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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------
FORM 10K
FOR ANNUAL AND TRANSITION REPORTS
PURSUANT TO SECTIONS 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2002
OR
| | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
FOR THE TRANSITION PERIOD FROM_____ TO_____ .
COMMISSION FILE NUMBER 1-3720
FRESENIUS MEDICAL CARE HOLDINGS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
NEW YORK 13-3461988
(STATE OR OTHER JURISDICTION (I.R.S. EMPLOYER
OF INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
(JURISDICTION OF INCORPORATION OR ORGANIZATION)
95 HAYDEN AVE., LEXINGTON, MA 02420
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
Registrant's telephone number, including area code: 781-402-9000
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Class D Special Dividend Preferred Stock, par value $.10 per share
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes |X| No | |
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to the
Form 10-K.
Indicate by check mark whether the registrant is an accelerated filer. (As
defined in Rule 12b-2 of the Act) Yes | | No |X|
State the aggregate market value of the voting stock held by non-affiliates of
the registrant. The aggregate market value shall be computed by reference to the
price at which the stock was sold, or the average bid and asked prices of such
stock, as of a specified date within 60 days prior to the date of filing. (See
definition of affiliate in Rule 405). $8,906,159 as of March 14, 2003.
1
Indicate the number of shares outstanding of each of the registrant's classes of
common stock, as of the latest practicable date:
As of March 14, 2003, 90,000,000 shares of common stock.
DOCUMENTS INCORPORATED BY REFERENCE
Registrant's Definitive Information Statement with respect to its 2002 Annual
Meeting of Stockholders, to be filed on or before April 30, 2003. (Part III)
2
TABLE OF CONTENTS
PART I
Item 1. Business ............................................................................ 4
Item 2. Properties .......................................................................... 24
Item 3. Legal Proceedings ................................................................... 25
Item 4. Submission of Matters to a Vote of Security Holders ................................. 27
PART II ...................................................................................... 27
Item 5. Market Price for Registrant's Common Equity and Related Stockholder Matters ......... 27
Item 6. Selected Financial Data ............................................................. 28
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 29
Item 7A. Quantitative and Qualitative Disclosures About Market Risks ......................... 39
Item 8. Consolidated Financial Statements and Supplementary Data ............................ 40
Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure 40
PART III ..................................................................................... 40
Item 10. Directors and Executive Officers of the Registrant .................................. 40
Item 11. Executive Compensation .............................................................. 40
Item 12. Security Ownership of Certain Beneficial Owners and Management ...................... 40
Item 13. Certain Relationships and Related Transactions ...................................... 40
PART IV ...................................................................................... 40
Item 14. Controls and Procedures ............................................................. 40
Item 15. Exhibits, Consolidated Financial Statement Schedules, and Reports on Form 8-K ....... 40
3
PART I
ITEM 1. BUSINESS
This section contains certain forward-looking statements that are subject
to various risks and uncertainties. Such statements include, without limitation,
discussions concerning the outlook of Fresenius Medical Care Holdings, Inc.
(collectively with all its direct and indirect subsidiaries, the "Company"),
government reimbursement, future plans and management's expectations regarding
future performance. Actual results could differ materially from those contained
in these forward-looking statements due to certain factors including, without
limitation, changes in business, economic and competitive conditions, regulatory
reforms, foreign exchange rate fluctuations, uncertainties in litigation or
investigative proceedings, the realization of anticipated tax deductions, and
the availability of financing. These and other risks and uncertainties, which
are more fully described elsewhere in this 2002 Form 10-K and in the Company's
reports filed from time to time with the Securities and Exchange Commission (the
"Commission") could cause the Company's results to differ materially from the
results that have been or may be projected by or on behalf of the Company.
Fresenius Medical Care Holdings, Inc., a New York corporation, is a
subsidiary of Fresenius Medical Care AG, a German corporation ("FMCAG"). The
Company conducts its operations through five principal subsidiaries: National
Medical Care, Inc. ("NMC"), Fresenius USA Marketing Inc.; Fresenius USA
Manufacturing Inc.; and SRC Holding Company, Inc., all Delaware corporations and
Fresenius USA Inc., a Massachusetts corporation.
The Company is primarily engaged in (i) providing kidney dialysis, and
clinical laboratory testing services, and (ii) manufacturing and distributing
products and equipment for dialysis treatment.
