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American Renal Associates Holdings, Inc. – ‘10-Q’ for 6/30/16

On:  Tuesday, 8/9/16, at 4:39pm ET   ·   For:  6/30/16   ·   Accession #:  1498068-16-11   ·   File #:  1-37751

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

 8/09/16  American Renal Assocs Holdin… Inc 10-Q        6/30/16   58:5.7M

Quarterly Report   —   Form 10-Q
Filing Table of Contents

Document/Exhibit                   Description                      Pages   Size 

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 2: EX-31.1     Certification -- Sarbanes-Oxley Act - Sect. 302     HTML     23K 
 3: EX-31.2     Certification -- Sarbanes-Oxley Act - Sect. 302     HTML     23K 
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13: R2          Consolidated Balance Sheets                         HTML    103K 
14: R3          Consolidated Balance Sheets (Parenthetical)         HTML     40K 
15: R4          Consolidated Statements of Operations               HTML     77K 
16: R5          Consolidated Statements of Comprehensive Income     HTML     30K 
                          (Loss)                                                 
17: R6          Consolidated Statements of Changes in Equity        HTML     81K 
18: R7          Consolidated Statements of Changes in Equity        HTML     20K 
                          (Parenthetical)                                        
19: R8          Consolidated Statements of Cash Flows               HTML    127K 
20: R9          Basis of Presentation and Organization              HTML     36K 
21: R10         Accounts Receivable                                 HTML     22K 
22: R11         Acquisitions                                        HTML     32K 
23: R12         Fair Value Measurements                             HTML    118K 
24: R13         Accrued Expenses and Other Current Liabilities      HTML     44K 
25: R14         Variable Interest Entities                          HTML     25K 
26: R15         Noncontrolling Interests Subject to Put Provisions  HTML     22K 
27: R16         Debt                                                HTML     72K 
28: R17         Income Taxes                                        HTML     21K 
29: R18         Stock-Based Compensation                            HTML     70K 
30: R19         Earnings Per Share                                  HTML    102K 
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33: R22         Subsequent Events                                   HTML     18K 
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35: R24         Acquisitions (Tables)                               HTML     27K 
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                          (Tables)                                               
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39: R28         Stock-Based Compensation (Tables)                   HTML     62K 
40: R29         Earnings Per Share (Tables)                         HTML     99K 
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47: R36         Noncontrolling Interests Subject to Put Provisions  HTML     21K 
                          (Details)                                              
48: R37         Debt (Details)                                      HTML     56K 
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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
"Financial Statements
"Consolidated Balance Sheets as of June 30, 2016 (Unaudited) and December 31, 2015
"Consolidated Statements of Operations for the three and six months ended June 30, 2016 and June 30, 2015 (Unaudited)
"Consolidated Statements of Comprehensive Income (Loss) for the three and six months ended June 30, 2016 and June 30, 2015 (Unaudited)
"Consolidated Statement of Changes in Equity for the six months ended June 30, 2016 (Unaudited)
"Consolidated Statements of Cash Flows for the six months ended June 30, 2016 and June 30, 2015 (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

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  ara_Current_Folio-10Q  

Table of Contents

 

 

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 June 30, 2016

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


Picture 1

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

Beverly, Massachusetts

01915

(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, or a smaller reporting company. See the definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer

Accelerated filer

 

 

 

 

Non-accelerated filer

(Do not check if a smaller reporting company)

Smaller reporting company

 

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 August 8, 2016 there were 30,868,050 shares of the registrant’s Common Stock outstanding.

 

 

 

 

 

 


 

Table of Contents

 

INDEX

 

 

 

 

 

 

PAGE

PART I. Financial Information 

 

 

 

 

Item 1. 

Financial Statements:

 

 

Consolidated Balance Sheets as of June 30, 2016 (Unaudited) and December 31, 2015

 

Consolidated Statements of Operations for the three and six months ended June 30, 2016 and June 30, 2015 (Unaudited)

 

Consolidated Statements of Comprehensive Income (Loss) for the three and six months ended June 30, 2016 and June 30, 2015 (Unaudited)

 

Consolidated Statement of Changes in Equity for the six months ended June 30, 2016 (Unaudited)

 

Consolidated Statements of Cash Flows for the six months ended June 30, 2016 and June 30, 2015 (Unaudited)

 

Notes to Consolidated Financial Statements (Unaudited)

 

 

 

Item 2. 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

23 

Item 3. 

Quantitative and Qualitative Disclosures About Market Risk

41 

Item 4. 

Controls and Procedures

41 

 

 

PART II. Other Information 

 

 

 

 

Item 1. 

Legal Proceedings

42 

Item 1A. 

Risk Factors

42 

Item 6. 

Exhibits

44 

 

 

SIGNATURES 

45 

 

 

 

 

 


 

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 under “Risk Factors” in the Company’s prospectus (the “Prospectus”), dated April 20, 2016, filed with the Securities and Exchange Commission (the “SEC”) pursuant to Rule 424(b) of the Securities Act of 1933, as amended, which is deemed to be part of the Company’s Registration Statement on Form S-1 (File No. 333-206686), as amended (the “Registration Statement”), and in this Form 10-Q, as such risk factors may be updated from time to time in our periodic filings with the SEC, and are accessible on the SEC’s website at www.sec.gov, and also include the following: 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 or decline in commercial payor reimbursement rates;

 

 

●  

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 proposed rule for 2017 released on June 24, 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 outcome of the UnitedHealth Group 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 correctly estimate the amount of revenues that we recognize in a reporting period;

 

 

●  

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 after the completion of the IPO.

 

There may be other factors that may cause our actual results to differ materially from the forward-looking statements, including factors disclosed under the sections entitled "Risk Factors" and "Management's Discussion and Analysis of Financial Condition and Results of Operations" in this Form 10-Q. 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


 

Table of Contents

AMERICAN RENAL ASSOCIATES HOLDINGS, INC. AND SUBSIDIARIES 

CONSOLIDATED BALANCE SHEETS

(dollars in thousands, except for share data)

 

 

 

 

 

 

 

 

 

 

    

June 30, 2016

    

December 31, 2015

 

 

 

(Unaudited)

 

 

 

 

Assets

 

 

 

 

 

 

 

Cash

 

$

93,268

 

$

90,988

 

Accounts receivable, less allowance for doubtful accounts of $8,867 and $7,435, respectively

 

 

76,904

 

 

76,919

 

Inventories

 

 

4,790

 

 

4,291

 

Prepaid expenses and other current assets

 

 

14,977

 

 

18,863

 

Income tax receivable

 

 

144

 

 

2,686

 

Total current assets

 

 

190,083

 

 

193,747

 

Property and equipment, net of accumulated depreciation of $151,367 and $138,163, respectively

 

 

160,887

 

 

142,701

 

Intangible assets, net of accumulated depreciation of $22,731 and $22,378, respectively

 

 

25,938

 

 

25,662

 

Other long-term assets

 

 

6,174

 

 

6,850

 

Goodwill

 

 

569,930

 

 

569,318

 

Total assets

 

$

953,012

 

$

938,278

 

 

 

 

 

 

 

 

 

Liabilities and Equity

 

 

 

 

 

 

 

Accounts payable

 

$

23,515

 

$

22,571

 

Accrued compensation and benefits

 

 

25,469

 

 

22,504

 

Accrued expenses and other current liabilities

 

 

45,642

 

 

26,788

 

Current portion of long-term debt

 

 

40,579

 

 

25,610

 

Total current liabilities

 

 

135,205

 

 

97,473

 

Long-term debt, less current portion

 

 

517,798

 

 

657,372

 

Income tax receivable agreement payable

 

 

27,800 

 

 

 —

 

Other long-term liabilities

 

 

10,361

 

 

9,483

 

Deferred tax liabilities

 

 

7,169

 

 

15,029

 

Total Liabilities

 

 

698,333

 

 

779,357

 

Commitments and contingencies (Note 13)

 

 

 

 

 

 

 

Noncontrolling interests subject to put provisions

 

 

134,762

 

 

108,211

 

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; 30,845,109 and 22,213,967 issued and outstanding at June 30, 2016 and December 31, 2015, respectively

 

 

184

 

 

98

 

Additional paid-in capital

 

 

72,405

 

 

 —

 

Receivable from noncontrolling interests

 

 

(498)

 

 

(529)

 

Accumulated deficit

 

 

(133,597)

 

 

(128,261)

 

Accumulated other comprehensive loss, net of tax

 

 

(301)

 

 

(501)

 

Total American Renal Associates Holdings, Inc. deficit

 

 

(61,807)

 

 

(129,193)

 

Noncontrolling interests not subject to put provisions

 

 

181,724

 

 

179,903

 

Total equity

 

 

119,917

 

 

50,710

 

Total liabilities and equity

 

$

953,012

 

$

938,278

 

 

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 June 30,

 

Six Months Ended June 30,

 

 

    

2016

    

2015

    

2016

    

2015

 

Patient service operating revenues

 

$

186,938

 

$

162,585

 

$

360,492

 

$

312,929

 

Provision for uncollectible accounts

 

 

(1,371)

 

 

(1,084)

 

 

(2,794)

 

 

(2,105)

 

Net patient service operating revenues

 

 

185,567

 

 

161,501

 

 

357,698

 

 

310,824

 

Operating expenses:

 

 

 

 

 

 

 

 

 

 

 

 

 

Patient care costs

 

 

109,719

 

 

96,103

 

 

215,174

 

 

188,233

 

General and administrative

 

 

31,648

 

 

20,087

 

 

53,147

 

 

37,290

 

Transaction-related costs (Note 1)

 

 

2,215

 

 

 —

 

 

2,239

 

 

 —

 

Depreciation and amortization

 

 

8,252

 

 

7,431

 

 

15,929

 

 

15,172

 

Total operating expenses

 

 

151,834

 

 

123,621

 

 

286,489

 

 

240,695

 

Operating income

 

 

33,733

 

 

37,880

 

 

71,209

 

 

70,129

 

Interest expense, net

 

 

(8,941)

 

 

(11,361)

 

 

(21,199)

 

 

(22,823)

 

Loss on early extinguishment of debt

 

 

(4,708)

 

 

 —

 

 

(4,708)

 

 

 —

 

Income tax receivable agreement expense

 

 

(7,835)

 

 

 —

 

 

(7,835)

 

 

 —

 

Income before income taxes

 

 

12,249

 

 

26,519

 

 

37,467

 

 

47,306

 

Income tax expense (benefit)

 

 

(1,147)

 

 

3,338

 

 

1,514

 

 

5,545

 

Net income

 

 

13,396

 

 

23,181

 

 

35,953

 

 

41,761

 

Less: Net income attributable to noncontrolling interests

 

 

(22,488)

 

 

(18,159)

 

 

(41,289)

 

 

(33,863)

 

Net income (loss) attributable to American Renal Associates Holdings, Inc.

