans as servicer pursuant to the

19


AMERICAN RENAL ASSOCIATES HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)
(Unaudited)
(dollars in thousands, except per share amounts)


terms of a loan servicing agreement as entered into between the Company and Term Loan Holdings (the “Loan Servicing Agreement”).  The Company is paid a quarterly fee for its services based on its reasonable costs and expenses, plus a specified percentage of such costs and expenses, which may be adjusted annually based on negotiations between the Company and Term Loan Holdings. The quarterly fee charged for the three months ended March 31, 2017 is immaterial. Each assigned clinic loan guaranteed by us and the applicable joint venture partner or partners in proportion to our respective ownership interests in the applicable joint venture with maturities consistent with the aggregate assigned clinic loans.  Our maximum potential liability for future payments, not including interest, is $17,335, of which we guaranteed $9,134 as of March 31, 2017.  These guarantees would become payable if the joint venture fails to meet its obligations under the applicable assigned clinic loan.
 
Income Tax Receivable Agreement
 
On April 26, 2016, the Company entered into the TRA for the benefit of our pre-IPO stockholders, including Centerbridge and our executive officers.  The TRA provides for the payment by us to our pre-IPO stockholders on a pro rata basis of 85% of the amount of cash savings, if any, in U.S. federal, state and local income tax that we actually realize as a result of any deductions (including net operating losses resulting from such deductions) attributable to the exercise of (or any payment, including any dividend equivalent right or payment, in respect of ) any compensatory stock option issued by us that is outstanding (whether vested or unvested) as of April 20, 2016, which is the record date set by the board of directors of the Company for this distribution.  See Note 2—Initial Public Offering.

Transaction Fee and Advisory Services Agreement
 
The Company entered into a transaction fee and advisory services agreement, dated as of May 7, 2010 (the “Advisory Services Agreement”), with Centerbridge Advisors, LLC (together with its affiliates, “Centerbridge”). Under the Advisory Services Agreement, Centerbridge agreed to provide certain investment banking, management, consulting, and financing planning services on an ongoing basis. In consideration for these services, the Company pays Centerbridge an annual advisory services fee (payable quarterly) the greater of (i) an amount equal to the greater of (x) $550 or (y) the advisory services fee of the previous fiscal year or (ii) an amount equal to 1.25% of EBITDA (as defined in the agreement), minus a personnel expense deduction, if applicable. During the three months ended March 31, 2017 and 2016, the Company recorded $0 and $457 of expense related to this agreement, respectively. Centerbridge was also entitled to receive an additional fee equal to 1% of the enterprise value and/or aggregate value, as applicable, for any fundamental or significant transactions, both as defined, in which Centerbridge is involved.  In connection with the IPO, the Advisory Services Agreement was terminated as of April 26, 2016 (other than the expense reimbursement and indemnification provisions).
 
Due from Related Party

In 2016, the Company entered into a sublease agreement with a clinic group, who are also noncontrolling interest shareholders, to provide financing for various facility buildouts. The total amount of initial financing provided by the Company was $1,044. As of March 31, 2017 the loans had an interest rate of 6% with maturities ranging from March 2026 through August 2031. Fixed principal and interest payments with respect to such loans are payable monthly. As of March 31, 2017 the remaining balance to be paid to the Company was $989.

14. COMMITMENTS AND CONTINGENCIES
 
Income Tax Receivable Agreement
 
As described in Note 2 – Initial Public Offering, the Company is a party to the TRA under which we are contractually committed to pay our pre-IPO stockholders on a pro rata basis 85% of the amount of cash savings, if any, in U.S. federal, state and local income tax that we actually realize (or are deemed to realize in the case of an early termination payment by us, or a change of control, as discussed below) as a result of any option deductions (as defined in the TRA).  The actual amount and timing of any payments under the TRA will vary depending upon a number of factors, including the amount and timing of taxable income we generate in the future, changes in the income tax rate, whether and when any Relevant Stock Options are exercised and the value of our common stock at the time of such exercise.

20


AMERICAN RENAL ASSOCIATES HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)
(Unaudited)
(dollars in thousands, except per share amounts)



Litigation
 
The Company and its subsidiaries are defendants in various legal actions in the normal course of business. In the opinion of the Company’s management, based in part on the advice of outside counsel, the resolution of these matters will not have a material effect on the Company’s financial position, results of operations or cash flows. See Note 15—Certain Legal Matters.
 
Regulatory
 
The healthcare industry is subject to numerous laws and regulations of federal, state, and local governments. Government activity has increased with respect to investigations and allegations concerning possible violations by healthcare providers of fraud and abuse statutes and regulations, which could result in the imposition of significant fines and penalties, as well as significant repayments for patient services previously billed. Compliance with such laws and regulations are subject to government review and interpretations, as well as regulatory actions unknown or unasserted at this time.
 
15. CERTAIN LEGAL MATTERS
 
As previously disclosed, American Renal Associates Holdings, Inc. (“ARA”) and its wholly owned operating subsidiary American Renal Associates LLC (“ARA OpCo”) were named as defendants in a complaint filed by three affiliates of UnitedHealth Group Inc. (“United”) in the United States District Court for the Southern District of Florida (the "Court") on July 1, 2016. On August 12, 2016, ARA and ARA OpCo each filed a motion to dismiss the action. On September 2, 2016, plaintiffs filed an amended complaint, dropping one of the United affiliates as a plaintiff. On September 30, 2016, ARA and ARA OpCo each filed a motion to dismiss the amended complaint. On January 17, 2017, plaintiffs filed a motion seeking to file a second amended complaint, which would add American Renal Management LLC ("ARM") as a defendant. ARA and ARA OpCo filed an opposition to the motion to further amend. On May 8, 2017, the Court granted ARA's motion to dismiss for lack of personal jurisdiction and dismissed ARA from the lawsuit without prejudice. The lawsuit remains pending against ARA OpCo and ARM with a hearing set on the motion to dismiss for June 23, 2017. The amended complaint and proposed second amended complaint relate to 30 patients who have received, and some of whom continue to receive, dialysis at 12 clinics in Florida and Ohio and who obtained coverage under one of United’s ACA-compliant individual marketplace plans, effective on or after January 1, 2016. The plaintiffs assert various state law claims and allege violations of certain state laws that prohibit false insurance claims, healthcare kickbacks, patient brokering, and violations of the applicable commercial plan agreements in connection with, among other things, premium payment assistance by the American Kidney Fund (“AKF”). The amended complaint and proposed second amended complaint seek unspecified actual, consequential and punitive monetary damages, together with interest and costs, and declaratory and injunctive relief, as well as attorney's fees and court costs. The Company has moved to dismiss the amended complaint in full, has opposed the motion to file a second amended complaint, and is vigorously defending itself in this legal matter. Jurisdictional discovery was completed and merits discovery has commenced. The Company has received letters from other insurance companies seeking information regarding matters relating to the insurance companies’ covered patients similar in nature to the matters underlying the United complaint.

In addition, as previously disclosed, on July 26, 2016, the Staff of the SEC sent a letter to the Company stating that it is conducting an inquiry and requesting that the Company provide certain documents and information relating to the subject matter covered by the United complaint described above. The Company has subsequently received follow up and additional requests for documents and information with respect to the same subject matter. The Company has fully cooperated with the SEC Staff.  On April 28, 2017, the Company was notified by the SEC Staff that the SEC had concluded its investigation and, based on the information it had as of that date, does not intend to recommend an enforcement action against the Company.

On August 31, 2016 and September 2, 2016, putative shareholder class action complaints were filed in the United States District Court for the Southern District of New York and the United States District Court for the District of Massachusetts, respectively, against the Company and certain officers and directors of the Company.  Both complaints asserted federal securities law claims against the Company and the individual defendants under Sections 10(b) and 20(a) of the Exchange Act and Rule 10b-5 promulgated thereunder by the SEC and in addition, the complaint filed in the United States District Court for the Southern District of New York asserted claims under Sections 11 and 15 of the Securities Act. The complaints alleged that the Company made material misstatements or omissions, including in connection with its initial public offering filings and other public filings. The complaints sought unspecified damages on behalf of the individuals or entities that

21


AMERICAN RENAL ASSOCIATES HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)
(Unaudited)
(dollars in thousands, except per share amounts)


purchased or otherwise acquired the Company’s securities from April 20, 2016 to August 18, 2016.  On October 26, 2016, the complaint filed in the Southern District of New York was voluntarily dismissed by the plaintiff without prejudice.  On November 30, 2016, Lead Plaintiff was appointed for the putative shareholder class action complaint pending in the United States District Court for the District of Massachusetts, captioned Esposito, et al. v. American Renal Associates Holdings, Inc., et al., No. 16-cv-11797 (the “Esposito Action”).  On February 1, 2017, Lead Plaintiff in the Esposito Action filed an amended complaint against the Company, certain former and current officers and directors of the Company, Centerbridge Capital Partners L.P., and certain of the underwriters in our initial public offering. The amended complaint asserts federal securities laws claims under Securities Act sections 11 and 15, as well as Exchange Act sections 10(b), 20(a), and SEC Rule 10b-5. The Company's response is currently due in May 2017. The Company intends to vigorously defend itself against these claims. In addition, the Company received a demand letter, dated January 27, 2017, from a purported shareholder relating to the subject matter covered by the United complaint and the class action complaints described above, which could lead to the initiation of a shareholder derivative lawsuit against the Company and its board of directors. By letter dated May 8, 2017, attorneys for the shareholder were informed that the Board of Directors had determined not to pursue potential claims against individuals as set forth in the demand letter.
On January 3, 2017, the Company received a subpoena from the United States Attorney’s Office, District of Massachusetts, requesting information relating to the Company’s payments and other interactions with the AKF and any efforts to educate patients qualified or enrolled in Medicare or Medicaid about enrollment in ACA-compliant individual marketplace plans, among other related matters under applicable healthcare laws for the period from January 1, 2013 through the present. As it has done with the other regulators who have expressed interest in such matters, the Company is cooperating fully with the government. In the event that the United States Attorney’s Office, District of Massachusetts, were to find violations of any federal criminal or civil laws, our business, financial condition and results of operations could be materially adversely affected.