- KIDNEY DIALYSIS AND OTHER SERVICES. The Company is the largest
private provider of kidney dialysis and related services in the U.S.
At December 31, 2002, the Company owned approximately 1,080
outpatient dialysis facilities in the U.S. (including Puerto Rico),
treating approximately 79,600 chronic patients (26.6% of estimated
U.S. patients). The Company operated or managed an additional 49
facilities treating approximately another 3,600 patients (1.2% of
estimated U.S. patients). Collectively, these company-operated
facilities treated 27.8% of the estimated dialysis patients in the
U.S. The Company believes its next largest competitor treated
approximately 15.0% of U.S. patients. Additionally, the Company
provides inpatient dialysis services, therapeutic apheresis,
hemoperfusion, and other services under contract to hospitals in the
U.S.
- DIALYSIS PRODUCTS. The Company manufactures a comprehensive line of
dialysis products, including hemodialysis machines, peritoneal
dialysis systems and disposable products. The Company manufactures
innovative and technologically advanced products, including the
Fresenius Polysulfone(TM) dialyzer, which the Company believes is
the best-performing, mass-produced dialyzer on the market, and
Delflex(R) peritoneal solutions with Safe-Lock(R) connectors.
For the year ended December 31, 2002, the Company had net revenues of $3.8
billion, an increase of 4% over 2001 revenues. The Company derives 88% of its
revenue from providing dialysis services and 12% from the sale of dialysis
products.
The following table summarizes revenues by operating segments for the
three years ended December 31, 2002, 2001 and 2000.
2002 2001 2000
------ ------ ------
Dialysis Care $3,294 $3,132 $2,609
Dialysis Products 456 478 480
------ ------ ------
Total $3,750 $3,610 $3,089
====== ====== ======
The Company's principal executive office is located at 95 Hayden Avenue,
Lexington, MA 02420-9192. Its telephone number is (781) 402-9000.
4
RENAL INDUSTRY OVERVIEW
END-STAGE RENAL DISEASE
End-stage renal disease ("ESRD") is the state of advanced chronic kidney
disease that is characterized by the irreversible loss of kidney function and
requires routine dialysis treatment or kidney transplantation to sustain life. A
normally functioning human kidney removes waste products and excess water from
the blood, preventing toxin buildup, eventual poisoning of the body and water
overload. Chronic kidney disease can be caused by a number of conditions,
primarily nephritis, inherited diseases, hypertension and diabetes. Nearly 60%
of all people with ESRD acquire the disease as a complication of one or more of
these primary conditions.
Based on the most recent information published by the Centers for Medicare
& Medicaid Services ("CMS") of the Department of Health and Human Services
("HHS"), the number of patients in the U.S. who received chronic dialysis grew
from approximately 66,000 in 1982 to approximately 285,980 at December 31, 2001
or at a compound annual rate of 8.0%. The Company attributes the continuing
growth in the number of dialysis patients principally to an increase in general
life expectancy and, thus, the overall aging of the general population, the
shortage of donor organs for kidney transplants, improved dialysis technology
that has expanded the patient population able to undergo life prolonging
dialysis and better treatment and survival of patients with hypertension,
diabetes and other illnesses that lead to ESRD. Moreover, improved technology
has enabled older patients and those who previously could not tolerate dialysis
due to other illnesses to benefit from this life-prolonging treatment.
There are currently only two methods for the treatment of ESRD: dialysis
and kidney transplantation. Transplants are limited by the scarcity of
compatible kidneys. Approximately 14,630 patients received kidney transplants in
the U.S. during 2001; an increase of 2% over 2000. Therefore, most patients
suffering from ESRD must rely on dialysis, which is the removal of toxic waste
products and excess fluids from the body by artificial means. There are two
major dialysis modalities commonly used today, hemodialysis and peritoneal
dialysis. Generally, the method of treatment used by an ESRD patient is chosen
by the physician in consultation with the patient, and is based on the patient's
medical conditions and needs.