 

$

(9,092)

 

$

5,022

 

$

(5,336)

 

$

7,898

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Earnings (loss) per share:

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

$

(0.75)

 

$

0.23

 

$

(0.69)

 

$

0.36

 

Diluted

 

$

(0.75)

 

$

0.22

 

$

(0.69)

 

$

0.35

 

Weighted-average number of common shares outstanding

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

 

28,406,999

 

 

22,124,805

 

 

25,344,510

 

 

22,116,155

 

Diluted

 

 

28,406,999

 

 

22,657,375

 

 

25,344,510

 

 

22,633,463

 

Cash dividends declared per share

 

$

1.30

 

 

 —

 

$

1.30

 

 

 —

 

 

See accompanying notes to consolidated financial statements.

 

4


 

Table of Contents

AMERICAN RENAL ASSOCIATES HOLDINGS, INC. AND SUBSIDIARIES 

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(Unaudited)

(dollars in thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended June 30,

 

Six Months Ended June 30,

 

 

    

2016

    

2015

    

2016

    

2015

 

Net income

 

$

13,396

 

$

23,181

 

$

35,953

 

$

41,761

 

Unrealized gain (loss) on interest rate swap, net of tax

 

 

100

 

 

(25)

 

 

200

 

 

(599)

 

Total comprehensive income

 

 

13,496

 

 

23,156

 

 

36,153

 

 

41,162

 

Less: Comprehensive income attributable to noncontrolling interests

 

 

(22,488)

 

 

(18,159)

 

 

(41,289)

 

 

(33,863)

 

Total comprehensive income (loss) attributable to American Renal Associates Holdings, Inc.

 

$

(8,992)

 

$

4,997

 

$

(5,136)

 

$

7,299

 

 

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

 

Common Stock

 

Additional
Paid-in

 

Receivable
from
Noncontrolling
Interest

 

Accumulated

 

Accumulated
Other
Comprehensive

 

 

 

 

Noncontrolling
Interests not
subject to put

 

 

    

provisions

    

Shares

    

Par Value

    

Capital

    

Holders

    

Deficit

    

Income (loss)

    

Total

    

provisions

 

Balance at December 31, 2015

 

$

108,211

 

22,213,967

 

$

98

 

$

 —

 

$

(529)

 

$

(128,261)

 

$

(501)

 

$

(129,193)

 

$

179,903

 

Net income (loss)

 

 

9,018

 

 

 

 

 

 

 

 

 

(5,336)

 

 

 

 

(5,336)

 

 

32,271

 

Stock-based compensation

 

 

 

 

 

 

 

10,211

 

 

 

 

 

 

 

 

10,211

 

 

 

Exercise of stock options

 

 

 

6,142

 

 

 

 

(71)

 

 

 

 

 

 

 

 

(71)

 

 

 

Excess tax benefit from exercise or vesting of equity awards

 

 

 

 

 

 

 

225

 

 

 

 

 

 

 

 

225

 

 

 

Issuance of common stock sold in initial public offering, net of offering expense of $19,495

 

 

 

8,625,000

 

 

86

 

 

170,169

 

 

 

 

 

 

 

 

170,255

 

 

 

Cash dividends, $1.30 per common share

 

 

 

 

 

 

 

(28,886)

 

 

 

 

 —

 

 

 

 

(28,886)

 

 

 

Cash dividend equivalents paid on share-based payments

 

 

 

 

 

 

 

(1,290)

 

 

 

 

 —

 

 

 

 

(1,290)

 

 

 

Cash dividend equivalents accrued on share-based payments

 

 

 

 

 

 

 

(1,540)

 

 

 

 

 —

 

 

 

 

(1,540)

 

 

 

Non-cash dividends

 

 

 

 

 

 

 

(26,232)

 

 

 

 

 

 

 

 

(26,232)

 

 

 

Income tax receivable agreement

 

 

 

 

 

 

 

(23,400)

 

 

 

 

 

 

 

 

(23,400)

 

 

 

Distributions to noncontrolling interests

 

 

(11,002)

 

 

 

 

 

 

 

 

 

 

 

 

 

 —

 

 

(32,971)

 

Contributions from noncontrolling interests

 

 

1,828

 

 

 

 

 

 

 

31

 

 

 

 

 

 

31

 

 

2,582

 

Purchases of noncontrolling interests

 

 

 

 

 

 

 

(216)

 

 

 

 

 

 

 

 

(216)

 

 

(61)

 

Sales of noncontrolling interests

 

 

83

 

 

 

 

 

59

 

 

 

 

 

 

 

 

59

 

 

 

Change in fair value of interest rate swaps, net of tax

 

 

 

 

 

 

 

 

 

 

 

 

 

200

 

 

200

 

 

 

Change in fair value of noncontrolling interests

 

 

26,624

 

 

 

 

 

(26,624)

 

 

 

 

 —

 

 

 

 

(26,624)

 

 

 

Balance at June 30, 2016

 

$

134,762

 

30,845,109

 

$

184

 

$

72,405

 

$

(498)

 

$

(133,597)

 

$

(301)

 

$

(61,807)

 

$

181,724

 

 

See accompanying notes to consolidated financial statements.

 

 

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Table of Contents

AMERICAN RENAL ASSOCIATES HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)  

(dollars in thousands)

 

 

 

 

 

 

 

 

 

 

 

Six Months Ended June 30,

 

Operating activities

    

2016

    

2015

 

Net income

 

$

35,953

 

$

41,761

 

Adjustments to reconcile net income to cash provided by operating activities:

 

 

 

 

 

 

 

Depreciation and amortization

 

 

15,929

 

 

15,172

 

Amortization of discounts, fees and deferred financing costs

 

 

1,807

 

 

1,432

 

Loss on extinguishment of debt

 

 

4,708

 

 

 

Stock-based compensation

 

 

10,211

 

 

572

 

Excess tax benefit from exercise or vesting of equity awards

 

 

(225)

 

 

 —

 

Deferred taxes

 

 

(7,769)

 

 

1,970

 

Income tax receivable agreement expense

 

 

7,835

 

 

 —

 

Non-cash charge related to interest rate swap

 

 

850

 

 

494

 

Non-cash rent charges

 

 

920

 

 

354

 

Change in operating assets and liabilities, net of acquisitions:

 

 

 

 

 

 

 

Accounts receivable

 

 

15

 

 

(3,979)

 

Inventories

 

 

(499)

 

 

(7)

 

Prepaid expenses and other current assets

 

 

1,305

 

 

(1,864)

 

Other assets

 

 

692

 

 

(1,237)

 

Accounts payable

 

 

944

 

 

(684)

 

Accrued compensation and benefits

 

 

2,965

 

 

5,226

 

Accrued expenses and other liabilities

 

 

13,363

 

 

2,608

 

Cash provided by operating activities

 

 

89,004

 

 

61,818

 

 

 

 

 

 

 

 

 

Investing activities

 

 

 

 

 

 

 

Purchases of property, equipment and intangible assets

 

 

(34,221)

 

 

(27,892)

 

Cash paid for acquisitions

 

 

(800)

 

 

(600)

 

Cash used in investing activities

 

 

(35,021)

 

 

(28,492)

 

 

 

 

 

 

 

 

 

Financing activities

 

 

 

 

 

 

 

Proceeds from issuance of common stock sold in initial public offering, net of underwriting discounts and offering expense

 

 

175,378

 

 

 —

 

Proceeds from issuance of long-term debt

 

 

60,000

 

 

 —

 

Cash paid for debt issuance and other financing costs

 

 

(1,350)

 

 

 —

 

Proceeds from term loans, net of deferred financing costs

 

 

39,764

 

 

34,485

 

Payments on long-term debt

 

 

(255,806)

 

 

(13,411)

 

Payments on capital lease obligations

 

 

 —

 

 

(5)

 

Dividends and dividend equivalents paid

 

 

(30,176)

 

 

 —

 

Proceeds from issuance of common stock   

 

 

 —

 

 

156

 

Excess tax benefit from exercise or vesting of equity awards

 

 

225

 

 

 

Common stock repurchases for tax withholdings of  net settlement equity awards

 

 

(71)

 

 

(82)

 

Distributions to noncontrolling interests

 

 

(43,973)

 

 

(40,932)

 

Contributions from noncontrolling interests

 

 

4,441

 

 

2,416

 

Purchases of noncontrolling interests

 

 

(277)

 

 

(3,326)

 

Proceeds from sales of additional noncontrolling interests

 

 

142

 

 

329

 

Cash used in financing activities

 

 

(51,703)

 

 

(20,370)

 

 

 

 

 

 

 

 

 

Increase in cash

 

 

2,280

 

 

12,956

 

Cash at beginning of period

 

 

90,988

 

 

61,475

 

Cash at end of period

 

$

93,268

 

$

74,431

 

 

 

 

 

 

 

 

 

Supplemental Disclosure of Cash Flow Information

 

 

 

 

 

 

 

Cash paid for income taxes

 

$

5,376

 

$

4,262

 

Cash paid for interest

 

 

23,307

 

 

20,758

 

 

 

 

 

 

 

 

 

Supplemental Disclosure of Non-Cash Financing Activities

 

 

 

 

 

 

 

Accrued offering expense

 

 

314

 

 

 —

 

Tax Receivable Agreement

 

 

23,400

 

 

 —

 

Non-Cash Dividend

 

 

26,232

 

 

 —

 

Liability for accrued dividend equivalent payments

 

 

1,540

 

 

 —

 

 

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 June 30, 2016, the Company owned and operated 201 dialysis clinics treating 13,755 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.