16. CHANGES IN OWNERSHIP INTEREST IN CONSOLIDATED SUBSIDIARIES

The effects of changes in the Company's ownership interest on the Company's equity are as follows:

 
Three Months Ended March 31,
 
 
2017
 
2016
 
Net (loss) income attributable to American Renal Holdings Associates, Inc.
$
(1,251
)
 
$
3,756

 
Increase in paid-in capital for the sales of noncontrolling interest

 

 
Decrease in paid-in capital for the purchase of noncontrolling interest and adjustments to ownership interest
(1,272
)
 

 
Net transfers to noncontrolling interests
(1,272
)
 

 
Net (loss) income attributable to American Renal Holdings Associates, Inc., net of transfers to noncontrolling interests
$
(2,523
)
 
$
3,756

 


22

Table of Contents


 
ITEM 2.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 
 
This discussion contains management’s discussion and analysis of our financial condition and results of operations for the period covered by this Form 10-Q and should be read in conjunction with the unaudited consolidated financial statements and notes thereto included elsewhere in this Form 10-Q and the audited consolidated financial statements and the notes thereto included in the Company’s Form 10-K for the fiscal year ended December 31, 2016.
 
The following discussion contains forward-looking statements that reflect our plans, estimates and beliefs and involve numerous risks and uncertainties. Actual results may differ materially from those contained in any forward-looking statement, due to a number of factors, including those discussed in the section of this Form 10-Q entitled “Special Note Regarding Forward-Looking Statements” and the section entitled "Risk Factors.” in this Form 10-Q and in the Form 10-K.  You should read these sections carefully.
 
Unless otherwise indicated or the context otherwise requires, references in this Form 10-Q  to “we,” “our,” “us”  and the “Company” and similar terms refer to American Renal Associates Holdings, Inc. and its consolidated entities taken together as a whole, except where these terms refer to providers of dialysis services, in which case they refer to our dialysis clinic joint ventures, in which we have a controlling interest and our physician partners have the noncontrolling interest, or to the dialysis facilities owned by such joint venture companies, as applicable. References to “ARA”  refer to American Renal Associates Holdings, Inc. and not any of its consolidated entities. References to “ARH”  refer to American Renal Holdings Inc., an indirect wholly owned subsidiary of Holdings. 

Executive Overview
 
We are the largest dialysis services provider in the United States focused exclusively on joint venture partnerships with physicians. We provide high-quality patient care and clinical outcomes through physicians, known as nephrologists, who specialize in treating patients suffering from end stage renal disease (“ESRD”). Our core values create a culture of clinical autonomy and operational accountability for our physician partners and staff members. We believe our joint venture model has helped us become one of the fastest-growing national dialysis services platforms, in terms of the growth rate of our non-acquired treatments since 2012.
 
We derive our patient service operating revenues from providing outpatient and inpatient dialysis treatments. The sources of these patient service operating revenues are principally government-based programs, including Medicare and Medicaid plans as well as commercial insurance plans. Substantially all of our payors (both government-based and commercial) have moved toward a bundled payment system of reimbursement, with a single lump-sum per treatment covering not only the dialysis treatment itself but also the ancillary items and services provided to a patient during the treatment, such as laboratory services and pharmaceuticals.
 
We operate our clinics exclusively through our JV model, in which we share the ownership and operational responsibility of our dialysis clinics with our nephrologist partners and other joint venture partners, while the providers of the majority of dialysis services in the United States operate through a combination of wholly owned subsidiaries and joint ventures. Each of our clinics is maintained as a separate joint venture in which generally we have the controlling interest and our nephrologist partners and other joint venture partners have a noncontrolling interest. We believe that our exclusive focus on a JV model makes us well-positioned to increase our market share by attracting nephrologists who are not only interested in our service platform but also want greater clinical autonomy and a potential return on capital investment associated with ownership of a noncontrolling interest in a dialysis clinic. We believe our JV model best aligns our interests with those of our nephrologist partners and their patients. By owning a portion of the clinics where their patients are treated, our nephrologist partners have a vested stake in the quality, reputation and performance of the clinics. We believe that this enhances patient and staff satisfaction and retention, clinical outcomes, patient growth, and operational and financial performance.
 
On April 26, 2016, we completed the initial public offering (the “IPO”) of 8,625,000 shares of the common stock, par value $0.01 per share (the “Common Stock”) of the Company, for cash consideration of $22.00 per share ($20.515 per share net of underwriting discounts).





23

Table of Contents

 
Key Factors Affecting Our Results of Operations
 
Clinic Growth and Start-Up Clinic Costs
 
Our results of operations are dependent on increases in the number of, and growth at, our de novo clinics and acquired clinics as well as growth at our existing clinics. We have experienced significant growth since opening our first clinic in December 2000. As of March 31, 2017, we had developed 166 de novo clinics and 51 acquired clinics. The following table shows the number of de novo and acquired clinics over the periods indicated: 
 
 
Three Months Ended March 31,
 
 
2017
 
2016
 
De novo clinics(1)
3

 
2

 
_____________________________
(1)
Clinics formed by us which began to operate and dialyze patients in the applicable period.

We did not acquire any clinics in the three months ended March 31, 2017 and March 31, 2016.

De novo clinics. We have primarily grown through de novo clinic development. A typical de novo facility requires approximately $1.3 to $2.0 million of capital for equipment purchases, leasehold improvements and initial working capital. A portion of the total capital required to develop a de novo clinic may be equity capital funded by us and our nephrologist partners in proportion to our respective ownership interests. The balance of such development cost may be funded through third-party debt financing or through intercompany loans provided by one of our wholly owned subsidiaries to the joint venture entity that, in each case, we and our nephrologist partners generally guarantee on a basis proportionate to our respective ownership interests. For the three months ended March 31, 2017 and March 31, 2016 our development capital expenditures were $4.5 million and $13.5 million, respectively, representing 2.5% and 7.9% of our net patient service operating revenues, respectively.
 
Our results of operations have been and will continue to be materially affected by the timing and number of openings, the timing of certifications of de novo clinic openings and the amount of de novo clinic opening costs incurred. In particular, our patient care costs on an absolute basis and as a percentage of our patient service operating revenues may fluctuate from quarter to quarter due to the timing and number of de novo clinic openings, which affect our operating income in a given quarter. Our patient care costs reflect pre-opening expenses, which primarily consist of staff expenses, including the costs of hiring and training new staff, as well as rent and utilities. In addition, a de novo clinic builds its patient volumes over time and, as a result, generally has lower revenue than our existing clinics. Newly established de novo clinics, although contributing to increased revenues, have adversely affected our results of operations in the short term due to a smaller patient base to absorb operating expenses. We consider a de novo clinic to be a “start-up clinic” until the first month it generates positive clinic-level EBITDA. We typically achieve positive clinic-level monthly EBITDA within, on average, six months after the first treatment at a clinic. However, approximately 19% of our de novo clinics have exceeded six months from first treatment to positive clinic-level monthly EBITDA, with these clinics averaging approximately 12 months to positive clinic-level monthly EBITDA. Clinic-level EBITDA differs from our consolidated EBITDA in that management fees, consisting of a percentage of the clinic’s net revenues paid to ARA for management services, are eliminated in consolidation but are reflected on a clinic-level basis.

Start-up clinic losses affect the comparability of our results from period to period and may disproportionately impact our operating margins in any given quarter, including quarters during which we have a significant number of clinics qualifying as start-up clinics. The following table sets forth the number of de novo clinics opened during the periods indicated.
 
 
Three Months Ended 
 
 
 
March 31,
 
June 30,
 
September 30,
 
December 31,
 
Total
2017
3

 

 

 

 
3

2016
2

 
6

 
5

 
7

 
20

2015
1

 
5

 
6

 
4

 
16

2014
2

 
4

 
3

 
6

 
15

2013
1

 
3

 
2

 
11

 
17

 

24

Table of Contents

Existing clinics. Depending on demand and capacity utilization, we may have space within our existing clinics to accommodate a greater number of dialysis stations or operate additional shifts in order to increase patient volume without compromising our quality standards. Such expansions leverage the fixed cost infrastructure of our existing clinics. From January 1, 2012 to March 31, 2017, we added 155 dialysis stations to our existing clinics, representing the equivalent of nearly eight de novo clinics.
 
Acquired clinics. We have also grown through acquisitions of existing clinics, and our results of operations have been and will continue to be affected by the timing and number of our acquisitions. Our acquisition strategy is primarily driven by the quality of the nephrologist in the market. We opportunistically pursue select acquisitions in situations where we believe the clinic offers us an attractive opportunity to enter a new market or expand within an existing market. Acquiring an existing dialysis clinic requires a greater initial investment, but an acquired clinic contributes positively to our results of operations sooner than a de novo clinic. Acquisition integration costs are typically minimal compared with start-up costs in connection with opening de novo clinics.
 
Our clinic growth drives our treatment growth. The following table summarizes the sources of our treatment growth for the periods indicated:
 
 
Three Months Ended March 31,
 
Source of Treatment Growth:
2017
 
2016
 
Non-acquired treatment growth(1)
9.2
%
 
14.4
%
 
Acquired treatment growth(2)
0.9
%
 
0.5
%
 
Total treatment growth
10.1
%
 
14.9
%
 
_____________________________
(1)
Represents net growth in treatments attributable to clinics operating at the end of the period that were also open at the end of the prior period and de novo clinics opened since the end of the prior period.
(2)
Represents net growth in treatments attributable to clinics acquired since the end of the prior period.

Sources of Revenues by Payor
 
Our patient service operating revenues are principally driven by our mix of commercial and government payor patients and commercial and government payment rates. We are generally paid more for services provided to patients covered by commercial healthcare plans than we are for patients covered by Medicare or Medicaid. ESRD patients covered by employer group health plans generally transition to Medicare coverage after a maximum of 33 months. Medicare payment rates are determined under the Medicare ESRD program's bundled payment system, which sets a base rate on an annual basis that is subject to adjustments to arrive at the actual payment rate for individual clinics. During the years ending December 31, 2014, 2015 and 2016, the Medicare ESRD PPS payment rates for our clinics were approximately $248, $247 and $247, respectively, per treatment. The Centers for Medicare and Medicaid Services (“CMS”) issues annual updates to the ESRD PPS, which may impact the base rate as well as the various adjusters. The ESRD PPS final rule for 2017 was released on October 28, 2016 by CMS (the “2017 Final Rule”). The 2017 Final Rule includes a base rate of $231.55, representing a $1.16 increase from the 2016 base rate of $230.39. CMS has estimated that the 2017 Final Rule will result in an overall increase of payments to ESRD facilities of 0.7%.
 
Medicare payment rates are generally insufficient to cover our total operating expenses allocable to providing dialysis treatments for Medicare patients. As a result, our ability to generate operating income is substantially dependent on revenues derived from commercial payors, which typically pay us either negotiated payment rates or a discount to our usual and customary fee schedule. Many commercial insurance programs have been moving towards a bundled payment system, which may not reimburse us for all of our operating costs, such as the cost of ESA’s and other pharmaceuticals.
 
The following table summarizes our patient service operating revenues by source for the periods indicated.
 