According to CMS data, as of December 31, 2001, there were approximately
4,080 Medicare-certified dialysis treatment centers in the U.S. Ownership of
these centers was fragmented. The Company estimates that at that time, the five
largest multi-facility providers accounted for approximately 2,460 facilities
(60% of facilities) and 189,400 patients (66% of patients). The remaining 34% of
patients were divided among smaller multi-facility providers, freestanding
facilities (many privately owned by physicians) and hospital-affiliated
facilities.
The Company believes that these proportions remained similar in 2002. The
Company estimates that the five multi-center providers accounted for
approximately 199,000 patients, or 67% of estimated U.S. patients at December
31, 2002.
According to CMS, as of December 31, 2001, approximately 91% of dialysis
patients in the U.S. received in-center treatment (virtually all hemodialysis)
and approximately 9% were treated at home. Of those treated at home, more than
95% received peritoneal dialysis.
TREATMENT OPTIONS FOR ESRD
Hemodialysis. Hemodialysis removes waste products and excess fluids from
the blood extracorporeally. In hemodialysis, the blood flows outside the body by
means of plastic tubes known as bloodlines into a specially designed filter, a
dialyzer, which functions as an artificial kidney by separating waste products
and excess water from the blood by diffusion and ultrafiltration. Dialysis
solution removes the waste products and excess water, and the cleansed blood is
returned to the patient. The movement of the blood and dialysis solution is
controlled by a hemodialysis machine, which pumps blood, adds anti-coagulants,
regulates the purification process and controls the mixing of dialysis solution
and the rate of its flow through the system. This machine may also monitor and
record the patient's vital signs.
Hemodialysis patients generally receive treatment three times per week,
typically for two and one-half to four hours or longer per treatment. The
majority of hemodialysis patients receive treatment at outpatient dialysis
clinics, such as ours, where hemodialysis treatments are performed with the
assistance of a nurse or dialysis technician under the general supervision of a
physician.
5
Peritoneal Dialysis. Peritoneal dialysis removes waste products and excess
fluids from the blood by use of the peritoneum, the membrane lining covering the
internal organs located in the abdominal area. Most peritoneal dialysis
treatments are self-administered by patients in their own homes and workplaces,
either by a treatment known as continuous ambulatory peritoneal dialysis
("CAPD") or by a treatment introduced by Fresenius USA in 1980 known as
continuous cycling peritoneal dialysis ("CCPD"). In both of these treatments,
the patient has a catheter surgically implanted to provide access to the
peritoneal cavity. Using this catheter, a sterile dialysis solution is
introduced into the peritoneal cavity and the peritoneum operates as the
dialyzing membrane. A typical CAPD peritoneal dialysis program involves the
introduction and disposal of solution four times a day. With CCPD a machine is
used to "cycle" solution to and from the patient's peritoneum during sleep.
STRATEGY
The Company's objective is to focus on generating revenue growth that
exceeds market growth of the dialysis industry, as measured by growth in patient
population, while maintaining the Company's leading position in the market and
increasing earnings at a faster pace than revenue growth.
The Company's dialysis services and product businesses have grown faster
than the market in terms of revenues over the past five years, and the Company
believes that it is well positioned to continue growth by focusing on the
following strategies:
- Continue to Provide High Standards of Patient Care. The Company
believes that its reputation for providing high standards of patient
care is a competitive advantage.
- Differentiate Our Patient Care Programs from that of Our
Competitors. The Company believes that its UltraCare(TM) patient
care program now offered at its dialysis facilities will distinguish
and differentiate the Company's patient care programs from that of
our competitors. UltraCare(TM) therapy employs single-use high flux
polysulfone dialyzers, on-line quality measurement, and ultra pure
dialysate. The Company's shift from multi-use to single-use
dialyzers has increased the Company's per treatment dialyzer costs.
These cost increases have been offset, however, by (i) the Company's
ability to achieve economies of scale in the production of these
dialyzers, due to its large-scale single-use dialzyer manufacturing
capacity, (ii) implementation of a new staffing model based on
single use that reduces the personnel costs per treatment, and (iii)
automated controls in the Company's new 2008 Series dialysis machine
that reduce concentrate usage and associated costs.
- Expand Presence in the U.S. The Company intends to continue to take
advantage of its reputation and market recognition by acquiring and
establishing new dialysis clinics within attractive markets.