 

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.  Refer to Note 8 – Long-Term Debt.  In connection to the IPO and the debt repayment, the Company incurred $2,215 of transaction-related costs for various legal, accounting, valuation and other professional and consulting services during the three and six months ended June 30, 2016.

 

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 audited consolidated financial statements as of December 31, 2015 and related notes included in our final prospectus for the IPO dated April 20, 2016 filed pursuant to Rule 424(b) under the Securities Act of 1933, as amended (the “Securities Act”), with the SEC (the “Prospectus”).  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.

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AMERICAN RENAL ASSOCIATES HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (continued)

(Unaudited)

(dollars in thousands, except per share amounts)

 

 

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. 

 

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, 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, the Chief Operating 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 March 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“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.  We are currently assessing the impact the adoption of ASU 2016-09 will have on our consolidated financial statements.

 

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842) – Leases: Amendments to the FASB Accounting Standards Codification. The amendments require organizations that lease assets – referred to as “lessees” – to recognize on the balance sheet the assets and liabilities for the rights and obligations created by those leases with terms of more than twelve months. ASU 2016-02 is effective for fiscal years beginning after December 15, 2019, and for interim periods within fiscal years beginning after December 15, 2020.  Early application is permitted for all organizations.  We are currently assessing the impact the adoption of ASU 2016-02 will have on our consolidated financial statements.

 

In August 2015, the FASB issued ASU 2015-15, Presentation and Subsequent Measurement of Debt Issuance Costs Associated with Line of Credit Arrangements. This ASU indicates that the guidance in ASU 2015-03 did not address presentation or subsequent measurement of debt issuance costs related to line of credit arrangements. Given the absence of authoritative guidance within ASU 2015-03, the SEC staff has indicated that they would not object to an entity deferring and presenting debt issuance costs as an asset and subsequently amortizing the costs ratably over the term of the line of credit arrangement, regardless of whether there are any outstanding borrowings on the line of credit arrangement. The Company adopted this standard in the first quarter ending March 31, 2016 and applied it retrospectively for all periods presented.  Debt issuance costs associated with the line of credit arrangements of $709 are presented in Other long term assets on the Company’s Consolidated Balance Sheet as of December 31, 2015.

 

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Table of Contents

AMERICAN RENAL ASSOCIATES HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (continued)

(Unaudited)

(dollars in thousands, except per share amounts)

 

In April 2015, the FASB issued ASU 2015-03, Interest—Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs. The amendments require that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. The amendments are effective beginning January 1, 2016. Early adoption is permitted. The Company adopted this standard in the first quarter ending March 31, 2016 and applied it retrospectively for all periods presented.  The impact of adopting the new accounting standard on the Company’s Consolidated Balance Sheet as of December 31, 2015, is a decrease in Other long-term assets and decrease in Long term debt of $1,191.  

 

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. 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 2% 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.

 

3. ACQUISITIONS

 

The Company periodically acquires the operating assets and liabilities of dialysis centers.  The results of operations for these acquisitions are included in the Company’s consolidated statements of operations from their respective acquisition consummation dates.

 

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AMERICAN RENAL ASSOCIATES HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (continued)

(Unaudited)

(dollars in thousands, except per share amounts)

 

On April 11, 2016, the Company acquired the assets of a dialysis center in New York.  The Company has a controlling interest in the joint venture.  The cash consideration paid was allocated preliminarily based on the estimated fair value, as follows:

 

 

 

 

 

 

Fixed Assets

    

$

122

 

Noncompete agreements

 

 

48

 

Goodwill

 

 

630

 

Purchase price

 

$

800

 

 

This acquisition was made to expand the Company’s market presence in New York.  The goodwill arising from this acquisition consists largely of synergies expected from combining the individual dialysis center’s operations with the Company.  This acquisition had an immaterial impact on the results of operations in this period.

 

The Company also incurred $18 of post-closing adjustments to goodwill related to past acquisitions.

 

 

 

4. 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.

 

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 June 30, 2016.

 

Noncontrolling interests subject to put provisions—See Note 7 for a discussion of the Company’s methodology for estimating fair value of noncontrolling interest subject to put provisions.

 

Interest rate swap agreements—See Note 8 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 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 12 – Related Party Transactions for further discussion of the Tax Receivable Agreement.

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Table of Contents

AMERICAN RENAL ASSOCIATES HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (continued)

(Unaudited)

(dollars in thousands, except per share amounts)

 

 

Transfers among levels are calculated on values as of the transfer date. There were no transfers between Levels 1, 2 and 3 during the six months ended June 30, 2016 and the year ended December 31, 2015.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

June 30, 2016

 

 

    

Total

    

Level 1

    

Level 2

    

Level 3

 

Assets

 

 

 

 

 

 

 

 

 

 

 

 

 

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

 

$

117

 

$

 —

 

$

117

 

$

 —

 

Liabilities

 

 

 

 

 

 

 

 

 

 

 

 

 

Tax Receivable Agreement Liability (included in Accrued expenses and other current liabilities and Income tax receivable agreement payable)

 

$

30,800

 

$

 —

 

$

 —

 

$

30,800

 

Interest rate swap agreements (included in Accrued expenses and other current liabilities)

 

 

820

 

 

 —

 

 

820

 

 

 —

 

Total Liabilities

 

$

31,620

 

$

 —

 

$

820

 

$

30,800

 

Temporary Equity

 

 

 

 

 

 

 

 

 

 

 

 

 

Noncontrolling interests subject to put provisions

 

$

134,762

 

$

 —

 

$

 —

 

$

134,762

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2015

 

 

    

Total

    

Level 1

    

Level 2

    

Level 3

 

Assets

 

 

 

 

 

 

 

 

 

 

 

 

 

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

 

$

238

 

$

 —

 

$

238

 

$

 —

 

Liabilities

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest rate swap agreements (included in Accrued expenses and other current liabilities

 

$

426

 

$

 —

 

$

426

 

$

 —

 

Temporary Equity

 

 

 

 

 

 

 

 

 

 

 

 

 

Noncontrolling interests subject to put provisions

 

$

108,211

 

$

 —

 

$

 —

 

$

108,211

 

 

The following table provides the fair value rollforward for the six months ended June 30, 2016 for the Tax receivable agreement liability, which is classified as a Level 3 financial instrument.

 

 

 

 

 

 

Balance at December 31, 2015

 

$

 -

 

Initial fair value as of April 20, 2016

 

 

23,400

 

Total realized/unrealized gains:

 

 

 

 

Included in earnings and reported as Income tax receivable agreement expense

 

 

7,400

 

Balance at June 30, 2016

 

$

30,800

 

 

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 $425,174 as of June 30, 2016 as compared to the carrying amount of $436,076. The Company estimates the fair value of the first lien term loans at $374,453 and second lien term loans at $237,963 as of December 31, 2015 compared to the carrying amounts of $378,235 and $238,559.  See Note 8 –Long-Term Debt for a discussion of the Company’s repayment of the second lien term loans. 

 

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Table of Contents

AMERICAN RENAL ASSOCIATES HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (continued)

(Unaudited)

(dollars in thousands, except per share amounts)

 

5. ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES

 

Accrued compensation and benefits consist of the following:

 

 

 

 

 

 

 

 

 

 

    

June 30, 2016

    

December 31, 2015

 

Accrued compensation

 

$

13,177

 

$

13,041

 

Accrued vacation pay

 

 

12,292

 

 

9,463

 

 

 

$

25,469

 

$

22,504

 

 

Accrued expenses and other current liabilities consist of the following:

 

 

 

 

 

 

 

 

 

 

    

June 30, 2016

    

December 31, 2015

 

Payor refunds and retractions

 

$

33,705

 

$

20,506

 

Other

 

 

11,937

 

 

6,282

 

 

 

$

45,642

 

$

26,788

 

 

 

6. VARIABLE INTEREST ENTITIES

 

The Company relies on the operating activities of certain entities that it does not directly own or control, 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 a majority voting interest and/or contractual rights granted to it provide the Company with the ability to direct the activities of these entities and 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.

 

NewCo

 

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 intercompany term loans (“assigned clinic loans”) provided to our joint venture subsidiaries by ARA OpCo to a newly formed entity, Term Loan Holdings LLC (“NewCo”), 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 NewCo, 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 $23,643 as of June 30, 2016. 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

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AMERICAN RENAL ASSOCIATES HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (continued)

(Unaudited)

(dollars in thousands, except per share amounts)

 

ownership interests in the applicable joint venture.  We guaranteed $12,529 of such assigned clinic loans as of June 30, 2016.

 

The Company has determined that we are not the primary beneficiary under VIE accounting guidance for NewCo. Based on our involvement with NewCo, we do not have the power to direct the activities which most significantly impact NewCo’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 NewCo is limited to the proportion of the assigned clinic loans which we guarantee. See Note 12 – Related Party Transactions.

 

7. 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 have the potential to accelerate as a result of an initial public offering of the Company. If these put provisions were exercised, the Company would be required to purchase 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 (12.5% - 17.5%) 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.