25

Table of Contents

 
Three Months Ended March 31,
 
Source of Revenues:
2017
 
2016
 
Government-based and other(1)
63.9
%
 
57.5
%
 
Commercial and other(2)
36.1
%
 
42.5
%
 
 
100.0
%
 
100.0
%
 
_____________________________
(1)
Principally Medicare and Medicaid and also includes hospitals and patient pay which we refer to collectively as “Government and other”.  “Patient pay” revenues consist of payments received directly from patients who are either uninsured or self-pay a portion of the bill.
(2)
Principally commercial insurance companies and also includes the Department of Veterans Affairs, which we refer to collectively as “Commercial and other”.

The percentage of treatments by payor source does not necessarily correlate with our results of operations or margins in any given period because of a number of other factors, including the effect of the difference in rates per treatment associated with each commercial payor .  For the three years and one year ended December 31, 2016, commercial payors and others, including the Department of Veterans Affairs (the “VA”), accounted for an average of approximately 14.6% and 16.8% of the treatments we performed, respectively. The change in the mix of patients and treatments between the three-year average and the year ended December 31, 2016 was largely driven by enrollment in Affordable Care Act (“ACA”) plans (both on-exchange and off-exchange). For the year ended December 31, 2016, we derived approximately 9% of patient service operating revenues from ACA-compliant individual marketplace plans (“ACA plans”), both on-exchange and off-exchange, and these ACA plans were the source of reimbursement for approximately 4% of the treatments performed during the year ended December 31, 2016. During the three months ended March 31, 2017, we have experienced an adverse change in the commercial treatment mix as compared to the year ended December 31, 2016, due primarily to a decline in ACA plans, as discussed below. For the three months ended March 31, 2017, the percentage of treatments accounted for by commercial payors and others, including the VA, was below the average for the three years ended December 31, 2016, and we expect it to remain lower than in recent periods.
 
Effective in November 2016, for patients enrolled in minimum essential Medicaid coverage, we suspended assistance in the application process for charitable premium support from the American Kidney Fund ("AKF"), which caused an adverse change in the mix of patients and treatments in 2017. This change has not affected our provision of such assistance in the application process to other patients.  Prior to the 2017 ACA open enrollment period, approximately 2% of our total patients chose to enhance their pre-existing minimum essential Medicaid coverage by electing to enroll in an ACA plan. Before we suspended assistance in the application process for charitable premium support from the AKF, this percentage had been growing. Virtually all of these low-income patients have relied on charitable premium assistance because they were ineligible for federal premium tax credits. Due to the suspension of assistance in the application process for charitable premium support from the AKF, virtually all of our  patients with ACA primary insurance coverage and secondary minimum essential Medicaid coverage reverted back to Medicaid-only coverage during 2017.
 
In addition, prior to the 2017 ACA open enrollment period, approximately 2% of our total patients were enrolled in an ACA plan and not enrolled in the Medicaid program. Approximately 85% of these patients relied on charitable premium assistance. These patients chose ACA plans for a variety of reasons, including ineligibility for government programs, the shift of coverage options from the individual and/or small group markets to ACA exchanges, lack of requisite work credits to be eligible for Medicare coverage, the opportunity to consolidate family coverage under one insurance plan and the lack of Medigap policy coverage due to certain state insurance department restrictions, among other reasons. These patients enrolled in ACA plans and not enrolled in the Medicaid program have experienced insurance coverage disruptions due to payors disallowing charitable premium assistance, the lack of availability of viable ACA insurance products in some markets, and a more uncertain regulatory environment.  The average revenue per treatment for ACA plans is below that of our overall average commercial revenue per treatment but above our Medicare rate. 
In 2016, following an internal review, in addition to the suspension described above, the Company adopted policies and procedures to ensure that its patient insurance education program meets robust certification standards to provide broad-based information to patients about their insurance options, so that the patients are in the best possible position to choose coverage based on their own best interests.  Under this program, the Company informs patients, when appropriate, about insurance plans available under the ACA and other individual marketplace plans as alternatives or supplements to coverage under Medicare or Medicaid. The Company will continue to advise its patients about the potential availability of assistance with the payment of premiums from the AKF under the AKF Health Insurance Premium Program (“HIPP”), subject to the

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suspension described above, and compliance with the AKF’s policies and procedures and approved regulatory guidance from CMS.
In addition, recently there have been other significant developments in the market that may affect our business, including the withdrawal of some insurers from offering ACA and individual marketplace plans in certain states, increases in premiums for ACA plans, and continuing efforts on the part of insurers to reduce the amount paid to providers per treatment.  Further, there could be additional changes in our business in the future resulting from potential regulatory actions and other third party practices following the recent CMS request for information seeking public comment on concerns relating to steering of patients eligible for Medicare and Medicaid into ACA plans, and the recent changes to the AKF HIPP program announced by AKF. 
The suspension has adversely impacted, and any CMS action relating to establishing policies to restrict or limit charitable assistance for ACA plans or other individual marketplace plans, will adversely impact the number of patients covered by ACA plans and other individual marketplace plans, the Company’s average reimbursement rate and its results of operations and cash flows, which impact may be material.  Further, the other changes to the Company’s patient insurance education program, whether or not the suspension continues or CMS restricts charitable premium assistance, together with the other developments in the market, including the impact of such changes on enrollment in ACA plans and other individual marketplace plans, other insurance coverage, and/or potential regulatory changes in the future, have and are expected to continue to adversely impact the number of the Company’s patients covered by insurance, as well as the Company’s average reimbursement rate in the future.
As previously disclosed, the total estimated annual financial impact associated with a more restrictive environment for patients previously enrolled in ACA plans who also relied on charitable premium assistance is expected to be $25 million in 2017. In arriving at this estimate, we included the anticipated effect on our results of operations of the decline in our patient service operating revenues due to patients who reverted to Medicaid-only coverage during the three months ended March 31, 2017, as well as the anticipated effect of a decline in patient service operation revenues from patients who were not enrolled in Medicaid but who received lower or no charitable premium assistance during the three months ended March 31, 2017. This estimate is based on our patient population enrolled in ACA plans and other factors as of December 31, 2016 and takes our weighted average dialysis facility ownership into account. Based on management’s expectations, we believe the full financial impact is likely to be realized during 2017 and will, accordingly, adversely affect our results of operations for this period.
Subsequent to December 31, 2016, the Company received letters from certain insurance companies indicating that they will not insure patients who receive premium payment assistance from third-party charitable organizations.  In addition to charitable premium support for patients enrolled in ACA plans, the AKF provides charitable premium support to patients with other insurance coverage, including Medicare supplemental insurance and commercial insurance.  If patients are unable to obtain or to continue to receive AKF charitable premium support due to insurance company challenges to covering patients receiving charitable premium support, legislative changes, rules or interpretations issued by HHS limiting such support or other reasons, the financial impact on our company could be substantially greater than the estimated annual financial impact described above relating to patients previously enrolled in ACA plans and, accordingly, could materially and adversely affect our results of operations. See the Company's Form 10-K for the year ended December 31, 2016, “Item 1A. Risk Factors-Risks Related to Our Business-If the number of patients with commercial insurance declines, our operating results and cash flows would be adversely affected” and “-Increased government scrutiny in our industry and potential regulatory changes could adversely affect our operating results and financial condition.”
We believe that 2017 will continue to be challenging due to the uncertainty around the ACA and the ability of our patients overall to access charitable premium assistance from non-profit organizations such as the American Kidney Fund. We also believe that pressure on commercial mix and commercial rates due to more restrictive health plan benefit design will continue to create additional challenges. In addition, the 2016 Presidential and Congressional elections have caused the future state of the exchanges and other ACA reforms to be less certain.  We are unable to predict the full effect of the foregoing factors on our business, results of operations and cash flows.
Clinical Staff, Pharmaceutical and Medical Supply Costs
 
Because our ability to influence the pricing of our services is limited, our profitability depends not only on our ability to grow but also on our ability to manage patient care costs, including clinical staff, pharmaceutical and medical supply costs. The principal drivers of our patient care costs are clinical staff hours per treatment, salary rates and vendor pricing and utilization of pharmaceuticals, including ESA’s, principally Aranesp and EPO, and medical supplies. The Company has entered into a rebate agreement with Amgen for ESAs which limits the supplier’s ability to increase the net price it charges the Company for these drugs through December 31, 2018. In the future any increase in price of Aranesp or EPO could adversely affect our operating results and financial condition. We may not have access to certain other ESAs that may be more cost-

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effective and due to product delays and availability, we expect our clinics will predominantly be using Aranesp or EPO in the foreseeable future.  Furthermore, even if we do have access to other sources of ESAs, we cannot assure you that these alternatives would be cost-effective for us or work as effectively as Aranesp or EPO. Increased utilization of Aranesp or EPO for patients for whom the cost of ESAs is included in a bundled reimbursement rate, including Medicare patients, could increase our operating costs without any increase in revenue. In addition, shortage of supplies could have a negative impact on our revenues, earnings and cash flows. Other cost categories, such as employee benefit costs and insurance costs, can also result in significant cost changes from period to period. Our results of operations are also affected by the start-up clinic costs described above.
 
Seasonality
 
Our treatment volumes are sensitive to seasonal fluctuations due to generally fewer treatment days during the first quarter of the calendar year. Additionally, our patients are generally responsible for a greater percentage of the cost of their treatments during the early months of the year, due to co-insurance, co-payments and deductibles, which does lead to lower total net revenues and lower net revenues per treatment during the early months of the year. Our quarterly operating results may fluctuate significantly in the future depending on these and other factors.

Impact of the IPO and Future Charges
 
The completion of the IPO has had effects on our results of operations and financial conditions. In connection with the IPO, our results of operations are affected by one-time costs and recurring costs of being a public company, including increases in executive and board compensation (including equity based compensation), increased insurance, accounting, legal and investor relations costs and the costs of compliance with the Sarbanes-Oxley Act of 2002 and the costs of complying with the other rules and regulations of the SEC and the New York Stock Exchange. In addition, when the available exemptions under the Jumpstart Our Business Startups Act cease to apply, we expect to incur additional expenses and devote increased management effort toward ensuring compliance with the applicable regulatory and corporate governance requirements. In addition, we have incurred and expect to incur additional legal expenses in connection with various legal and regulatory matters described below and related matters.  See “—Operating Expenses—Certain Legal Matters” and “Part II. Item 1.  Legal Proceedings.”
 