- Increase Spectrum of Dialysis Services. One of the Company's
objectives is to continue to expand its role within the broad
spectrum of services provided to dialysis patients. The Company
implemented this strategy by providing expanded and enhanced patient
services, including laboratory services, to both its own clinics and
those operated by third parties. The Company estimates that Spectra
Renal Management ("SRM") provides laboratory services for
approximately 39% of the ESRD patients in the United States. The
6
Company has developed disease state management methodologies which
involve the coordination of total patient care for ESRD patients,
that it believes are attractive to managed care payors.
The Company has formed Optimal Renal Care, LLC, a joint venture with
The Permanente Federation. The Company has also formed Renaissance
Health Care as a joint venture with participating nephrologists.
The Company provides ESRD and Chronic Kidney Disease programs
to more than 3,000 patients. The Company also operates a surgical
center for the management and care of vascular access for patients
which decreases hospitalization.
- Continue to Offer Complete Dialysis Product Lines. The Company
offers broad and competitive hemodialysis and peritoneal dialysis
product lines. These product lines enjoy broad market acceptance and
enable the Company to provide the customer with a single source for
all of their dialysis machines, systems and disposable products.
During the year ended December 31, 2002 the Company's product
revenues were derived approximately 24% from machine sales and 76%
from sales of disposable products.
- Extend Our Position as an Innovator in Product and Process
Technology. The Company is committed to technological leadership in
both hemodialysis and peritoneal dialysis products. FMCAG has a
global research and development team with more than 200 members
focused on developing dialysis systems that are safer, more
effective and easier to use and that can be easily customized to
meet the differing needs of customers around the world. The Company
believes that its extensive expertise in patient treatment and
clinical data will further enhance its ability to develop more
effective products and treatment methodologies. The Company's
ability to manufacture dialysis products on a cost-effective and
competitive basis results in large part from our process
technologies. Over the past several years, the Company has reduced
manufacturing costs per unit through development of proprietary
manufacturing technologies that have streamlined and automated its
production processes.
- Expand into Related Services. Fresenius Medical Care Cardiovascular
Resources Holdings ("FMC-CVR"), in which the Company owns a 45%
equity interest, is a leading provider of perfusion and related
cardiovascular services. The addition of this business provides a
strong nationwide platform for expansion and innovation in the
extracorporeal service business which compliments our extracorporeal
dialysis service business well.
For a description of other elements of the Company's strategy see
"--Dialysis Services" and "--Dialysis Products Business." For additional
information in respect to the Company's industry segments, see Notes to
Consolidated Financial Statements - Note 19, "Industry Segments and Information
about Foreign Operations."
DIALYSIS SERVICES
OVERVIEW
The Company is the largest provider of kidney dialysis and related
services in the U.S. to patients suffering from chronic kidney disease. The
Company also provides clinical laboratory testing services for dialysis patients
(Company owned and non-Company owned clinics).
The Company's provider business is primarily operated through the Dialysis
Services business unit ("Dialysis Services"). Clinical laboratory testing
services are primarily provided by SRM.
DIALYSIS SERVICES
As of December 31, 2002, the Company owned approximately 1,080 dialysis
centers in the U.S. (including Puerto Rico). The centers are generally
concentrated in areas of high population density. In 2002, the Company acquired
11 existing centers, developed 64 new centers and consolidated or sold 13
centers. The number of patients treated at the Company's centers has increased
from approximately 76,600 at December 31, 2001 to approximately 79,600 at
December 31, 2002.
7
With the Company's large patient population, it has developed the PSP
database which enables it to improve dialysis treatment outcomes and improve
the quality and effectiveness of dialysis products. In addition to the Company's
patient database, it believes that local physicians, hospitals and managed care
plans refer their ESRD patients to its clinics for treatment due to:
- its reputation for quality patient care and treatment;
- its extensive network of dialysis clinics, which enables physicians
to refer their patients to conveniently located clinics; and
- its reputation for technologically advanced products for dialysis
treatment.
The Company treats approximately 28% of the dialysis patients in the U.S.,
including those patents treated in clinics the Company manages. Based on
publicly available reports, the Company believes its next largest competitor
treats approximately 15.0% of U.S. dialysis patients. For the year 2002,
dialysis services accounted for 88% of the Company's total revenue.