 

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AMERICAN RENAL ASSOCIATES HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (continued)

(Unaudited)

(dollars in thousands, except per share amounts)

 

8. DEBT

 

Long-term debt consists of the following:

 

 

 

 

 

 

 

 

 

 

    

June 30, 2016

    

December 31, 2015

 

First Lien Credit Agreement

 

$

436,076

 

$

378,235

 

Second Lien Credit Agreement

 

 

 —

 

 

238,559

 

Term Loans

 

 

107,483

(1)

 

59,578

 

Lines of Credit

 

 

16,572

 

 

12,818

 

Other

 

 

3,286

 

 

3,527

 

 

 

 

563,417

 

 

692,717

 

Less: discounts and fees, net of accumulated amortization

 

 

(5,040)

 

 

(9,735)

 

Less: current maturities

 

 

(40,579)

 

 

(25,610)

 

 

 

$

517,798

 

$

657,372

 

_____________________________

(1)

Includes assigned clinic loans 

 

Scheduled maturities of long-term debt as of June 30, 2016 are as follows: 

 

 

 

 

 

 

2016 (remainder)

    

$

19,419

 

2017

 

 

42,828

 

2018

 

 

35,589

 

2019

 

 

448,487

 

2020

 

 

12,302

 

Thereafter

 

 

4,792

 

 

 

$

563,417

 

 

During the six months ended June 30, 2016, the Company made mandatory principal payments of $2,159 under the First Lien Credit Agreement.

 

As of June 30, 2016, there were no borrowings outstanding under the Revolving Credit Facility as provided for under our First Lien Credit Agreement.

 

The following describes changes to our long term debt since March 31, 2016.

 

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.

 

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AMERICAN RENAL ASSOCIATES HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (continued)

(Unaudited)

(dollars in thousands, except per share amounts)

 

Interest Rate Swap Agreements

 

In May 2013, the Company entered into two interest rate swap agreements (the ‘‘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 Swaps are designated as a cash flow hedge, with a termination date of March 31, 2017. As a result of the application of hedge accounting treatment, to the extent the Swaps 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.

 

As of June 30, 2016 the interest rate swap continues to be ineffective, which was determined as of March 31, 2016.  Amounts previously recorded in accumulated other comprehensive loss related to these interest rate swaps, totaling $501, will be reclassified into earnings over the term of the previously hedged borrowing using the swaplet method.  The Company reclassified $100 and $200 previously recorded in accumulated other comprehensive loss into interest expense during the three and six months ended June 30, 2016, respectively.  The Company expects that the remaining $301 of unrealized losses will be reclassified out of accumulated other comprehensive loss and into interest expense, net over the next nine months.

 

As more fully described within Note 4, Fair Value of Financial Instruments, the Company uses a three-level fair value hierarchy that prioritizes the inputs used to measure fair value. The fair value of the Swaps 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, 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.

 

Clinic Loan Assignment and NewCo Distribution

 

On April 26, 2016, the Company transferred substantially all of the assigned clinic loans provided to our joint venture subsidiaries by ARA OpCo to NewCo, which ownership interest was distributed to our pre-IPO stockholders pro rata in accordance with their ownership in the Company.  The balance of such assigned clinic loans was $26,135 as of April 26, 2016 and $23,643 as of June 30, 2016.  As a result of the distribution of membership interests in NewCo (the “NewCo Distributions”), the balance of such assigned clinic loans was reflected on our consolidated balance sheet beginning on the date the assigned clinic loans were transferred.  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 $13,840 of such assigned clinic loans as of April 20, 2016, which is the record date set by the board of directors of the Company for this distribution, and $12,529 as of June 30, 2016.

 

9. 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 June 30, 2016 and 2015 was  (9.36%)  and 12.59%, respectively, and 4.04% and 11.72% for the six months ended June 30, 2016 and 2015, respectively. These rates

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (continued)

(Unaudited)

(dollars in thousands, except per share amounts)

 

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, as well as the change in fair value of the TRA liability, which is not deductible for income tax purposes. 

 

10. STOCK-BASED COMPENSATION

 

For the three and six months ended June 30, 2016 and 2015, stock-based compensation expense was reflected in the accompanying consolidated statements of operations as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended June 30,

 

Six Months Ended June 30,

 

 

    

2016

    

2015

    

2016

    

2015

 

Patient care costs

 

$

1,520

 

$

67

 

$

1,613

 

$

126

 

General and administrative

 

 

8,318

 

 

230

 

 

8,611

 

 

477

 

Total stock-based compensation before tax

 

$

9,838

 

$

297

 

$

10,224

 

$

603

 

Income tax benefit

 

 

(3,935)

 

 

(119)

 

 

(4,090)

 

 

(241)

 

 

As of June 30, 2016, the Company has 5,735,942 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 June 30, 2016, options to purchase an aggregate of 3,988,550 shares of common stock are available for future grants under the 2016 Plan. 

 

During the three and six months ended June 30, 2016, the Company granted options to purchase 11,450 shares of common stock under the 2016 Plan.  The options are subject to vesting terms over three years and have a weighted average exercise price of $27.53.  

 

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:

 

 

 

 

 

 

 

 

Six Months Ended June 30,

 

 

    

2016

 

Expected volatility

 

 

25.00%

 

Expected term in years

 

 

6.0

 

Risk-free interest rate

 

 

1.20%

 

Expected annual dividend yield

 

 

0%

 

Weighted-average grant-date fair value

 

 

$27.53

 

 

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 becomes due upon vesting for unvested options.  This resulted in a modification.  Additionally, in connection with the cash dividend, the Company has made payments to date equal to $1.30 per share, or $1,119  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 $6,226.  

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AMERICAN RENAL ASSOCIATES HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (continued)

(Unaudited)

(dollars in thousands, except per share amounts)

 

 

In connection with the NewCo Distribution, as described in Note 8, the Company also equitably adjusted the outstanding stock options by reducing exercise prices and making cash dividend equivalent payments of $2,533, of which  $171 was paid to vested option holders and $2,362 is payable to unvested option holders only if such unvested options become vested. Options were also equitably adjusted for the TRA, as described in Note 12.  Options were adjusted by reducing exercise prices and, if necessary, increasing the number of shares subject to such stock options. 

 

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 $8,705 in incremental compensation expense and $743 of stock compensation expense due to transactions at the time of the IPO during the three months ended June 30, 2016. As of June 30, 2016, the Company had $44,487 of unrecognized compensation costs related to unvested share-based compensation arrangements.

 

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AMERICAN RENAL ASSOCIATES HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (continued)

(Unaudited)

(dollars in thousands, except per share amounts)

 

11. EARNINGS (LOSS) 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. 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 June 30,

 

Six Months Ended June 30,

 

 

    

2016

    

2015

    

2016

    

2015

 

Basic

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income (loss) attributable to American Renal Associates Holdings, Inc.

 

$

(9,092)

 

$

5,022

 

$

(5,336)

 

$

7,898

 

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

 

 

(12,133)

 

 

 

 

(12,133)

 

 

 

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

 

$

(21,225)

 

$

5,022

 

$

(17,469)

 

$

7,898

 

Weighted-average common shares outstanding

 

 

28,406,999

 

 

22,124,805

 

 

25,344,510

 

 

22,116,155

 

Earnings (loss) per share, basic

 

$

(0.75)

 

$

0.23

 

$

(0.69)

 

$

0.36

 

Diluted

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income (loss) attributable to American Renal Associates Holdings, Inc.

 

$

(9,092)

 

$

5,022

 

$

(5,336)

 

$

7,898

 

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

 

 

(12,133)

 

 

 

 

(12,133)

 

 

 

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

 

$

(21,225)

 

$

5,022

 

$

(17,469)

 

$

7,898

 

Weighted-average common shares outstanding, basic

 

 

28,406,999

 

 

22,124,805

 

 

25,344,510

 

 

22,116,155

 

Weighted-average effect of dilutive securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

Effect of assumed exercise of stock options

 

 

 —

 

 

532,570

 

 

 —

 

 

517,308

 

Weighted-average common shares outstanding, diluted

 

 

28,406,999

 

 

22,657,375

 

 

25,344,510

 

 

22,633,463

 

Earnings (loss) per share, diluted

 

$

(0.75)

 

$

0.22

 

$

(0.69)

 

$

0.35

 

Outstanding options excluded as impact would be anti-dilutive

 

 

555,329

 

 

10,541

 

 

336,133

 

 

9,558

 

 

 

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AMERICAN RENAL ASSOCIATES HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (continued)

(Unaudited)

(dollars in thousands, except per share amounts)

 

 

12. RELATED PARTY TRANSACTIONS

 

NewCo

 

In 2016, the Company transferred substantially all of the assigned clinic loans provided to our joint venture subsidiaries to NewCo, as described in Note 6 – Variable Interest Entities. A Centerbridge entity, which does not hold any economic interest in NewCo, is the manager of NewCo, and affiliates of Centerbridge and our executive officers own economic interests in NewCo.  As of June 30, 2016, such assigned clinic loans aggregated $23,643 had maturities ranging from November 2016 to September 2020, with a weighted average maturity of approximately 3.4 years (May 2019), and interest rates ranging from 3.46% to 8.08%, with a weighted average interest rate of 5.12%. 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 terms of a loan servicing agreement as entered into between the Company and NewCo (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 NewCo. The quarterly fee charged for the three months ended June 30, 2016 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 $23,643, of which we guaranteed $12,529 as of June 30, 2016.  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.  The Company recorded an estimated liability of $23,400 based on the fair value of the TRA as of April 20, 2016.  As of June 30, 2016, the Company’s total liability under the TRA is estimated to be $31,235, of which $3,435 is included as a component of other accrued expenses on the condensed consolidated balance sheet. 

 

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 six months ended June 30, 2016 and 2015, the Company recorded $537 and  $970  of expense related to this agreement, respectively. Centerbridge was also entitled to receive an additional fee equal to 1.0% 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).

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AMERICAN RENAL ASSOCIATES HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (continued)

(Unaudited)

(dollars in thousands, except per share amounts)

 

 

Due from Related Party

 

In 2014, the Company entered into a revolving note agreement with an executive allowing for $2,000 of borrowing availability. The revolving note was recourse and was secured by a pledge of a portion of the Company’s common stock owned by the executive.  The note provided for interest at the Eurodollar base rate subject to a floor of  1.25% plus a margin of 3.25% and a maturity of 2019. On August 28, 2015, the Company agreed to forgive all indebtedness and accrued interest thereunder, and canceled the revolving note agreement with the executive. There were approximately $2,105 in outstanding borrowings and accrued interest which was expensed as transaction-related costs

 

13. COMMITMENTS AND CONTINGENCIES

 

Income Tax Receivable Agreement

 

As described in Note 12 – Related Party Transactions, 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.  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, whether and when any Relevant Stock Options are exercised and the value of our common stock at the time of such exercise.   