As a result of certain modifications made to our outstanding market and performance-based stock options at the time of the IPO, the amount of the unrecognized non-cash compensation costs increased by approximately $38.9 million. As of March 31, 2017, we had approximately $12.3 million of unrecognized compensation costs related to unvested share-based compensation arrangements of which $3.5 million is attributable to share-based awards with market and performance conditions and $8.8 million is attributable to share-based awards with performance or time-based vesting. The compensation costs associated with time-based vesting awards are expected to be recognized as expense over a weighted average period of approximately two years. The compensation costs associated with the market and performance based option modification at the time of the IPO (the “Modification Expense”) will be recognized over a period of approximately 12 months from the date of the IPO.
 
In addition, in connection with the distribution (the “Term Loan Holdings Distributions”) of membership interests in an entity holding assigned clinic loans (the “Assigned Clinic Loans”), described in “Note 2—Initial Public Offering” of the notes to the consolidated financial statements, since the interest on these loans is no longer be eliminated in consolidation, we now incur additional interest expense.
 
On April 26, 2016, we entered into an income tax receivable agreement (the “TRA”) for the benefit of our pre-IPO stockholders, which provides for the payment by us to our pre-IPO stockholders on a pro rata basis of 85% of the amount of cash savings, if any, in U.S. federal, state and local income tax that we actually realize as a result of the option deductions (as defined in the TRA). While the actual amount and timing of any payments under the TRA will vary depending upon a number of factors, including the amount and timing of the taxable income we generate in the future and whether and when any relevant stock options, as defined in the TRA, are exercised and the value of our common stock at such time, we expect that during the term of the TRA the payments that we make will be material. We recorded a liability for the value of the TRA at the time of the IPO. We calculated fair value of the TRA by using a Monte Carlo simulation-based approach that relies on significant assumptions about our stock price, stock volatility and risk-free rate as well as the timing and amounts of options exercised. Changes in assumptions based on future events, including changes in the price of our common stock from our IPO price, will change the amount of the liability for the TRA, and such changes may be material. Any changes to the TRA liability will be recognized in our statement of operations as Income tax receivable agreement income (expense) in future periods. See “Note 5—Fair Value Measurements” of the notes to the consolidated financial statements.
 


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FTC Decision and Order
 
We are subject to a Decision and Order entered In the Matter of American Renal Associates Inc. and Fresenius Medical Care Holdings, Inc. by the Federal Trade Commission. The Decision and Order was entered in 2007 following a nonpublic investigation by the Federal Trade Commission into proposed dialysis clinic acquisition activities in Rhode Island and the execution of an Agreement Containing Consent Order by the parties. The Decision and Order prohibits us for a period of ten years through October 17, 2017, without prior notice to the Federal Trade Commission from: (1) acquiring dialysis clinics located in ZIP codes in and around the cities of Cranston and Warwick, Rhode Island, and/or (2) entering into any contract to manage or operate dialysis clinics in ZIP codes in and around the cities of Cranston and Warwick. These prohibitions are subject to a number of exceptions that permit us to develop, own, manage or operate de novo dialysis clinics or dialysis clinics owned or operated as of the date the Decision and Order was entered, or to perform specified services, including offsite laboratory services, bookkeeping services, accounting services, billing services, supply services and purchasing and logistics services with the adherence to confidentiality requirements. We have complied and intend to continue to comply with the terms of the Decision and Order and on September 19, 2016 we submitted an annual compliance report to the Federal Trade Commission. We do not believe that compliance with the Decision and Order will have a material impact on our revenues, earnings or cash flows.

Key Performance Indicators
 
We use a variety of financial and other information to evaluate our financial condition and operating performance. Some of this information is financial information that is prepared in accordance with GAAP, while other financial information, such as Adjusted EBITDA and Adjusted EBITDA-NCI, is not prepared in accordance with GAAP. The following table presents certain operating data, which we monitor as key performance indicators, for the periods indicated.
 
Three Months Ended March 31,
 
Operating Data and Other Non-GAAP Financial Data:
2017
 
2016
 
Number of clinics (as of end of period)
217

 
194

 
Number of de novo clinics opened (during period)
3

 
2

 
Patients (as of end of period)
14,735

 
13,420

 
Number of treatments
531,220

 
482,666

 
Non-acquired treatment growth
9.2
%
 
14.4
%
 
Patient service operating revenues per treatment
$
336

 
$
360

 
Patient care costs per treatment
$
226

 
$
218

 
Adjusted patient care costs per treatment (1)
$
223

 
$
218

 
General and administrative expenses per treatment
$
59

 
$
45

 
Adjusted general and administrative expenses per treatment (2)
$
45

 
$
45

 
Provision for uncollectible accounts per treatment
$
3

 
$
3

 
Adjusted EBITDA (including noncontrolling interests) (3)
$
35,568

 
$
46,020

 
Adjusted EBITDA-NCI (3)
$
21,415

 
$
27,219

 
_____________________________
(1)
Excludes $1.7 million of Modification Expense during the three months ended March 31, 2017.
(2)
Excludes $7.4 million of Modification Expense during the three months ended March 31, 2017.
(3)
See “Non-GAAP Financial Measures” below.

Number of Clinics
 
We track our number of clinics as an indicator of growth. The number of clinics as of the end of the period includes all opened de novo clinics, acquired clinics and existing clinics. See “—Key Factors Affecting Our Results of Operations—Clinic Growth and Start-Up Clinic Costs” for a discussion of clinic growth and start-up costs as a factor affecting our operating performance.
 




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Patient Volume
 
The number of patients as of the end of the period is an indicator we use to assess our performance. Our patient volumes are correlated with our de novo clinic openings and, to a lesser extent, our marketing efforts and certain external factors, such as the overall economic environment. We believe that patients choose to get their dialysis services at one of our clinics due to their relationship with our physicians, as well as the quality of care, comfort and amenities and convenience of location and clinic hours.

Non-Acquired Treatments
 
We evaluate our operating performance based on the growth in number of non-acquired treatments, or treatments performed at our existing and de novo clinics, including those de novo clinics opened during the applicable period. Accordingly, our non-acquired treatment growth rate is affected by the timing and number of de novo clinic openings. We calculate non-acquired treatment growth by dividing the number of treatments performed during the applicable period by the number of treatments performed during the corresponding prior period, excluding the number of treatments performed at clinics acquired during the applicable period, and expressing the resulting number as a percentage.
 
Per Treatment Metrics
 
We evaluate our patient service operating revenues, patient care costs, general and administrative expenses and provision for uncollectible accounts on a per treatment basis to assess our operational efficiency. We believe our disciplined revenue cycle management has contributed to the consistency of our historical results.

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Non-GAAP Financial Measures
 
This quarterly report on Form 10-Q makes reference to certain Non-GAAP measures.  These non-GAAP measures are not recognized measures under U.S. GAAP and do not have a standardized meaning prescribed by U.S. GAAP. When used, these measures are defined in such terms as to allow the reconciliation to the closest U.S. GAAP measure. These measures are therefore unlikely to be comparable to similar measures presented by other companies. Rather, these measures are provided as additional information to complement those U.S. GAAP measures by providing further understanding of the Company’s results of operations from management’s perspective. Accordingly, they should not be considered in isolation nor as a substitute for analysis of the Company’s financial information reported under U.S. GAAP. We use non-GAAP measures, such as Adjusted EBITDA and Adjusted EBITDA-NCI, to provide investors with a supplemental measure of our operating performance and thus highlight trends in our core business that may not otherwise be apparent when relying solely on U.S. GAAP financial measures.
 
Adjusted EBITDA
 
We use Adjusted EBITDA and Adjusted EBITDA-NCI to track our performance. “Adjusted EBITDA” is defined as net income before income taxes, interest expense, net, depreciation and amortization, as adjusted for stock-based compensation, loss on early extinguishment of debt, transaction-related costs, certain legal matters costs, executive severance costs, income tax receivable agreement income and expense and management fees. “Adjusted EBITDA-NCI” is defined as Adjusted EBITDA less net income attributable to noncontrolling interests. We believe Adjusted EBITDA and Adjusted EBITDA-NCI provide information useful for evaluating our business and understanding our operating performance in a manner similar to management. We believe Adjusted EBITDA is helpful in highlighting trends because Adjusted EBITDA excludes the results of actions that are outside the operational control of management, but can differ significantly from company to company depending on long-term strategic decisions regarding capital structure, the tax jurisdictions in which companies operate and capital investments. We believe Adjusted EBITDA-NCI is helpful in highlighting the amount of Adjusted EBITDA that is available to us after reflecting the interests of our joint venture partners. Adjusted EBITDA and Adjusted EBITDA-NCI are not measures of operating performance computed in accordance with GAAP and should not be considered as a substitute for operating income, net income, cash flows from operations, or other statement of operations or cash flow data prepared in conformity with GAAP, or as measures of profitability or liquidity. In addition, Adjusted EBITDA and Adjusted EBITDA-NCI may not be comparable to similarly titled measures of other companies. Adjusted EBITDA and Adjusted EBITDA-NCI may not be indicative of historical operating results, and we do not mean for these items to be predictive of future results of operations or cash flows. Adjusted EBITDA and Adjusted EBITDA-NCI have limitations as analytical tools, and you should not consider these items in isolation, or as substitutes for an analysis of our results as reported under GAAP. Some of these limitations are that Adjusted EBITDA and Adjusted EBITDA-NCI:

do not include stock-based compensation expense;
do not include transaction-related costs; 
do not include depreciation and amortization—because construction and operation of our dialysis clinics requires significant capital expenditures, depreciation and amortization are a necessary element of our costs and ability to generate profits;
do not include interest expense—as we have borrowed money for general corporate purposes, interest expense is a necessary element of our costs and ability to generate profits and cash flows; 
do not include income tax receivable agreement income and expense;
do not include loss on early extinguishment of debt;
do not include costs related to certain legal matters;
beginning with the quarter ended December 31, 2016, do not include executive severance costs;
do not include management fees;
do not include certain income tax payments that represent a reduction in cash available to us; and
do not reflect changes in, or cash requirements for, our working capital needs.
 

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You should not consider Adjusted EBITDA and Adjusted EBITDA-NCI as alternatives to income from operations or net income, determined in accordance with GAAP, as an indicator of our operating performance, or as alternatives to cash flows from operating activities, determined in accordance with GAAP, as an indicator of cash flows or as a measure of liquidity. This presentation of Adjusted EBITDA and Adjusted EBITDA-NCI may not be directly comparable to similarly titled measures of other companies, since not all companies use identical calculations.