At the Company's centers, hemodialysis treatments are provided at
individual "stations" through the use of dialysis machines. A nurse or dialysis
technician attaches the necessary tubing to the patient and monitors the
dialysis equipment and the patient's vital signs. The capacity of a center is a
function of the number of stations and such factors as the type of treatment,
patient requirements, length of time per treatment and local operating practices
and ordinances regulating hours of operation.
Each of the Company's dialysis centers is under the general supervision of
a medical director ("Medical Director"), who is a physician. See "Patient,
Physician and Other Relationships." Each dialysis center also has an
administrator or clinic manager who supervises the day-to-day operations of the
facility and the staff. The staff typically consists of registered nurses,
licensed practical nurses, patient care technicians, a social worker, a
registered dietician, a unit clerk and biomedical technicians.
As part of the dialysis therapy, the Company provides various related
services to ESRD patients in the U.S. at its dialysis centers, including the
administration of erythropoietin ("EPO"), a bioengineered protein that
stimulates the production of red blood cells. EPO is used to treat anemia, a
medical complication frequently experienced by ESRD patients, and is
administered to most of the Company's patients. EPO is produced by a single
source manufacturer, Amgen Inc., and any interruption of supply could materially
adversely affect the Company's business and results of operations. The Company's
current contract with Amgen Inc. covers the period from January 2002 to December
2003 with price guarantees and volume and outcome based discounts.
The Company's centers also offer services for home dialysis patients, the
majority of whom are treated with peritoneal dialysis. For such patients, the
Company provides certain materials, training and patient support services,
including clinical monitoring, supply of EPO, follow-up assistance and
arrangements for the delivery of the supplies to the patient's residence. See
"--Regulatory and Legal Matters-- Reimbursement" and "--Legal Proceedings" for a
discussion of billing for such products and services.
The Company also provides dialysis services under contract to hospitals in
the U.S. on an "as needed" basis for patients suffering from acute kidney
failure and for ESRD patients who are hospitalized. The Company services these
patients either at their bedside, using portable dialysis equipment, or at a
dialysis site maintained by the hospital.
8
FRESENIUS ULTRACARE(TM) PROGRAM
In 2002, the Company started a new program in the Dialysis Services group
called UltraCare(TM). This program combines the latest of the Company's product
technology with the Company's highly trained and skilled staff and is designed
to offer our patients an unsurpassed level of care. The basis for this form of
treatment is the Optiflux Polysulfone single use dialyzer. These dialyzers
deliver the highest level of blood clearance and are the most efficient dialyzer
available. Optiflux Dialyzers are combined with our 2008 Series Hemodialysis
Delivery System, which has several systems to allow the tailoring of treatment
to meet the individual needs of patients, as well as advanced online patient
monitoring. Staff will be alerted if clearance is less than target, and
treatment can be adjusted.
ACQUISITIONS
The Company's growth in revenues and operating earnings in prior years has
resulted, in significant part, from its ability to effect acquisitions of health
care businesses, particularly dialysis centers, on reasonable terms. The Company
paid aggregate consideration, for acquisitions of new clinics of approximately
$37 million in 2002 and approximately $388 million in cash and FMCAG preference
shares, in 2001.
The Company regularly evaluates and explores opportunities with various
other health care companies and other businesses regarding acquisitions and
joint business ventures. In 2002, the Company completed new acquisitions and
acquisitions of previously managed clinics totaling 11 dialysis facilities in
the U.S. providing care to approximately 960 patients. These acquisitions and
agreements expand the Company's presence in selected key areas of the United
States.
QUALITY ASSURANCE IN DIALYSIS CARE
At each of the Company's dialysis clinics, a quality assurance committee
is responsible for reviewing quality of care data, setting goals for quality
enhancement and monitoring the progress of quality assurance initiatives. The
Company believes that it enjoys a reputation of providing high quality care to
dialysis patients. In 2002, the Company continued to develop and implement
programs to assist in achieving its quality goals. The Company's Access
Intervention Management Program ("AIM"), started in 2001, detects and corrects
arteriovenous access failure in hemodialysis treatment, which is the major cause
of hospitalization and morbidity.
SOURCES OF DIALYSIS SERVICES NET REVENUES
The following table provides information for the periods indicated
regarding the percentage of the Company's U.S. dialysis treatment services net
revenues provided by (a) the Medicare ESRD program, (b) private/alternative
payors, such as commercial insurance and private funds, (c) Medicaid and other
government sources and (d) hospitals.