 

Professional Liability Coverage

 

The Company maintains professional liability insurance coverage on a claims-made basis. Under this type of policy, claims based on occurrences during its term, but reported subsequently, will be uninsured should the policy not be renewed or replaced with other coverage. Management expects to be able to obtain renewal or other coverage in future periods, and has accrued the estimated cost associated with coverage of past occurrences reported in subsequent periods.

 

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 its financial position, results of operations or cash flows.

 

ARAH and 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 on July 1, 2016. The complaint relates to 27 patients who have received, and some of whom continue to receive, dialysis at 12 clinics in Florida and Ohio and who elected to obtain coverage under one of United’s Affordable Care Act (“ACA”) insurance products, 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, health care kickbacks, patient brokering, and violations of the applicable commercial plan agreements in connection with, among other things, premium payment assistance by a third party charitable organization.  The complaint seeks 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 believes this lawsuit is without merit and the Company intends to vigorously defend itself in this legal matter.  On July 26, 2016, the Staff of the Securities and Exchange Commission (the “SEC”) sent a letter to the Company stating that it is conducting an inquiry and requesting that ARAH provide certain documents and information relating to the subject matter covered by the United complaint described above.  The Company intends to respond to this request and to

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (continued)

(Unaudited)

(dollars in thousands, except per share amounts)

 

fully cooperate with SEC Staff.   No assurance can be given as to the timing or outcome of these matters, nor can any assurance be given as to whether the filing of this lawsuit and any inquiries will affect the Company’s other relationships, or the Company’s business generally.

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

 

14. SUBSEQUENT EVENTS

 

The Company was named as a defendant in a complaint filed by three affiliates of UnitedHealth Group Inc. (“United”) in the United States District Court of the Southern District of Florida on July 1, 2016.  Refer to Note 13 – “Commitments and Contingencies”. 

 

 

 

 

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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 respective consolidated financial statements and related footnotes included in both Part I of this Form 10-Q and the Company’s prospectus (the “Prospectus”), dated April 20, 2016, filed with the Securities and Exchange Commission pursuant to Rule 424(b) of the Securities Act of 1933, as amended, which is deemed to be part of the Company’s Registration Statement on Form S-1 (File No. 333-206686), as amended (the “Registration Statement”), as well as the section of the Prospectus entitled Management’s Discussion and Analysis of Financial Condition and Results of Operations. On April 26, 2016, the Company 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).

 

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 Prospectus.  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

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clinics. We believe that this enhances patient and staff satisfaction and retention, clinical outcomes, patient growth, and operational and financial performance.

 

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 June 30, 2016, we had developed 151 de novo clinics and 50 acquired clinics. The following table shows the number of de novo and acquired clinics over the periods indicated: 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended June 30,

 

Six Months Ended June 30,

 

 

    

2016

    

2015

    

2016

    

2015

 

De novo clinics(1)

 

6

 

5

 

8

 

6

 

Acquired clinics(2)

 

1

 

 —

 

1

 

1

 

Total new clinics

 

7

 

5

 

9

 

7

 


 

 

(1)

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

 

 

(2)

Clinics acquired by us in the applicable period.

 

De novo clinics. We have primarily grown through de novo clinic development. A typical de novo facility requires approximately $1.3 to $1.7 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 June 30, 2016 and June 30, 2015 our development capital expenditures were $14.9 million and $14.2 million, respectively, representing 8.0% and 8.8% of our net revenues, respectively.

 

Our results of operations have been and will continue to be materially affected by the timing and number of openings, and 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 15% of our de novo clinics have exceeded six months from first treatment to positive clinic-level monthly EBITDA, 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.

 

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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

 

2016

 

2

 

6

 

 —

 

 —

 

8

 

2015

 

1

 

5

 

6

 

4

 

16

 

2014

 

2

 

4

 

3

 

6

 

15

 

2013

 

1

 

3

 

2

 

11

 

17

 

 

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 June 30, 2016, we added 139 dialysis stations to our existing clinics, representing the equivalent of nearly eight de novo clinics.

 

Acquired clinics. Our results of operations have been and will continue to be affected by the timing and number of our acquisitions. We have also grown through acquisitions of existing clinics. 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 June 30,

 

Six Months Ended June 30,

 

Source of Treatment Growth:

    

2016

    

2015

 

2016

    

2015

 

Non-acquired treatment growth(1)

 

10.8

%  

11.7

%  

12.6

%  

10.7

%

Acquired treatment growth(2)

 

1.0

%  

4.4

%  

0.7

%  

4.4

%

Total treatment growth

 

11.8

%  

16.1

%  

13.3

%  

15.1

%


 

 

(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 and 2015, the Medicare ESRD PPS payment rates for our clinics were approximately $248 and $247, respectively, per treatment. The ESRD PPS final rule for 2016 released on October 29, 2015 (the “2016 Final Rule”) lowered the base rate from $239.43 to $230.39 and modified criteria for certain rate adjustments. Due to the various adjusters, the changes in the Medicare payment rates for 2016 will not be material to us. 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

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commercial payors, which pay us either negotiated payment rates or based on 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 erythropoietin (“EPO”) and other pharmaceuticals.

 

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 ended December 31, 2015, commercial payors and others, including the veterans administration, accounted for an average of approximately 13% of the treatments we performed, while the average for the last four quarters ended June 30, 2016 is 16%. The change in the mix of patients and treatments has largely been driven by enrollment in available medical coverage including ACA insurance products and other commercial insurance products.

 

The following table summarizes our patient service operating revenues by source for the periods indicated.

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended June 30,

 

Six Months Ended June 30,

 

Source of Revenues:

    

2016

    

2015

    

2016

    

2015

 

Government-based and other(1)

 

54.7

%  

58.2

%  

56.0

%  

59.2

%

Commercial and other(2)

 

45.3

%  

41.8

%  

44.0

%  

40.8

%

 

 

100.0

%  

100.0

%  

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 veterans administration, which we refer to collectively as “Commercial and other”.

 

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 proposed rule for 2017 was released on June 24, 2016 by CMS (the “2017 Proposed Rule”).  The 2017 Proposed Rule includes a base rate of $231.04, representing a $0.65 increase from the 2016 base rate of $230.39. CMS has estimated that the 2017 Proposed Rule, if finalized as proposed, would result in an overall increase of payments to ESRD facilities of 0.5%. See ‘‘Risk Factors—Future adjustments to the ESRD PPS implemented by CMS could have a negative impact upon our Medicare program revenues.’’

 

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 EPO and Aranesp, and medical supplies. The price of EPO supplied by Amgen increased for us in 2016 while the price of Aranesp decreased.  In the future any such increase in price of EPO or Aranesp could adversely affect our operating results and financial condition. We may not have access to certain other ESAs that may be more cost-effective and due to product delays and availability, we expect our clinics will predominantly be using EPO and Aranesp 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 EPO or Aranesp. Increased utilization of EPO or Aranesp 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, such as the current shortage of peritoneal dialysis solution affecting dialysis providers throughout the United States, 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.

 

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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 which may 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.

 

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.

 

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 June 30, 2016, we had approximately $44.5 million of unrecognized compensation costs related to unvested share-based compensation arrangements of which $40.3 million is attributable to share-based awards with market and performance conditions and $4.2 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 three 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 of membership interests in an entity holding assigned clinic loans (the “NewCo Distributions”), since the interest on these loans will no longer be eliminated in consolidation, we expect to incur additional interest expense. This increase in interest expense is expected to be offset by the reduction in interest expense as a result of the refinancing of our second lien term loans.

 

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. See "Certain Relationships and Related Party Transactions—Income Tax Receivable Agreement” in the Prospectus. 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 initial public offering 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 12 to the consolidated financial statements included in Part I of this Form 10-Q.  In addition, we expect to incur additional legal expenses in connection with the United Healthcare litigation described below and related matters.

 

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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 24, 2014 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 June 30,

 

Six Months Ended June 30,

 

Operating Data and Other Non-GAAP Financial Data:

    

2016

    

2015

 

2016

    

2015

 

Number of clinics (as of end of period)

 

 

201

 

 

181

 

 

201

 

 

181

 

Number of de novo clinics opened (during period)

 

 

6

 

 

5

 

 

8

 

 

6

 

Patients (as of end of period)

 

 

13,755

 

 

12,300

 

 

13,755

 

 

12,300

 

Number of treatments

 

 

498,368

 

 

445,695

 

 

981,034

 

 

865,661

 

Non-acquired treatment growth

 

 

10.8

%  

 

11.7

%  

 

12.6

%  

 

10.7

%

Patient service operating revenues per treatment

 

$

375

 

$

365

 

$

367

 

$

361

 

Patient care costs per treatment

 

$

220

 

$

216

 

$

219

 

$

217

 

Adjusted patient care costs per treatment (1)

 

$

217

 

$

216

 

$

218

 

$

217

 

General and administrative expenses per treatment

 

$

64

 

$

45

 

$

54

 

$

43

 

Adjusted general and administrative expenses per treatment (2)

 

$

47

 

$

45

 

$

46

 

$

43

 

Provision for uncollectible accounts per treatment

 

$

3

 

$

2

 

$

3

 

$

2

 

Adjusted EBITDA (including noncontrolling interests) (in thousands)(3)

 

$

54,118

 

$

46,143

 

$

100,138

 

$

86,874

 

Adjusted EBITDA-NCI (in thousands) (3)

 

$

31,630

 

$

27,984

 

$

58,849

 

$

53,011

 

 


 

 

(1)

Excludes $1.4 million of stock compensation expense as a result of modifications during the three months ended June 30, 2016.