The following table presents Adjusted EBITDA and Adjusted EBITDA-NCI for the periods indicated and the reconciliation from net income to such amounts: 
 
Three Months Ended March 31,
 
(in thousands)
2017
 
2016
 
Net Income
$
12,902

 
$
22,557

 
Add:
 
 
 
 
Stock-based compensation
10,088

 
386

 
Depreciation and amortization
9,074

 
7,677

 
Interest expense, net
7,609

 
12,258

 
Income tax (benefit) expense
(3,524
)
 
2,661

 
Transaction-related costs (a)

 
24

 
Income tax receivable agreement income (b)
(4,517
)
 

 
Certain legal matters (c)
3,936

 

 
Management fees (d)

 
457

 
Adjusted EBITDA (including noncontrolling interests)
35,568

 
46,020

 
Less: Net income attributable to noncontrolling interests
(14,153
)
 
(18,801
)
 
Adjusted EBITDA –NCI
$
21,415

 
$
27,219

 
_____________________________
(a)
Represents costs related to debt refinancing and other transactions. See “Note 2—Initial Public Offering” of the notes to the consolidated financial statements.
(b)
Represents income associated with the change in fair value of the TRA liability. See “—Components of Earnings—Interest, and Taxes” and  “Note 5—Fair Value Measurements” of the notes to the consolidated financial statements.
(c)
Represents costs related to the specific legal and regulatory matters described in “Part II. Item 1. Legal Proceedings” and “Note 15—Certain Legal Matters” of the notes to the consolidated financial statements.
(d)
Represents management fees paid to Centerbridge prior to the termination of our Advisory Services Agreement in connection with our IPO. See “Note 13—Related Party Transactions” of the notes to the consolidated financial statements.

Components of Earnings
 
Net Patient Service Operating Revenues

Patient service operating revenues. The major component of our revenues, which we refer to as patient service operating revenues, is derived from dialysis services. Our patient service operating revenues primarily consist of reimbursement from government-based programs and other (Medicare, Medicaid, state workers’ compensation programs and hospitals) and commercial insurance payors and other (including the VA) for dialysis treatments and related services at our clinics. Patient service operating revenues are recognized as services are provided to patients. We maintain a usual and customary fee schedule for dialysis treatment and other patient services; however, actual collectible revenues are normally at a discount to the fee schedule. Medicare and Medicaid programs are billed at predetermined net realizable rates per treatment that are established by statute or regulation. Revenue for contracted payors is recorded at contracted rates and other payors are billed at usual and customary rates, and a contractual allowance is recorded to reflect the expected net realizable revenue for services provided.

Provision for uncollectible accounts. Patient service operating revenues are reduced by the provision for uncollectible revenues to arrive at net patient service operating revenues. Provision for uncollectible accounts represents reserves established for amounts for which patients are primarily responsible that we believe will not be collectible.

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Contractual allowances, along with provisions for uncollectible amounts, are estimated based upon contractual terms, regulatory compliance and historical collection experience. Net revenue recognition and allowances for uncollectible billings require the use of estimates of the amounts that will actually be realized. Changes in estimates are reflected in the then-current financial statements based on on-going actual experience trends, or subsequent settlements and realizations depending on the nature and predictability of the estimates and contingencies.
 
Operating Expenses
 
Patient care costs. Patient care costs are those costs directly associated with operating and supporting our dialysis clinics. Patient care costs consist principally of salaries, wages and benefits, pharmaceuticals, medical supplies, facility costs and laboratory testing. Salaries, wages and benefits consist of compensation and benefits to staff at our clinics, including stock-based compensation expense. Salaries, wages and benefits also include certain labor costs associated with de novo clinic openings. Facility costs consist of rent and utilities and also include rent in connection with de novo clinic openings. Patient care costs also include medical director fees and insurance costs.
 
General and administrative expenses. General and administrative expenses generally consist of compensation and benefits to personnel at our corporate office for clinic and corporate administration, including accounting, billing and cash collection functions, as well as regulatory compliance and legal oversight; charitable contributions; and professional fees. General and administrative expenses also include stock-based compensation expense in connection with stock awards to our corporate officers and employees.
 
Transaction-related costs. Transaction-related costs represent costs associated with our debt refinancing and other IPO related transactions.  These costs include legal, accounting, valuation and other professional or consulting fees.
 
Depreciation and amortization. Depreciation and amortization expense is primarily attributable to our clinics’ equipment and leasehold improvements and amortizing intangible assets. We calculate depreciation and amortization expense using a straight-line method over the assets’ estimated useful lives.
 
Certain legal matters.  Certain legal matters cost includes professional fees and other expenses associated with our handling of, and response to, the UnitedHealth Group litigation, the SEC inquiry, the CMS request for information, the securities litigation, the subpoena from the United States Attorney's Office, District of Massachusetts, and our internal review and analysis of factual and legal issues relating to the aforementioned matters.
See Part II, Item 1 – “Legal Proceedings.”
 
Operating Income
 
Operating income is equal to our net patient service operating revenues minus our operating expenses. Our operating income is impacted by the factors described above and reflects the effects of losses relating to our start up clinics.

Interest and Taxes
 
Interest expense, net. Interest expense represents charges for interest associated with our corporate level debt and credit facilities entered into by our dialysis clinics.
 
Income tax receivable agreement income/expense. Income tax receivable agreement income/expense is the income/expense associated with the change in the fair value of the TRA from the prior quarter end.
 
Income tax expense (benefit). Income tax expense relates to our share of pre-tax income from our wholly owned subsidiaries and joint ventures as these entities are pass-through entities for tax purposes. We are not taxed on the share of pre-tax income attributable to noncontrolling interests, and net income attributable to noncontrolling interests in our financial statements has not been presented net of income taxes attributable to these noncontrolling interests.
 
Net Income Attributable to Noncontrolling Interests
 
Noncontrolling interests represent the equity interests in our consolidated entities that we do not wholly own, which is primarily the equity interests of our nephrologist partners in our JV clinics. Our financial statements reflect 100% of the revenues and expenses for our joint ventures (after elimination of intercompany transactions and accounts) and 100% of the assets and liabilities of these joint ventures (after elimination of intercompany assets and liabilities), although we do not own

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100% of the equity interests in these consolidated entities.  Our net income attributable to noncontrolling interests may fluctuate in future periods depending on the purchases or sales by us of non-controlling interests in our clinics from our nephrologist partners, including pursuant to put obligations as described below under “– Liquidity and Capital Resources – Put Obligations”. The net income attributable to owners of our consolidated entities, other than us, is classified within the line item Net income attributable to noncontrolling interests. See also “—Critical Accounting Policies and Estimates—Noncontrolling Interests” and Note 8. “Noncontrolling Interests Subject to Put Provisions”.

Results of Operations
 
Three Months Ended March 31, 2017 Compared With Three Months Ended March 31, 2016
 
The following table summarizes our results of operations for the periods indicated.
 
 
Three Months Ended March 31,
 
Increase (Decrease)
 
 
 
 
 
 
 
Percentage
 
2017
 
2016
 
Amount
 
Change
Patient service operating revenues
$
178,632

 
$
173,554

 
$
5,078

 
2.9
 %
Provision for uncollectible accounts
(1,607
)
 
(1,423
)
 
(184
)
 
12.9
 %
Net patient service operating revenues
177,025

 
172,131

 
4,894

 
2.8
 %
Operating expenses:
 

 
 

 
 
 
 
Patient care costs
120,301

 
105,455

 
14,846

 
14.1
 %
General and administrative
31,244

 
21,499

 
9,745

 
45.3
 %
Transaction-related costs

 
24

 
(24
)
 
NM

Depreciation and amortization
9,074

 
7,677

 
1,397

 
18.2
 %
Certain legal matters
3,936

 

 
3,936

 
NM

Total operating expenses
164,555

 
134,655

 
29,900

 
22.2
 %
Operating income
12,470

 
37,476

 
(25,006
)
 
(66.7
)%
Interest expense, net
(7,609
)
 
(12,258
)
 
4,649

 
(37.9
)%
Income tax receivable agreement income
4,517

 

 
4,517

 
NM

Income before income taxes
9,378

 
25,218

 
(15,840
)
 
(62.8
)%
Income tax (benefit) expense
(3,524
)
 
2,661

 
(6,185
)
 
NM

Net income
12,902

 
22,557

 
(9,655
)
 
(42.8
)%
Less: Net income attributable to noncontrolling interests
(14,153
)
 
(18,801
)
 
4,648

 
(24.7
)%
Net (loss) income attributable to American Renal Associates Holdings, Inc.
$
(1,251
)
 
$
3,756

 
$
(5,007
)
 
NM

___________________
NM – Not Meaningful

Net Patient Service Operating Revenues
 
Patient service operating revenues. Patient service operating revenues for the three months ended March 31, 2017 were $178.6 million, an increase of 2.9% from $173.6 million for the three months ended March 31, 2016. The increase in patient service operating revenues was primarily due to an increase of approximately 10.1% in the number of dialysis treatments. The increase in treatments resulted principally from non-acquired treatment growth of 9.2% from existing clinics and de novo clinics. Patient service operating revenues relating to start-up clinics for the three months ended March 31, 2017 were $4.6 million compared to $1.8 million for the three months ended March 31, 2016, an increase of $2.8 million due to the timing of opening and certification of de novo clinics, as described under “ – Key Factors Affecting our Results of Operations – Clinic Growth and Start-Up Clinic Costs”. Patient service operating revenues per treatment for the three months ended March 31, 2017 was $336 compared with $360 for the three months ended March 31, 2016, a decrease of 6.7%, driven by changes in commercial and other mix, primarily related to a decrease in patients covered by ACA and other individual marketplace plans, and due to the timing of opening and certification of de novo clinics, as described under “ – Key Factors Affecting our Results

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of Operations – Sources of Revenues by Payor”. As a source of revenue by payor type, government-based and other payors accounted for 63.9% and 57.5%, respectively, of our revenues for the three months ended March 31, 2017 and 2016
 
Provision for uncollectible accounts. Provision for uncollectible accounts for the three months ended March 31, 2017 was $1.6 million, or 0.9% of net patient service operating revenues, as compared to $1.4 million, or 0.8% of net patient service operating revenues, for the same period in 2016. Our accounts receivable, net of the bad debt allowance, represented approximately 39 and 40 days of patient service operating revenues as of March 31, 2017 and 2016, respectively.
 
Operating Expenses  
 
Patient care costs. Patient care costs for the three months ended March 31, 2017 were $120.3 million, an increase of 14.1% from $105.5 million for the three months ended March 31, 2016. This increase was primarily due to an increase in the number of treatments as well as $1.7 million of Modification Expense described above. As a percentage of net patient service operating revenues, patient care costs were approximately 68.0% (or 67.0% excluding the Modification Expense) for the three months ended March 31, 2017 compared to 61.3% for the three months ended March 31, 2016. Excluding the Modification Expense, the change was primarily attributable to lower revenues per treatment described above and by increases in start-up clinic expenses related to our de novo development program, including expenses incurred due to delays in certifications. Patient care costs per treatment for the three months ended March 31, 2017 were $226, compared to $218 for the three months ended March 31, 2016.  Patient care costs per treatment excluding the Modification Expense were $223 for the three months ended March 31, 2017.
 