YEAR ENDED DECEMBER 31,
--------------------------
2002 2001 2000
------ ------ ------
Medicare ESRD program ....... 61.5% 59.7% 59.1%
Private/alternative payors .. 29.5 31.2 32.1
Medicaid and other government
sources ..................... 4.5 4.6 4.2
Hospitals ................... 4.5 4.5 4.6
------ ------ ------
Total ..................... 100.0% 100.0% 100.0%
====== ====== ======
9
Under the Medicare ESRD program, Medicare reimburses dialysis providers
for the treatment of certain individuals who are diagnosed as having ESRD,
regardless of age or financial circumstances.
PATIENT, PHYSICIAN AND OTHER RELATIONSHIPS
The Company believes that its success in establishing and maintaining
dialysis centers in the U.S. depends in significant part upon its ability to
obtain the acceptance of, and referrals from, local physicians, hospitals and
managed care plans. A dialysis patient generally seeks treatment at a center
that is convenient to the patient and at which the patient's nephrologist has
staff privileges.
The conditions for coverage under the Medicare ESRD program require that
treatment at a dialysis center be under the general supervision of a Medical
Director. Generally, the Medical Director must be board certified or board
eligible in internal medicine and have at least 12 months of training or
experience in the care of patients at ESRD centers. The Company's Medical
Directors maintain their own private practices.
10
COMPETITION
Dialysis Services. The dialysis services industry is highly competitive.
The Company's major competitors in dialysis services include Gambro AB, DaVita,
Inc. (formerly Total Renal Care Inc.) and Renal Care Group, Inc. Ownership of
dialysis centers in the U.S. is fragmented, with a large number of operators
each owning 10 or fewer centers and a small number of larger providers, the
largest of which is the Company. Consolidation of the industry has been ongoing
over the last decade. In urban areas, where many of the Company's dialysis
centers are located, there frequently are many competing centers in proximity to
the Company's centers. The Company experiences direct competition from time to
time from former Medical Directors, former employees or referring physicians who
establish their own centers. Furthermore, other health care providers or product
manufacturers, some of which have significant operations or resources, may
decide to enter the dialysis services business in the future.
Because services to the majority of patients in the U.S. are primarily
reimbursed under government programs, competition for patients is based
primarily on quality and accessibility of service and the ability to obtain
referrals from physicians and hospitals. However, extension of periods during
which commercial insurers are primarily responsible for reimbursement and the
growth of managed care has placed greater emphasis on service costs for patients
with private insurance coverage.
LABORATORY SERVICES
The Company provides clinical laboratory testing services through its SRM
business unit. SRM is the leading U.S. dialysis clinical laboratory providing
blood, urine and other bodily fluid testing services to assist physicians in
determining whether a dialysis patient's therapy regimen, diet and medicines
remain optimal. SRM laboratories are located in New Jersey and Northern
California.
In 2002, SRM performed over 36 million tests for more than 115,000
dialysis patients in 1713 clinics across the United States. SRM also provided
testing services to clinical research projects and others. The Company plans to
expand SRM into related markets such as hospital dialysis units and physician
office practices to offer assistance with the pre-ESRD patient base.
COMPETITION
SRM competes in the U.S. with large nationwide laboratories, dedicated
dialysis laboratories and numerous local and regional laboratories, including
hospital laboratories. In the laboratory services market, companies compete on
the basis of performance, including quality of laboratory testing, timeliness of
reporting test results and cost-effectiveness. The Company believes that SRM's
services are competitive in these areas.
11
DIALYSIS PRODUCTS
The Company manufactures and distributes equipment and disposable products
for the treatment of kidney failure using both hemodialysis and peritoneal
dialysis. Such products include hemodialysis machines, peritoneal dialysis
cyclers and related equipment, dialyzers, peritoneal dialysis solutions in
flexible plastic bags, hemodialysis concentrates and solutions, granulate mixes,
bloodlines, disposable tubing assemblies and equipment for water treatment in
dialysis centers. Other products manufactured by third parties and distributed
by the Company include dialyzers, special blood access needles, heparin (used to
prevent blood clotting) and commodity supplies such as bandages, clamps and
syringes.