 

 

(2)

Excludes $8.0 million of stock compensation expense as a result of modifications and other one-time stock compensation expense as a result of transactions at the time of the IPO during the three months ended June 30, 2016.

 

 

(3)

See “Non-GAAP Financial Measures” below.

 

 

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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.

 

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.

 

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, 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 decisions that are outside the operational control of management and can differ significantly from company to company depending

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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 it 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 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.

 

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.

 

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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 June 30,

 

Six Months Ended June 30,

 

(in thousands)

    

2016

    

2015

    

2016

    

2015

 

Net Income

 

$

13,396

 

$

23,181

 

$

35,953

 

$

41,761

 

Add:

 

 

 

 

 

 

 

 

 

 

 

 

 

Stock-based compensation

 

 

9,838

 

 

297

 

 

10,224

 

 

603

 

Depreciation and amortization

 

 

8,252

 

 

7,431

 

 

15,929

 

 

15,172

 

Interest expense, net

 

 

8,941

 

 

11,361

 

 

21,199

 

 

22,823

 

Income tax (benefit) expense

 

 

(1,147)

 

 

3,338

 

 

1,514

 

 

5,545

 

Transaction-related costs(a)

 

 

2,215

 

 

 —

 

 

2,239

 

 

 —

 

Loss on early extinguishment of debt(b)

 

 

4,708

 

 

 —

 

 

4,708

 

 

 —

 

Income tax receivable agreement expense(c)

 

 

7,835

 

 

 —

 

 

7,835

 

 

 —

 

Management fee(d)

 

 

80

 

 

535

 

 

537

 

 

970

 

Adjusted EBITDA (including noncontrolling interests)

 

 

54,118

 

 

46,143

 

 

100,138

 

 

86,874

 

Less: Net income attributable to noncontrolling interests

 

 

(22,488)

 

 

(18,159)

 

 

(41,289)

 

 

(33,863)

 

Adjusted EBITDA –NCI

 

$

31,630

 

$

27,984

 

$

58,849

 

$

53,011

 

 


 

 

(a)

Represents costs related to debt refinancing and other transactions. See “Note 8 – Debt.”

 

 

(b)

Represents costs related to debt refinancing. See “Note 8 – Debt.”

 

 

(c)

Represents costs related to Income tax receivable agreement. See “Note 4 – Fair Value Measurement.”

 

 

(d)

Represents management fees paid to Centerbridge. See “Note 12-Related Party Transactions.”

 

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.

 

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.

 

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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.

 

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, Loss on Early Extinguishment of Debt, 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.

 

Loss on early extinguishment of debt.  Loss on early extinguishment of debt represents the write-off of unamortized debt issuance costs.

 

Income tax receivable agreement expense. Income tax receivable agreement expense is the expense associated with the change in the fair value of the TRA.

 

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 100% of the equity interests in these consolidated entities. 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.’’

 

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Results of Operations

 

Three Months Ended June 30, 2016 Compared With Three Months Ended June 30, 2015

 

The following table summarizes our results of operations for the periods indicated.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended June 30,

 

Increase (Decrease)

 

 

 

 

 

 

 

 

 

 

 

 

Percentage

 

 

    

2016

    

2015

    

Amount

    

Change

 

Patient service operating revenues

 

$

186,938

 

$

162,585

 

$

24,353

 

15.0

%  

Provision for uncollectible accounts

 

 

(1,371)

 

 

(1,084)

 

 

(287)

 

26.5

%  

Net patient service operating revenues

 

 

185,567

 

 

161,501

 

 

24,066

 

14.9

%  

Operating expenses:

 

 

 

 

 

 

 

 

 

 

 

 

Patient care costs

 

 

109,719

 

 

96,103

 

 

13,616

 

14.2

%  

General and administrative

 

 

31,648

 

 

20,087

 

 

11,561

 

57.6

%  

Transaction-related costs

 

 

2,215

 

 

 —

 

 

2,215

 

NM

%  

Depreciation and amortization

 

 

8,252

 

 

7,431

 

 

821

 

11.0

%  

Total operating expenses

 

 

151,834

 

 

123,621

 

 

28,213

 

22.8

%  

Operating income

 

 

33,733

 

 

37,880

 

 

(4,147)

 

(10.9)

%  

Interest expense, net

 

 

8,941

 

 

11,361

 

 

(2,420)

 

(21.3)

%  

Loss on early extinguishment of debt

 

 

4,708

 

 

 —

 

 

4,708

 

NM

%  

Income tax receivable agreement expense

 

 

7,835

 

 

 —

 

 

7,835

 

NM

%  

Income before income taxes

 

 

12,249

 

 

26,519

 

 

(14,270)

 

(53.8)

%  

Income tax expense

 

 

(1,147)

 

 

3,338

 

 

(4,485)

 

NM

%  

Net income

 

 

13,396

 

 

23,181

 

 

(9,785)

 

(42.2)

%  

Less: Net income attributable to noncontrolling interests

 

 

(22,488)

 

 

(18,159)

 

 

(4,329)

 

23.8

%  

Net income (loss) attributable to American Renal Associates Holdings, Inc.

 

$

(9,092)

 

$

5,022

 

$

(14,114)

 

(281.0)

%  

 

NM – Not Meaningful

 

Net Patient Service Operating Revenues

 

Patient service operating revenues. Patient service operating revenues for the three months ended June 30, 2016 were $186.9 million, an increase of 15.0% from $162.6 million for the three months ended June 30, 2015. The increase in patient service operating revenues was primarily due to an increase of approximately 11.8% in the number of dialysis treatments. The increase in treatments resulted principally from non-acquired treatment growth of 10.8% from existing clinics and de novo clinics. Patient service operating revenues relating to start-up clinics for the three months ended June 30, 2016 were $2.2 million compared to $1.5 million for the three months ended June 30, 2015, an increase of $0.7 million due to the timing of opening de novo clinics which increase was limited by delays in certifications of de novo clinics. Patient service operating revenues per treatment for the three months ended June 30, 2016 was $375 compared with $365 for the three months ended June 30 2015 driven by a meaningful improvement in commercial and other mix, primarily related to an increase in patients covered by ACA and other commercial insurance products. As a source of revenue by payor type, government-based and other payors accounted for 54.7% and 58.2%, respectively, of our revenues for the three months ended June 30, 2016 and 2015. 

 

Provision for uncollectible accounts. Provision for uncollectible accounts for the three months ended June 30, 2016 was $1.4 million, or 0.7% of net patient service operating revenues, as compared to $1.0 million, or 0.7% of net patient service operating revenues, for the same period in 2015. Our accounts receivable, net of the bad debt allowance, represented approximately 38 and 42 days of patient service operating revenues as of June 30, 2016 and 2015 respectively.

 

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Operating Expenses  

 

Patient care costs. Patient care costs for the three months ended June 30, 2016 were $109.7 million, an increase of 14.2% from $96.1 million for the three months ended June 30, 2015. This increase was primarily due to an increase in the number of treatments as well as $1.4 million of Modification Expense described above. As a percentage of net patient service operating revenues, patient care costs were approximately 59.1% for the three months ended June 30, 2016 compared to 59.5% for the three months ended June 30, 2015. The decrease was primarily attributable to higher revenues per treatment described above and lower ancillary and pharmaceutical costs as a percentage of net patient service operating revenues, offset 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 June 30, 2016 were $220, compared to $216 for the three months ended June 30, 2015.  Patient care costs per treatment excluding the Modification Expense were $217 for the three months ended June 30, 2016.

 

General and administrative expenses. General and administrative expenses for the three months ended June 30, 2016 were $31.6 million, an increase of 57.6% from $20.1 million for the three months ended June 30, 2015, primarily due to corporate costs associated with becoming a public company, including $8.0 million of Modification Expense described above and other one-time stock compensation charges as a result of transactions at the time of the IPO, and an increase in the number of treatments. As a percentage of net patient service operating revenues, general and administrative expenses were approximately 17.1% for the three months ended June 30, 2016 compared to 12.4% for the three months ended June 30, 2015. General and administrative expenses per treatment for the three months ended June 30, 2016 were $64, compared to $45 for the three months ended June 30, 2015.  General and administrative expenses per treatment excluding the Modification Expense were $47 for the three months ended June 30, 2016.  The increase is primarily attributable to costs associated with becoming a public company.

 

Transaction-related costs. Transaction-related costs for the three months ended June 30, 2016 was $2.2 million, or 1.2% of net patient service operating revenues.  These costs are associated with our debt restructuring and other transactions associated with our IPO.  No transaction-related costs were incurred in the three months ended June 30, 2015.

 

Depreciation and amortization. Depreciation and amortization expense for the three months ended June 30, 2016 was $8.3 million, compared to $7.4 million for the three months ended June 30, 2015. As a percentage of net patient service operating revenues, depreciation and amortization expense was approximately 4.4% for the three months ended June 30, 2016 compared to 4.6% for the three months ended June 30, 2015.

 

Operating Income

 

Operating income for the three months ended June 30, 2016 was $33.7 million, a decrease of $4.1 million, or 10.9%, from $37.9 million for the three months ended June 30, 2015. The decrease was primarily due to the factors described above, but was partially offset by the impact of the rebasing reimbursement environment for Medicare. In addition, for the three months ended June 30, 2016 and 2015, start-up clinics reduced operating income by $3.5 million and $1.7 million, respectively, an increase of $1.6 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 18.2% for the three months ended June 30, 2016 compared to 23.5% for the three months ended June 30, 2015, reflecting the factors described above. Excluding the impact of the Modification Expense of $9.4 million, as a percentage of net patient service operating revenues, operating income was 23.3% for the three months ended June 30, 2016 compared to 23.5% for the three months ended June 30, 2015, reflecting the factors described above.

 

Interest and Taxes

 

Interest expense, net. Interest expense, net for the three months ended June 30, 2016 was $8.9 million, and $11.4 million for the three months ended June 30, 2015, a decrease of 21.3% primarily due to our debt refinancing.