General and administrative expenses. General and administrative expenses for the three months ended March 31, 2017 were $31.2 million, an increase of 45.3% from $21.5 million for the three months ended March 31, 2016, primarily due to corporate costs associated with becoming a public company, including $7.4 million of Modification Expense described above, an increase in the number of treatments and increased legal costs in addition to the legal costs relating to Certain Legal Matters described below. As a percentage of net patient service operating revenues, general and administrative expenses were approximately 17.6% (or 13.5% excluding the Modification Expense) for the three months ended March 31, 2017 compared to 12.5% for the three months ended March 31, 2016. General and administrative expenses per treatment for the three months ended March 31, 2017 were $59, compared to $45 for the three months ended March 31, 2016.  General and administrative expenses per treatment excluding the Modification Expense were $43 for the three months ended March 31, 2017
 
Transaction-related costs. There were no transaction-related costs for the three months ended March 31, 2017. Transaction-related costs for the three months ended March 31, 2016 were costs associated with our IPO.

Depreciation and amortization. Depreciation and amortization expense for the three months ended March 31, 2017 was $9.1 million, compared to $7.7 million for the three months ended March 31, 2016. As a percentage of net patient service operating revenues, depreciation and amortization expense was approximately 5.1% for the three months ended March 31, 2017 compared to 4.5% for the three months ended March 31, 2016.
 
Certain Legal Matters. Certain legal matter costs for the three months ended March 31, 2017 was $3.9 million. See Part II, Item 1 – “Legal Proceedings.”
 
Operating Income
 
Operating income for the three months ended March 31, 2017 was $12.5 million, a decrease of $25.0 million, or 66.7%, from $37.5 million for the three months ended March 31, 2016. The decrease was primarily due to the factors described above under "Operating Expenses", and includes the impact of the rebasing reimbursement environment for Medicare, in which Medicare rate updates are not keeping pace with annual increases to our operating costs. In addition, for the three months ended March 31, 2017 and 2016, start-up clinics reduced operating income by $2.9 million and $2.3 million, respectively, an increase of $0.6 million reflecting the timing of opening and certification of de novo clinics each year as described under “– Key Factors Affecting our Results of Operations – Clinic Growth and Start-Up Clinic Costs”. As a percentage of net patient service operating revenues, operating income was 7.0% for the three months ended March 31, 2017 compared to 21.8% for the three months ended March 31, 2016, reflecting the factors described above. Excluding the impact of the Modification Expense of $9.1 million, as a percentage of net patient service operating revenues, operating income was 12.2% for the three months ended March 31, 2017.



 

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Interest and Taxes
 
Interest expense, net. Interest expense, net for the three months ended March 31, 2017 was $7.6 million, and for the three months ended March 31, 2016 was $12.3 million, a decrease of 37.9% primarily due to our debt refinancing in April 2016, offset by an increase in third party clinic debt, including the Assigned Clinic Loans.

Income tax receivable agreement income. Income tax receivable agreement income for the three months ended March 31, 2017 was $4.5 million.  This income represents the change in the estimated fair value of the TRA liability during the period. 
 
Income tax expense (benefit)  The provision (benefit) for income taxes for the three months ended March 31, 2017 and March 31, 2016 represented an effective tax rate of (37.6%) and 10.6%, respectively. The variation from the statutory federal rate of 35% on our share of pre-tax income during the three months ended March 31, 2017 and 2016 is primarily due to the tax impact of the noncontrolling interest in the clinics as a result of our joint venture model and the change in fair value of the TRA liability, which is not deductible for income tax purposes. 
 
Net Income Attributable to Noncontrolling Interests
 
Net income attributable to noncontrolling interests for the three months ended March 31, 2017 was $14.2 million, representing a decrease of 24.7% from $18.8 million for the three months ended March 31, 2016. The decrease was primarily due to reduced profitability in our joint ventures due to the factors described above.

Liquidity and Capital Resources

Our primary sources of liquidity are funds generated from our operations, short-term borrowings under our revolving credit facility and borrowings of long-term debt. Our principal needs for liquidity are to pay our operating expenses, to fund the development and acquisition of new clinics, to fund capital expenditures, to service our debt and may in the future be to fund purchases of put rights held by our physician partners. In addition, a significant portion of our cash flows is used to make distributions to the noncontrolling equity interests held by our nephrologist partners in our joint venture clinics. Except as otherwise indicated, the following discussion of our liquidity and capital resources presents information on a consolidated basis, without adjusting for the effect of noncontrolling interests.
 
We believe our cash flows from operations, combined with availability under our revolving credit facility, provide sufficient liquidity to fund our current obligations, projected working capital requirements and capital spending for a period that includes the next 12 months. If existing cash and cash generated from operations and borrowings under our revolving credit facility are insufficient to satisfy our liquidity requirements, we may seek to obtain additional debt or equity financing. If additional funds are raised through the issuance of debt, this debt could contain covenants that would restrict our operations. Any financing may not be available in amounts or on terms acceptable to us. If we are unable to obtain required financing, we may be required to reduce the scope of our planned growth efforts, which could harm our financial condition and operating results.
 
If we decide to pursue one or more acquisitions, we may incur additional debt or sell additional equity to finance such acquisitions.

As discussed in Part II. Item 1. Legal Proceedings, the Company is involved various legal proceedings.  We cannot yet assess our potential liability, if any. Any adverse outcome would have a material adverse effect on our business, financial condition and results of operations.

Regardless of the outcome, we will continue to incur significant expenses to defend these proceedings. We have incurred approximately $10.7 million in legal costs as of March 31, 2017 to defend ourselves.  The potential costs that we may incur in the future will likely continue to vary from quarter to quarter, depending on the timing of proceedings. There can be no assurance that costs to defend these proceedings will not exceed our estimate.









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Cash Flows  
 
The following table shows a summary of our cash flows for the periods indicated.
 
 
Three Months Ended March 31,
(dollars in thousands)
2017
 
2016
Net cash provided by operating activities
$
16,522

 
$
36,576

Net cash used in investing activities
(6,406
)
 
(16,396
)
Net cash used in financing activities
(26,929
)
 
(15,203
)
Net (decrease) increase in cash and restricted cash
$
(16,813
)
 
$
4,977

 
Cash Flows from Operations
 
Net cash provided by operating activities for the three months ended March 31, 2017 was $16.5 million compared to $36.6 million for the same period in 2016, a decrease of $20.1 million, or 54.8%, primarily attributable to decreases in accounts payable and the payor refund liability, offset by the impact of the non-cash Modification Expense.
 
Cash Flows from Investing Activities
 
Net cash used in investing activities for the three months ended March 31, 2017 was $6.4 million compared to $16.4 million for the same period in 2016, a decrease of $10.0 million, or 60.9%, due to fluctuations in the timing and number of our de novo clinic openings, as well as the timing of acquisitions.
 
Cash Flows from Financing Activities
 
Net cash used in financing activities for the three months ended March 31, 2017 was $26.9 million compared to $15.2 million for the same period in 2016, an increase of $11.7 million.  Our distributions to our partners were $19.0 million for the three months ended March 31, 2017 compared to $21.4 million for the same period in 2016. Additionally, our purchases of noncontrolling interests in existing clinics were $4.5 million for the three months ended March 31, 2017, with no purchases for the same period in 2016.
  
Capital Expenditures
 
For the three months ended March 31, 2017 and 2016, we made capital expenditures of $6.4 million and $16.4 million, respectively, of which $4.5 million and $13.5 million, respectively, were development capital expenditures, primarily incurred in connection with de novo clinic development, and $1.9 million and $2.9 million, respectively, were maintenance capital expenditures, primarily consisting of capital improvements at our existing clinics, including renovations and equipment replacement. For the remainder of 2017, we expect to spend approximately 5% to 6% of total net revenues for development capital expenditures and 1% to 2% of total net revenues on maintenance capital expenditures.

Debt Facilities
 
As of March 31, 2017, we had outstanding $569.9 million in aggregate principal amount of indebtedness, with an additional $100.0 million of borrowing capacity available under our revolving credit facility (and no outstanding letters of credit). Our outstanding indebtedness included $432.6 million of term B loans under our first lien credit agreement as of March 31, 2017. Our outstanding indebtedness included $3.0 million of other corporate debt as of March 31, 2017. Our outstanding indebtedness also included our third-party clinic-level debt, which includes term loans and lines of credit (other than assigned clinic loans) totaling $117.0 million as of March 31, 2017 with maturities ranging from April 2017 to December 2023 and interest rates ranging from 3.15% to 7.11%. In addition, our clinic level debt includes our assigned clinic loans held by Term Loan Holdings of $17.3 million as of March 31, 2017 with maturities ranging from June 2017 to July 2020 and interest rates ranging from 3.46% to 8.08%. See “Note 9—Debt” in the notes to our unaudited consolidated financial statements.

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On April 26, 2016, the Company entered into the first amendment (“the Amendment”) to the First Lien Credit Agreement. The Amendment increased the borrowing capacity under the first lien revolving credit facility by $50.0 million to an aggregate amount of $100.0 million, increased the interest rate margin by 0.25% on the first lien term loans, and provided for additional borrowings of $60.0 million of incremental first lien term loans. The Company also applied $165.6 million of the net proceeds from the IPO, proceeds from the additional first lien term loans, and cash on hand to repay the outstanding balance on the second lien term loans.  We refer to such increase of revolving credit facility borrowing capacity, borrowings under our first lien credit facility and repayment of second lien term loans as the “Refinancing”
 
Initial Public Offering
 
On April 26, 2016, the Company completed its initial public offering of 8,625,000 shares of Common Stock for cash consideration of $22.00 per share ($20.515 per share net of underwriting discounts).  Net proceeds of $176.9 million from the initial public offering, together with borrowings under our first lien credit facility and cash on hand, were used in the Refinancing to repay in full, all outstanding amounts under our second lien credit facility.
 