OVERVIEW
The following table shows actual net revenues of the Company's products
business for 2002, 2001 and 2000 related to hemodialysis products, peritoneal
dialysis products and other activities, principally technical service:
YEAR ENDED DECEMBER 31,
(DOLLARS IN THOUSANDS)
-------------------------------------------------------------------------------------
2002 2001 2000
----------------------- ----------------------- -----------------------
Total % of Total % of Total % of
Revenues Total Revenues Total Revenues Total
-------- -------- -------- -------- -------- --------
Hemodialysis Products $343,470 75% $340,841 71% $334,447 70%
Peritoneal Dialysis Products 71,582 16 83,653 18 90,985 19
Other 41,449 9 53,324 11 54,635 11
-------- -------- -------- -------- -------- --------
Total $456,501 100% $477,818 100% $480,067 100%
======== ======== ======== ======== ======== ========
HEMODIALYSIS PRODUCTS
The Company believes that it is a leader in the hemodialysis product field
and continually strives to extend and improve the capabilities of its
hemodialysis systems to offer an advanced treatment mode at reasonable cost. The
Company, through its Dialysis Products business unit ("Dialysis Products"),
offers a comprehensive hemodialysis product line.
Dialysis Machines. The Company assembles, tests and calibrates
hemodialysis machines and sells these machines in the U.S., Canada and Mexico.
Components for these machines are provided by FMCAG and other suppliers. The
Company sells its dialysis machines as Series 2008H and 2008K models in the U.S.
The Company's dialysis machines offer the following features and advantages:
- Volumetric dialysate balancing and ultrafiltration control system.
This system, was introduced in 1977, provides for safe and more
efficient use of highly permeable dialyzers, permitting faster
dialysis with controlled rates of fluid removal;
- Proven hydraulic systems, providing reliable operation and servicing
flexibility;
- Compatibility with all manufacturers' dialyzers and a wide variety
of blood-lines and dialysis solutions, permitting maximum
flexibility in both treatment and disposable products usage;
- Modular design, which permits us to offer dialysis clinics a broad
range of options to meet specific patient or regional treatment
requirements. Modular design also allows upgrading through module
substitution without the need to replace the entire machine;
- Additional modules that provide monitoring and response capability
for selected bio-physical patient parameters, such as body
temperature, relative blood volume and electrolyte balances. This
concept, known as physiological dialysis, permits hemodialysis
treatments with lower incidence of a variety of symptoms or side
effects, which still occur frequently in standard hemodialysis. Our
most recent module, the Blood Volume Monitor(TM) controls removal of
excess fluid from the patient;
- Sophisticated microprocessor controls, and display and readout
panels that are adaptable to meet local language requirements;
12
- Battery backup, which continues operation of the blood circuit and
all protective systems for 15 to 20 minutes following a power
failure;
- Online clearance, measurement of dialyzer clearance for quality
assurance with the On-Line Clearance Module, providing immediate
effective clearance information, real time treatment outcome
monitoring, and therapy adjustment during dialysis without requiring
invasive procedures or blood samples;
- On-line data collection capabilities and computer interfacing with
our Hypercare module and FDS08(R) system. Our machines can:
- monitor and assess prescribed therapy;
- connect a large number of hemodialysis machines and peripheral
devices, such as patient scales, blood chemistry analyzers and
blood pressure monitors, to a personal computer network;
- enter nursing records automatically at bedside to register and
document patient treatment records, facilitate billing, and
improve record-keeping and staff efficiency;
- adapt to new data processing devices and trends;
- perform home hemodialysis with remote monitoring by a staff
caregiver; and
- record and analyze trends in medical outcome factors in
hemodialysis patients; and
Dialyzers. The Company manufactures dialyzers using hollow fiber
polysulfone membranes, a synthetic material. While competitors currently sell
polysulfone membranes in the market, the Company developed and is the only
manufacturer with more than 15 years' experience in applying the technology
required to mass produce polysulfone membranes. The Company believes that
polysulfone offers the following superior performance characteristics compared
to other materials used in dialyzers:
- higher biological compatibility, resulting in reduced incidence of
adverse reactions to the fibers;
- greater capacity to clear uremic toxins from patient blood during
dialysis, permitting more thorough, more rapid dialysis, resulting
in shorter treatment time; and
- a complete range of permeability, or membrane pore size, which
permits dialysis at prescribed rates -- high flux, medium flux and
low flux, for acute dialysis, and allows tailoring of dialysis
therapy to individual patients.