 

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Loss on early extinguishment of debt. Loss on early extinguishment of debt for the three months ended June 30, 2016 was $4.7 million as a result of our debt refinancing activities.  The loss was comprised of a write-off of unamortized debt issuance costs.

 

Income tax receivable agreement expense.  Income tax receivable agreement expense for the three months ended June 30, 2016 was $7.8 million.  These costs represent the change in the fair value of the TRA during the period. 

 

Income tax expense (benefit).  The provision (benefit) for income taxes for the three months ended June 30, 2016 and June 30, 2015 represented an effective tax rate of (9.36%) and 12.59%, respectively. The variation from the statutory federal rate of 35% on our share of pre-tax income during the three months ended June 30, 2016 and 2015 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 June 30, 2016 was

$22.5 million, representing an increase of 23.8% from $18.2 million for the three months ended June 30, 2015. The increase was primarily due to growth in the earnings of our existing joint ventures.

 

Six Months Ended June 30, 2016 Compared With Six Months Ended June 30, 2015

 

The following table summarizes our results of operations for the periods indicated.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Six Months Ended June 30,

 

Increase (Decrease)

 

 

 

 

 

 

 

 

 

 

 

 

Percentage

 

 

    

2016

    

2015

    

Amount

    

Change

 

Patient service operating revenues

 

$

360,492

 

$

312,929

 

$

47,563

 

15.2

%

Provision for uncollectible accounts

 

 

(2,794)

 

 

(2,105)

 

 

(689)

 

32.7

%

Net patient service operating revenues

 

 

357,698

 

 

310,824

 

 

46,874

 

15.1

%

Operating expenses:

 

 

 

 

 

 

 

 

 

 

 

 

Patient care costs

 

 

215,174

 

 

188,233

 

 

26,941

 

14.3

%

General and administrative

 

 

53,147

 

 

37,290

 

 

15,857

 

42.5

%

Transaction-related costs

 

 

2,239

 

 

 —

 

 

2,239

 

NM

%

Depreciation and amortization

 

 

15,929

 

 

15,172

 

 

757

 

5.0

%

Total operating expenses

 

 

286,489

 

 

240,695

 

 

45,794

 

19.0

%

Operating income

 

 

71,209

 

 

70,129

 

 

1,080

 

1.5

%

Interest expense, net

 

 

21,199

 

 

22,823

 

 

(1,624)

 

(7.1)

%

Loss on early extinguishment of debt

 

 

4,708

 

 

 —

 

 

4,708

 

NM

%

Income tax receivable agreement expense

 

 

7,835

 

 

 —

 

 

7,835

 

NM

%

Income before income taxes

 

 

37,467

 

 

47,306

 

 

(9,839)

 

(20.8)

%

Income tax expense

 

 

1,514

 

 

5,545

 

 

(4,031)

 

NM

%

Net income

 

 

35,953

 

 

41,761

 

 

(5,808)

 

(13.9)

%

Less: Net income attributable to noncontrolling interests

 

 

(41,289)

 

 

(33,863)

 

 

(7,426)

 

21.9

%

Net income (loss) attributable to American Renal Associates Holdings, Inc.

 

$

(5,336)

 

$

7,898

 

$

(13,234)

 

(167.6)

%

 

NM – Not Meaningful

 

Net Patient Service Operating Revenues

 

Patient service operating revenues. Patient service operating revenues for the six months ended June 30, 2016 were $360.5 million, an increase of 15.2% from $312.9 million for the six months ended June 30, 2015. The increase in patient service operating revenues was primarily due to an increase of approximately 13.3% in the number of dialysis treatments. The increase in treatments resulted principally from non-acquired treatment growth of 12.6% from existing clinics and de novo clinics. The Company estimates that the extra leap year day during the six months ended June 30,

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2016 added approximately 0.7% to the non-acquired growth rate during the period. Patient service operating revenues relating to start-up clinics for the six months ended June 30, 2016 were $4.0 million compared to $5.2 million for the six months ended June 30, 2015, a decrease of $1.2 million due to the timing of opening and delays in certification of de novo clinics. Patient service operating revenues per treatment for the six months ended June 30, 2016 was $367 compared with $361 for the six months ended June 30 2015 driven by a meaningful improvement in commercial and other mix, primarily related to an increase in patients covered by ACA and other commercial insurance products. As a source of revenues, government-based and other payors accounted for 56.0% and 59.2%, respectively, of our revenues for the six months ended June 30, 2016 and 2015. 

 

Provision for uncollectible accounts. Provision for uncollectible accounts for the six months ended June 30, 2016 was $2.8 million, or 0.8% of net patient service operating revenues, as compared to $2.1 million, or 0.7% of net patient service operating revenues, for the same period in 2015. Our accounts receivable, net of the bad debt allowance, represented approximately 38 and 42 days of patient service operating revenues as of both June 30, 2016 and 2015 respectively.

 

Operating Expenses  

 

Patient care costs. Patient care costs for the six months ended June 30, 2016 were $215.2 million, an increase of 14.3% from $188.2 million for the six months ended June 30, 2015. This increase was primarily due to an increase in the number of treatments. As a percentage of net patient service operating revenues, patient care costs were approximately 60.2% for the six months ended June 30, 2016 compared to 60.6% for the six months ended June 30, 2015. The decrease was primarily attributable to personnel cost increases and the Modification Expense of $1.4 million, offset by lower ancillary and pharmaceutical costs as a percentage of net patient service operating revenues. Patient care costs per treatment for the six months ended June 30, 2016 and 2015 were $219 and $217, respectively. 

 

General and administrative expenses. General and administrative expenses for the six months ended June 30, 2016 were $53.1 million, an increase of 42.5% from $37.3 million for the six months ended June 30, 2015, primarily due to an increase in corporate costs associated with becoming a public company, including the Modification Expense of $8.0 million and one-time stock compensation as a result of transactions at the time of the IPO. As a percentage of net patient service operating revenues, general and administrative expenses were approximately 14.9% for the six months ended June 30, 2016 compared to 12.0% for the six months ended June 30, 2015. General and administrative expenses per treatment for the six months ended June 30, 2016 were $54, compared to $43 for the six months ended June 30, 2015.  General and administrative expenses per treatment excluding the applicable Modification Expense are $46 for the six months ended June 30, 2016.

 

Transaction-related costs. Transaction-related costs for the six months ended June 30, 2016 was $2.2 million.  These costs are associated with our debt refinancing and other transactions associated with our IPO.  No transaction-related costs were incurred in the six months ended June 30, 2015.

 

Depreciation and amortization. Depreciation and amortization expense for the six months ended June 30, 2016 was $15.9 million, compared to $15.2 million for the six months ended June 30, 2015. As a percentage of net patient service operating revenues, depreciation and amortization expense was approximately 4.5% for the six months ended June 30, 2016 compared to 4.9% for the six months ended June 30, 2015.

 

Operating Income

 

Operating income for the six months ended June 30, 2016 was $71.2 million, an increase of $1.1 million, or 1.5%, from $70.1 million for the six months ended June 30, 2015. The increase was primarily due to the factors described above, but was partially offset by the impact of the rebasing reimbursement environment for Medicare. In addition, for the six months ended June 30, 2016 and 2015, start-up clinics reduced operating income by $5.7 million and $3.6 million, respectively, an increase of $2.1 million reflecting the timing of opening 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 19.9% for the six months ended June 30, 2016 compared to 22.6% for the six months ended June 30, 2015, reflecting the factors described above.  Excluding the

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impact of the Modification Expense of $9.4 million, as a percentage of net patient service operating revenues, operating income was 22.5% for the six months ended June 30, 2016, reflecting the factors described above.

 

Interest and Taxes

 

Interest expense, net. Interest expense, net for the six months ended June 30, 2016 was $21.2 million, and $22.8 million for the six months ended June 30, 2015, a decrease of 7.1% primarily due to the debt refinancing.

 

Loss on early extinguishment of debt. Loss on early extinguishment of debt for the six months ended June 30, 2016 was $4.7 million as a result of our debt refinancing activities.  The loss was comprised of a write-off of unamortized debt issuance costs. 

 

Income tax receivable agreement expense.  Income tax receivable agreement expense for the six months ended June 30, 2016 was $7.8 million, or 2.2% of net patient service operating revenues.  These costs represent the change in the fair value of the tax receivable agreement during the period.

 

Income tax expense. The provision for income taxes for the six months ended June 30, 2016 and June 30, 2015 represented an effective tax rate of 4.04% and 11.72%, respectively. The variation from the statutory federal rate of 35% on our share of pre-tax income during the six months ended June 30, 2016 and 2015 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 six months ended June 30, 2016 was

$41.3 million, representing an increase of 21.9% from $33.9 million for the six months ended June 30, 2015. The increase was primarily due to growth in the earnings of our existing joint ventures.

 

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.

 

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Cash Flows  

 

The following table shows a summary of our cash flows for the periods indicated.

 

 

 

 

 

 

 

 

 

 

 

Six Months Ended June 30,

 

(dollars in thousands)

    

2016

    

2015

 

Net cash provided by operating activities

 

$

89,004

 

$

61,818

 

Net cash used in investing activities

 

 

(35,021)

 

 

(28,492)

 

Net cash used in financing activities

 

 

(51,703)

 

 

(20,370)

 

Net increase (decrease) in cash

 

$

2,280

 

$

12,956

 

 

Cash Flows from Operations

 

Net cash provided by operating activities for the six months ended June 30, 2016 was $89.0 million compared to $61.8 million for the same period in 2015, an increase of $27.2 million, or 44.0%, primarily attributable to an increase in net income excluding the impact of the non-cash Modification expense as well as an increase in the payor refund liability included in accrued expenses.

 

Cash Flows from Investing Activities

 

Net cash used in investing activities for the six months ended June 30, 2016 was $35.0 million compared to $28.5 million for the same period in 2015, an increase of $6.5 million, or 22.9%, due to fluctuations in the timing and number of our de novo clinic openings.