Contractual Obligations and Commitments
 
The following is a summary of contractual obligations and commitments as of March 31, 2017 (excluding put obligations relating to our joint ventures, dividend equivalent payments due to our pre-IPO option holders and obligations under our income tax receivable agreement, which are described separately below):
 
Scheduled payments under contractual obligations (dollars in thousands) 
 
Total 
 
Less than 1
year 
 
1-3 years 
 
3-5 years 
 
More than 5
years 
Third-party clinic-level debt
 
$
134,292

 
$
32,593

 
$
63,423

 
$
30,777

 
$
7,499

Term B loans(1)
 
432,599

 
3,477

 
429,122

 

 

Other corporate debt
 
2,962

 
361

 
1,144

 
1,240

 
217

Operating leases(2)
 
180,511

 
26,340

 
49,176

 
40,749

 
64,246

Interest payments(3)
 
64,014

 
20,096

 
41,701

 
2,025

 
192

Total
 
$
814,378

 
$
82,867

 
$
584,566

 
$
74,791

 
$
72,154

_____________________________
(1)
Bear interest at a variable rate, with principal payments of $1.2 million and interest payments due quarterly.
(2)
Net of estimated sublease proceeds of approximately $1.0 million per year from 2017 through 2022 and approximately $0.5 million or less thereafter.
(3)
Represents interest payments on debt obligations, including the term B loans under the first lien credit agreement. To project interest payments on floating rate debt, we have used the rate as of March 31, 2017.

Put Obligations
 
We also have potential obligations with respect to some of our non-wholly owned subsidiaries in the form of put provisions, which are exercisable at our nephrologist partners’ future discretion at certain time periods (“time-based puts”) or upon the occurrence of certain events (“event-based puts”) as set forth in each specific put provision, which may include the sale of assets, closure of the clinic, acquisitions over a certain dollar amount, departure of key executives and other events. The time when some of the time-based put rights were exercised was accelerated upon our IPO and may be accelerated upon the occurrence of certain events, such as a sale of all or substantially all of our assets or a change of control. If the put obligations are exercised by a physician partner, we are required to purchase, at fair market value calculated as set forth in the applicable joint venture agreements, a previously agreed upon percentage of such physician partner’s ownership interest. See “Note 8—Noncontrolling Interests Subject to Put Provisions” in the notes to our unaudited consolidated financial statements for discussion of these put provisions.  The table below summarizes our potential obligation as of March 31, 2017.
 

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Noncontrolling interest subject to put provisions
(dollars in thousands)
 
Time-based puts
 
$
96,265

Event-based puts
 
36,200

Total Obligation
 
$
132,465

 
As of March 31, 2017, $21.9 million of time-based put obligations were exercisable by our nephrologist partners. The following is a summary of the estimated potential cash payments in each of the specified years under all time-based puts existing as of March 31, 2017 and reflects the payments that would be made, assuming (a) all vested puts as of March 31, 2017 were exercised on April 1, 2017 and paid according to the applicable agreement and (b) all puts exercisable thereafter were exercised as soon as they vest and are paid accordingly.
 
(dollars in thousands) 
Year 
 
Amount
Exercisable 
2017
 
23,540

2018
 
12,020

2019
 
16,631

2020
 
20,563

2021
 
14,067

Thereafter
 
9,444

Total
 
$
96,265

 
The estimated fair values of the interests subject to these put provisions can also fluctuate and the implicit multiple of earnings at which these obligations may be settled will vary depending upon clinic performance, market conditions and access to the credit and capital markets. In addition, our estimates are subject to challenges by our partners which could cause an increase to the amount we owe. As of March 31, 2017, we had recorded liabilities of approximately $96.3 million for all existing time-based obligations, of which we have estimated approximately $21.2 million were accelerated as a result of physicians with IPO put rights having elected to potentially exercise the puts.  The actual purchase price for the puts is currently being determined, which may affect our estimates described above.  Once the determination is complete, the physician partners will have the right to decide how much of their put rights, if any, they will exercise.  In addition, as of March 31, 2017, we had $36.2 million of event-based put obligations (including certain time-based put obligations that became event-based put obligations but are not currently exercisable), none of which were exercisable by our nephrologist partners at March 31, 2017
 
Dividend Equivalent Payments
 
On April 26, 2016, the Company declared and paid a cash dividend to our pre-IPO stockholders equal to $1.30 per share, or $28.9 million in the aggregate.  In connection with the dividend, all employees with outstanding options had their option exercise price reduced and in some cases were awarded a future dividend equivalent payment, which were paid on vested options and becomes due upon vesting for unvested options.  Additionally, in connection with the cash dividend, the Company has made payments to date equal to $1.30 per share, or $1.4 million in the aggregate, to option holders, and, in the case of some performance and market options, as of March 31, 2017 a future payment will be due upon vesting totaling $5.4 million.  
 
In connection with the Term Loan Holdings Distribution, as described in "Note 2 - Initial Public Offering", the Company also equitably adjusted the outstanding stock options by reducing exercise prices and making cash dividend equivalent payments of $2.5 million, of which $0.2 million was paid to vested option holders and $2.3 million is payable to unvested option holders as of March 31, 2017, only if such unvested options become vested.
 
In March 2013, the Company declared and paid a dividend to holders of the Company’s common stock equal to $7.90 per share.  In connection with the dividend, all employees with outstanding 2010 Plan options had their option exercise price reduced and in some cases were awarded a future dividend equivalent payment, which becomes due upon vesting, of $2.6 million, of which an immaterial amount was paid to vested option holders and $2.6 million is payable to unvested option holders as of March 31, 2017, only if such unvested options become vested.
 

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Assuming that all currently outstanding options entitled to cash dividend equivalent payments vest according to their respective vesting schedules, the Company anticipates a payment of approximately $8.7 million will be made during 2017, with an additional approximately $1.8 million to be paid thereafter.

Income Tax Receivable Agreement
 
On April 26, 2016, upon the completion of the IPO, we entered into the TRA, which provides for the payment by us to our pre-IPO stockholders on a pro rata basis of 85% of the amount of cash savings, if any, in U.S. federal, state and local income tax that we actually realize as a result of any deductions (including net operating losses resulting from such deductions) attributable to the exercise of (or any payment, including any dividend equivalent right or payment, in respect of) any compensatory stock option issued by us that was outstanding (whether vested or unvested) as of the day before the date of our IPO prospectus (such stock options, “Relevant Stock Options” and such deductions, “Option Deductions”). We plan to fund the payments under the TRA with cash flows from operations and, to the extent necessary, the proceeds of borrowings under our credit facilities. The amounts and timing of our obligations under the TRA are subject to a number of factors, including the amount and timing of the taxable income we generate in the future, whether and when any Relevant Stock Options are exercised and the value of our common stock at the time of such exercise, and to uncertainty relating to the future events that could impact such obligations. Estimating the amount of payments that may be made under the TRA is by its nature imprecise given such uncertainty. However, we expect that during the term of the TRA the payments that we make will be material. Such payments will reduce the liquidity that would otherwise have been available to us. The amount of cash savings for 2016 is estimated to be $1.1 million as of March 31, 2017.
 
Off Balance Sheet Arrangements
 
We have no off-balance sheet arrangements that have, or are reasonably likely to have, a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures, or capital resources that would be material to investors. 
 

Recent Accounting Pronouncements
 
See Note 1 "– Presentation – Recent Accounting Pronouncements” to the consolidated financial statements.

Critical Accounting Policies and Estimates
 
For a description of the Company’s critical accounting policies and use of estimates, refer to “Management’s Discussion and Analysis of Financial Condition and Results of Operations— Critical Accounting Policies and Estimates” in the Company's Form 10-K for the year ended December 31, 2016.  There have been no material changes to our critical accounting policies and use of estimates from those described in the Form 10-K.

ITEM 3.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 
For the Company's disclosures about market risk, please see "Part II—Item 7A—Quantitative and Qualitative Disclosures About Market Risk" in the Company's Form 10-K for the year ended December 31, 2016 filed with the Securities and Exchange Commission. Except as described below, there have been no material changes to the Company's disclosures about market risk in Part II—Item 7A of such Form 10-K.     

Interest Rate Risk

     We enter into interest swap and cap agreements from time to time as a means of hedging exposure to, and volatility from, variable-based interest rate changes as part of an overall interest rate risk management strategy. These swap agreements are not held for trading or speculative purposes and have the economic effect of converting the London Interbank Offered Rate ("LIBOR") variable component of our interest rate on our long-term debt to a fixed rate.     

In March 2017, the Company entered into a forward starting interest rate swap agreement (the “2017 Swap”) with a notional amount of $133,000, as a means of fixing the floating interest rate component on $460,000 of its variable-rate debt under the Term B Loans, with an effective date of March 31, 2018. The forward starting 2017 Swap is designated as a cash flow hedge, with a termination date of March 31, 2021.

In March 2017, the Company entered into two interest rate cap agreements (the “Caps”) with notional amounts totaling $147,000, as a means of capping the floating interest rate component on $460,000 of its variable‑rate debt under the Term B Loans. The Caps are designated as a cash flow hedge, with a termination date of March 31, 2021.

As a result of the application of hedge accounting treatment, to the extent the 2017 Swaps and Caps are effective, the unrealized gains and losses related to the derivative instrument are recorded in accumulated other comprehensive income (loss)

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and are reclassified into operations in the same period in which the hedged transaction affects earnings and to the extent the 2017 Swaps and Caps are ineffective and produce gains and losses differently from the losses or gains being hedged, the ineffective portion is recognized in earnings immediately. Hedge effectiveness is tested quarterly. Based on the Company's interest rate swaps and caps outstanding as of March 31, 2017, a 1 percentage point increase in interest rates would have increased interest expense by $1.0 million. See “Note 9 - Debt” of the notes to consolidated financial statements for further discussion of these derivative agreements.
 
ITEM 4.
CONTROLS AND PROCEDURES
 
(a) Evaluation of Disclosure Controls and Procedures.  
 
Our management, with the participation of our Chief Executive Officer, or CEO, and Chief Financial Officer, or CFO, evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act) as of March 31, 2017. In designing and evaluating our disclosure controls and procedures, our management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives, and our management necessarily applied its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on this evaluation, our CEO and CFO concluded that our disclosure controls and procedures were effective at the reasonable assurance level as of March 31, 2017
 
(b) Changes in Internal Control over Financial Reporting.  
 
There have been no changes in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act) during the quarter ended March 31, 2017 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. 

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PART II
OTHER INFORMATION
 
ITEM 1.
LEGAL PROCEEDINGS  

Inquiries By The Federal Government

We are subject to a Decision and Order entered In the Matter of American Renal Associates Inc. and Fresenius Medical Care Holdings, Inc. by the Federal Trade Commission. The Decision and Order was entered in 2007 following a nonpublic investigation by the Federal Trade Commission into proposed dialysis clinic acquisition activities in Rhode Island and the execution of an Agreement Containing Consent Order by the parties. The Decision and Order prohibits us for a period of ten years through October 17, 2017, without prior notice to the Federal Trade Commission from: (1) acquiring dialysis clinics located in ZIP codes in and around the cities of Cranston and Warwick, Rhode Island, and/or (2) entering into any contract to manage or operate dialysis clinics in ZIP codes in and around the cities of Cranston and Warwick, Rhode Island. These prohibitions are subject to a number of exceptions that permit us to develop, own, manage or operate de novo dialysis clinics or dialysis clinics owned or operated as of the date the Decision and Order was entered, or to perform specified services, including offsite laboratory services, bookkeeping services, accounting services, billing services, supply services and purchasing and logistics services with the adherence to confidentiality requirements. We have complied and intend to continue to comply with the terms of the Decision and Order and on September 19, 2016 we submitted an annual compliance report to the Federal Trade Commission. We do not believe that compliance with the Decision and Order will have a material impact on our revenues, earnings or cash flows.