 

Cash Flows from Financing Activities

 

Net cash used in financing activities for the six months ended June 30, 2016 was $51.7 million compared to $20.4 million for the same period in 2015, an increase of $31.3 million. Our distributions to our partners were $44.0 million for the six months ended June 30, 2016 compared to $40.9 million for the same period in 2015. The following table displays the factors impacting cash from financing activities during the six months ended June 30, 2016:

 

 

 

 

 

 

 

 

 

 

Six Months Ended June 30,

(dollars in thousands)

    

2016

    

2015

Proceeds from issuance of common stock sold in initial public offering, net of underwriting discounts and offering expense

 

$

175,378

 

$

 —

Dividends and dividend equivalents paid

 

 

(30,176)

 

 

 —

Net cash paid due to debt refinancing

 

 

(197,156)

 

 

 —

Distributions to noncontrolling interests

 

 

(43,973)

 

 

(40,932)

 

Capital Expenditures

 

For the six months ended June 30, 2016 and 2015, we made capital expenditures of $34.2 million and $27.9 million, respectively, of which $28.5 million and $23.3 million, respectively, were development capital expenditures and $5.7 million and $4.6 million, respectively, were maintenance capital expenditures.  For the remainder of 2016, we expect to spend approximately 5% to 6% of total annual net revenues for development capital expenditures and 1% to 2% of total annual net revenues on maintenance capital expenditures. 

 

Debt Facilities

 

As of June 30, 2016, we had outstanding $563.4 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 $436.1 million of term B loans under our first lien credit agreement as of June 30, 2016. Our outstanding indebtedness included $3.3 million of other corporate debt as of June 30, 2016. Our outstanding indebtedness also included our third-party clinic-level debt, which includes term loans and lines of credit

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(other than assigned clinic loans) totaling $100.4 million as of June 30, 2016 with maturities ranging from July 2016 to December 2023 and interest rates ranging from 3.15% to 7.34%. In addition, our clinic level debt includes our assigned clinic loans held by NewCo of $23.6 million as of June 30, 2016 with maturities ranging from November 2016 to September 2020 and interest rates ranging from 3.46% to 8.08%.  See “Note 8—Debt” in the notes to our unaudited consolidated financial statements.

 

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”.  See “Description of Indebtedness” in the Prospectus.    

 

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 June 30, 2016 (excluding put obligations relating to our joint ventures and obligations under our Income Tax Receivable Agreement, which are described separately below):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Scheduled payments under contractual obligations (in thousands) 

    

Total 

    

Less than 1
year 

    

1-3 years 

    

3-5 years 

    

More than 5
years 

 

Third-party clinic-level long-term debt (including current portion)

 

$

124,054

 

$

16,856

 

$

66,103

 

$

36,304

 

$

4,791

 

Term B loans(1)

 

 

436,076

 

 

2,318

 

 

9,272

 

 

424,486

 

 

 —

 

Other corporate debt

 

 

3,287

 

 

245

 

 

3,042

 

 

 —

 

 

 —

 

Operating leases(2)

 

 

151,442

 

 

11,644

 

 

44,566

 

 

36,161

 

 

59,071

 

Interest payments(3)

 

 

65,875

 

 

11,348

 

 

40,632

 

 

13,768

 

 

127

 

Total

 

$

780,734

 

$

42,411

 

$

163,615

 

$

510,719

 

$

63,989

 

 


 

 

(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 2016 through 2022 and approximately $0.5 million or less thereafter.

 

 

(3)

Represents interest payments on debt obligations, including the term B loans, the term loans under the second lien credit agreement and the loans under the revolving credit facility. To project interest payments on floating rate debt, we have used the rate as of June 30, 2016

 

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 may be exercised may be accelerated as a result of the

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IPO. 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 7—Noncontrolling Interests Subject to Put Provisions” in the notes to our unaudited consolidated financial statements for discussion of these put provisions.  The below table summarizes our potential obligation as of June 30, 2016.

 

 

 

 

 

 

(in thousands)

Noncontrolling interest subject to put provisions

    

As of June 30, 2016

 

Time-based puts

 

$

105,247

 

Event-based puts

 

 

29,515

 

Total Obligation

 

$

134,762

 

 

As of June 30, 2016, $15.5 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 June 30, 2016 and reflects the payments that would be made, assuming (a) all vested puts as of June 30, 2016 were exercised on July 1, 2016 and paid according to the applicable agreement and (b) all puts exercisable thereafter were exercised as soon as they vest and are paid accordingly.

 

 

 

 

 

 

(in thousands) 
Year 

    

Amount
Exercisable 

 

2016

 

 

20,903

 

2017

 

 

10,438

 

2018

 

 

15,334

 

2019

 

 

17,485

 

2020

 

 

18,285

 

Thereafter

 

 

22,802

 

Total

 

$

105,247

 

 

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, and may increase as a result of the IPO completed by the Company on April 26, 2016. In addition, our estimates are subject to challenges by our partners which could cause an increase to the amount we owe. As of June 30, 2016, we had recorded liabilities of approximately $105.2 million for all existing time-based obligations, of which we have estimated approximately $30.2 million may be accelerated as a result of physicians with IPO put rights having elected to potentially exercise the puts.  The estimated potential cash payments in the next twelve months, if all puts as to which partners have expressed interest in exercising are exercised, is approximately $16.8 million. 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 June 30, 2016, we had $29.5 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 June 30, 2016.    

 

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 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

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be material. Such payments will reduce the liquidity that would otherwise have been available to us. See "Certain Relationships and Related Party Transactions—Income Tax Receivable Agreement” in the Prospectus.

 

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 of Part I “Financial Information – Notes to Consolidated Financial Statements – Presentation – Recent Accounting Pronouncements”.

 

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 Prospectus.  There have been no material changes to our critical accounting policies and use of estimates from those described in the Prospectus.

 

 

ITEM 3.QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

There have been no material changes from the information previously disclosed under “Management’s Discussion and Analysis of Financial Condition and Results of Operations— Quantitative and Qualitative Disclosure About Market Risk” included in the Prospectus. 

 

 

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 June 30, 2016. 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 June 30, 2016

 

(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 June 30, 2016 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  

 

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.

 

ARAH and 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 on July 1, 2016. The complaint relates to 27 patients who have received, and some of whom continue to receive, dialysis at 12 clinics in Florida and Ohio and who elected to obtain coverage under one of United’s Affordable Care Act (“ACA”) insurance products, 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, health care kickbacks, patient brokering, and violations of the applicable commercial plan agreements in connection with, among other things, premium payment assistance by a third party charitable organization.  The complaint seeks 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 believes this lawsuit is without merit and the Company intends to vigorously defend itself in this legal matter.  On July 26, 2016, the Staff of the Securities and Exchange Commission (the “SEC”) sent a letter to the Company stating that it is conducting an inquiry and requesting that ARAH provide certain documents and information relating to the subject matter covered by the United complaint described above.  The Company intends to respond to this request and to fully cooperate with SEC Staff.   No assurance can be given as to the timing or outcome of these matters, nor can any assurance be given as to whether the filing of this lawsuit and any inquiries will affect the Company’s other relationships, or the Company’s business generally. 

 

ITEM 1A.RISK FACTORS  

 

Investing in our Common Stock involves a high degree of risk. You should carefully consider the risk factors previously disclosed in the “Risk Factors” section of the Prospectus together with other information in the Prospectus and this Form 10-Q, including our consolidated financial statements and related notes included elsewhere in the Prospectus and this Form 10-Q, before deciding whether to invest in shares of our Common Stock. The occurrence of any of the events described in these risk factors could materially adversely affect our business, financial condition, cash flows, results of operations and growth.  Except as described below, there have been no material changes to the risk factors disclosed in the Prospectus.

Future adjustments to the ESRD PPS implemented by CMS could have a negative impact upon our Medicare program revenues.

CMS issues annual updates to the ESRD PPS which may impact the base rate as well as the various adjusters.  The ESRD PPS proposed rule for 2017 released on June 30, 2016 proposes a base rate of $231.04, representing a $0.65 increase from the 2016 base rate of $230.39.  Even if the ESRD PPS final rule for 2017 (the “2017 Final Rule”) is identical to the 2017 Proposed Rule, it is unclear whether the 2017 Final Rule will have the effect of increasing or decreasing the actual payment rate for some or all of our clinics. The 2017 Proposed Rule updates the outlier services fixed dollar loss amounts for adult and pediatric patients and Medicare Allowable Payments using 2015 claims data, resulting in increases for pediatric beneficiaries and decreases for adult beneficiaries.  Some of our clinics benefited from outlier services fixed dollar loss amounts and Medicare Allowable Payments for adult patients and, accordingly, their payment rates may be adversely affected if the 2017 Proposed Rule is finalized.  The ESRD Quality Incentive Program,

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which reduces future payments to dialysis facilities that do not meet or exceed certain performance standards in a measurement year by up to 2%, was also modified by the 2017 Proposed Rule, and those modifications, if finalized, could adversely affect the payment rates for our facilities.  The 2017 Proposed Rule also proposes an equivalency payment for hemodialysis when more than 3 treatments are furnished in a week, similar to the current policy regarding peritoneal dialysis, where the total amount that would be otherwise paid for 3 hemodialysis treatments in a week is divided by the number of treatments furnished, resulting in the new per-treatment rate.  This equivalency payment, if included in the 2017 Final Rule, could adversely affect the payment rates for our facilities. Additional adjustment factors, including facility-level and patient-level adjustments and changes to the training add-on and outlier adjustment, as well as differences between the 2017 Proposed Rule and the 2017 Final Rule could have the effect of increasing or decreasing the actual payment rate for some or all of our clinics. Future adjustments to the ESRD PPS implemented by CMS could have a negative impact upon our Medicare program revenues.

 

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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)

 

 

 

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 June 30, 2016, 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 herewith

 

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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)

 

 

 

/s/ Jonathan L. Wilcox

 

Name: Jonathan L. Wilcox

 

Title:   Chief Financial Officer

(Principal Financial Officer and Authorized Signatory)

 

 

August 9, 2016

 

 

 

(Date)

 

 

 

45



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