Certain Legal Matters

As previously disclosed, American Renal Associates Holdings, Inc. (“ARA”) and its wholly owned operating subsidiary American Renal Associates LLC (“ARA OpCo”) were named as defendants in a complaint filed by three affiliates of UnitedHealth Group Inc. (“United”) in the United States District Court for the Southern District of Florida (the "Court") on July 1, 2016. On August 12, 2016, ARA and ARA OpCo each filed a motion to dismiss the action. On September 2, 2016, plaintiffs filed an amended complaint, dropping one of the United affiliates as a plaintiff. On September 30, 2016, ARA and ARA OpCo each filed a motion to dismiss the amended complaint. On January 17, 2017, plaintiffs filed a motion seeking to file a second amended complaint, which would add American Renal Management LLC ("ARM") as a defendant. ARA and ARA OpCo filed an opposition to the motion to further amend. On May 8, 2017, the Court granted ARA's motion to dismiss for lack of personal jurisdiction and dismissed ARA from the lawsuit without prejudice. The lawsuit remains pending against ARA OpCo and ARM with a hearing set on the motion to dismiss for June 23, 2017. The amended complaint and proposed second amended complaint relate to 30 patients who have received, and some of whom continue to receive, dialysis at 12 clinics in Florida and Ohio and who obtained coverage under one of United’s ACA-compliant individual marketplace plans, effective on or after January 1, 2016. The plaintiffs assert various state law claims and allege violations of certain state laws that prohibit false insurance claims, healthcare kickbacks, patient brokering, and violations of the applicable commercial plan agreements in connection with, among other things, premium payment assistance by the American Kidney Fund (“AKF”). The amended complaint and proposed second amended complaint seek unspecified actual, consequential and punitive monetary damages, together with interest and costs, and declaratory and injunctive relief, as well as attorney's fees and court costs. The Company has moved to dismiss the amended complaint in full, has opposed the motion to file a second amended complaint, and is vigorously defending itself in this legal matter. Jurisdictional discovery was completed and merits discovery has commenced. The Company has received letters from other insurance companies seeking information regarding matters relating to the insurance companies’ covered patients similar in nature to the matters underlying the United complaint.

In addition, as previously disclosed, on July 26, 2016, the Staff of the SEC sent a letter to the Company stating that it is conducting an inquiry and requesting that the Company provide certain documents and information relating to the subject matter covered by the United complaint described above. The Company has subsequently received follow up and additional requests for documents and information with respect to the same subject matter. The Company has fully cooperated with the SEC Staff. On April 28, 2017, the Company was notified by the SEC Staff that the SEC had concluded its investigation and, based on the information it had as of that date, does not intend to recommend an enforcement action against the Company.

On August 31, 2016 and September 2, 2016, putative shareholder class action complaints were filed in the United States District Court for the Southern District of New York and the United States District Court for the District of Massachusetts, respectively, against the Company and certain officers and directors of the Company.  Both complaints asserted federal securities law claims against the Company and the individual defendants under Sections 10(b) and 20(a) of the Exchange Act and Rule 10b-5 promulgated thereunder by the SEC and in addition, the complaint filed in the United States District Court for the Southern District of New York asserted claims under Sections 11 and 15 of the Securities Act. The

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complaints alleged that the Company made material misstatements or omissions, including in connection with its initial public offering filings and other public filings. The complaints sought unspecified damages on behalf of the individuals or entities that purchased or otherwise acquired the Company’s securities from April 20, 2016 to August 18, 2016.  On October 26, 2016, the complaint filed in the Southern District of New York was voluntarily dismissed by the plaintiff without prejudice.  On November 30, 2016, Lead Plaintiff was appointed for the putative shareholder class action complaint pending in the United States District Court for the District of Massachusetts, captioned Esposito, et al. v. American Renal Associates Holdings, Inc., et al., No. 16-cv-11797 (the “Esposito Action”).  On February 1, 2017, Lead Plaintiff in the Esposito Action filed an amended complaint against the Company, certain former and current officers and directors of the Company, Centerbridge Capital Partners L.P., and certain of the underwriters in our initial public offering. The amended complaint asserts federal securities laws claims under Securities Act sections 11 and 15, as well as Exchange Act sections 10(b), 20(a), and SEC Rule 10b-5. The Company’s response is currently due in May 2017. The Company intends to vigorously defend itself against these claims. In addition, the Company received a demand letter, dated January 27, 2017, from a purported shareholder relating to the subject matter covered by the United complaint and the class action complaints described above, which could lead to the initiation of a shareholder derivative lawsuit against the Company and its board of directors. By letter dated May 8, 2017, attorneys for the shareholder were informed that the Board of Directors had determined not to pursue potential claims against individuals as set forth in the demand letter.
On January 3, 2017, the Company received a subpoena from the United States Attorney’s Office, District of Massachusetts, requesting information relating to the Company’s payments and other interactions with the AKF and any efforts to educate patients qualified or enrolled in Medicare or Medicaid about enrollment in ACA-compliant individual marketplace plans, among other related matters under applicable healthcare laws for the period from January 1, 2013 through the present. As it has done with the other regulators who have expressed interest in such matters, the Company is cooperating fully with the government. In the event that the United States Attorney’s Office, District of Massachusetts, were to find violations of any federal criminal or civil laws, our business, financial condition and results of operations could be materially adversely affected.
 
Other

From time to time, we are subject to various legal actions and proceedings involving claims incidental to the conduct of our business, including contractual disputes and professional and general liability claims, as well as audits and investigations by various government entities, in the ordinary course of business. Based on information currently available, established reserves, available insurance coverage and other resources, we do not believe that the outcomes of any such pending actions, proceedings or investigations are likely to be, individually or in the aggregate, material to our business, financial condition, results of operations or cash flows. However, legal actions and proceedings are subject to inherent uncertainties and it is possible that the ultimate resolution of such matters, if unfavorable, may be materially adverse to our business, financial condition, results of operations or cash flows.

No assurance can be given as to the timing or outcome of the legal matters discussed above, nor can any assurance be given as to whether the filing of these lawsuits and any inquiries will affect the Company’s other relationships, or the Company’s business generally. We cannot predict the outcome of any of these matters and an adverse result in one or more of them could have a material adverse effect on our business, results of operations and financial condition.

Although we are not currently subject to any regulatory proceedings, in light of the heightened scrutiny with respect to the matters described above, there is no assurance that formal regulatory investigations or proceedings will not be commenced by any U.S. federal or state healthcare and other regulatory agencies. In addition, we may in the future be subject to additional inquiries, litigation or other proceedings or actions, regulatory or otherwise, arising in relation to the matters described above and related litigation and investigative matters. An unfavorable outcome of any such litigation or regulatory proceeding or action could have a material adverse effect on our business, financial condition and results of operations.

ITEM 1A.
RISK FACTORS  
 
There have been no material changes with respect to this item from the disclosure included in the Company's Form 10-K for the year ended December 31, 2016.

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ITEM 6.
EXHIBITS
 
The following is a list of all exhibits filed or furnished as part of this Report:
 
EXHIBIT
NUMBER
    
EXHIBIT DESCRIPTION
 
 
 
3.1
 
Amended and Restated Certificate of Incorporation of American Renal Associates Holdings, Inc. (incorporated by reference to Exhibit 3.1 to the Registrant’s Current Report on Form 8-K filed on April 26, 2016)
 
 
 
3.2
 
Amended and Restated Bylaws of American Renal Associates Holdings, Inc. (incorporated by reference to Exhibit 3.2 to the Registrant’s Current Report on Form 8-K filed on April 26, 2016)
 
 
 
10.1*†

 
Form of Option Agreement under the American Renal Associates Holdings, Inc. 2016 Omnibus Incentive Plan
 
 
 
10.2*†
 
Form of Restricted Stock Agreement under the American Renal Associates Holdings, Inc. 2016 Omnibus Incentive Plan
 
 
 
10.3*†
 
Form of Restricted Stock Agreement for Non-Employee Directors under the American Renal Associates Holdings, Inc. 2016 Omnibus Incentive Plan
 
 
 
10.4*†
 
Form of Restricted Stock Unit Agreement under the American Renal Associates Holdings, Inc. 2016 Omnibus Incentive Plan
 
 
 
31.1*
 
Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 
 
 
31.2*
 
Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 
 
 
32.1*
 
Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
 
 
32.2*
 
Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
 
 
101*
 
The following financial information from the Quarterly Report on Form 10-Q for the fiscal quarter ended March 31, 2017, formatted in XBRL (Extensible Business Reporting Language) and furnished electronically herewith: (i) the Consolidated Balance Sheets; (ii) the Consolidated Statements of Operations ; (iii) the Consolidated Statements of Cash Flows; and (iv) the Notes to the Consolidated Financial Statements.
_____________________________
*     Filed or furnished herewith
† Identifies exhibits that consist of a management contract or compensatory plan or arrangement    



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SIGNATURES  
 
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
 
AMERICAN RENAL ASSOCIATES HOLDINGS INC.
 
(Registrant)
 
 
 
 
 
Title:   Chief Financial Officer
(Principal Financial Officer and Authorized Signatory)
 
 
(Date)


45

Dates Referenced Herein   and   Documents Incorporated by Reference

This ‘10-Q’ Filing    Date    Other Filings
3/31/21
12/31/18
12/15/18
3/31/18
12/31/17
12/15/17
10/17/17
6/23/17
Filed on:5/9/178-K
5/8/17
4/28/17
4/1/17
For Period End:3/31/17
2/1/17
1/27/173
1/17/17
1/3/178-K
1/1/17
12/31/1610-K
12/15/16
12/14/16
11/30/16
10/28/16
10/26/16
9/30/1610-Q
9/19/16
9/2/16
8/31/16
8/18/16
8/12/16
7/26/16
7/1/168-K
6/30/1610-Q
4/26/164,  8-K
4/20/168-K,  CORRESP,  S-1/A
4/7/16
3/31/1610-Q
1/1/16
12/31/15
12/31/14
1/1/13
1/1/12
5/7/10
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