The Company's full line of polysulfone dialyzers includes the new F Series
Optiflux family as well as the traditional reuse and non-reuse dialyzers
including the F70NR, F50NR and F7NR series of single-use polysulfone dialyzers.
Single use dialyzers are becoming more popular, and the Company has increased
production of single-use dialyzers at its Ogden, Utah facility to meet demand
for these products.
Single Use Dialyzers. The Company has nearly completed a $65 million
capital commitment to significantly expand the capacity of its dialyzer
manufacturing plant in Ogden, Utah through the addition of three new dialyzer
assembly lines.
13
Other Hemodialysis Products. The Company manufactures and distributes
arterial, venous, single needle and pediatric bloodlines. The Company produces
both liquid and dry dialysate concentrates. Liquid dialysate concentrate is
mixed with purified water by the hemodialysis machine to produce dialysis
solution, which is used in hemodialysis treatment to remove the waste products
and excess water from the patient's blood. Dry acid concentrate requires less
storage space. The Company also produces dialysis solutions in bags, as well as
connection systems for central concentrate supplies and devices for mixing
dialysis solutions and supplying them to hemodialysis machines. Other
distributed products include solutions for priming bloodlines, disinfecting and
decalcifying hemodialysis machines, fistula needles, hemodialysis catheters, and
products for acute renal treatment.
PERITONEAL DIALYSIS PRODUCTS
The Company offers a full line of peritoneal dialysis products. The
Company manufactures peritoneal dialysis solutions in bags, peritoneal dialysis
cycling machines for CCPD and disposable products for both CAPD and CCPD, such
as tubing, sterile solutions and sterile kits to prepare patients for dialysis.
CAPD Systems. The Company manufactures standard and specialized peritoneal
dialysis solutions. The Company believes that its peritoneal dialysis products
offer significant advantages for CAPD, including:
- ease of use and greater protection against contamination by touch
than other peritoneal dialysis systems presently available. Its
products incorporate our Safe-Lock(R) connection system for
introducing and draining dialysis solution into and from the
abdominal cavity;
- suitability for all peritoneal dialysis patients through the
Inpersol(R) and Safe-Lock(R) product lines. Inpersol products are
interchangeable with those of other manufacturers; Safe-Lock(R)
products may be used only by peritoneal dialysis patients whose
catheters include the Safe-Lock connector, which attaches to a
solution bag fitted with the other part; and
- higher solution bag volumes with our new Premier twin-bag system
which provides solution container and pre-attached tubing set in one
package. The higher solution volumes permit larger dosages without
increasing the number of required daily solution exchanges performed
by the patient.
CCPD Products. The Company introduced the first peritoneal dialysis
cycler machine in 1980. The Company believes that CCPD therapy offers benefits
over CAPD therapy for patients who need more therapy due to body size,
ultrafiltration loss or other reasons. In a standard CAPD program, a patient
manually introduces two liters of fresh peritoneal dialysis solution and drains
the used solution four times over a 24-hour period. Treatment occurs seven days
per week and the patient must perform the treatment while awake. With CCPD
therapy, the cycler automatically delivers a prescribed volume of dialysis
solution into the peritoneal cavity through an implanted catheter, allows the
solution to dwell for a specified time, and completes the process by draining
the solution. CCPD therapy offers the following benefits over CAPD:
- Solution exchanges take place automatically, which may reduce the
risk of peritonitis due to less frequent handling of the catheter
and connections;
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- The patient can cycle at home, throughout the night while asleep.
The patient has complete daytime freedom, wearing only the
surgically implanted catheter and capping device; and
- CCPD delivers more effective therapy than CAPD due to the supine
position of the patient during the night, higher volume exchanges
and preferable cycle management.
The Company's cycling equipment incorporates microprocessor technology,
and the patient, hospital or clinic staff can easily program it to perform
specific prescribed therapy for a given patient. Since all components are
monitored and programmable, these machines allow the physician to prescribe any
of a number of current therapy procedures. Our CCPD products and therapies
include:
- PD-PLUS(R), a variant on CCPD therapy the Company introduced in
1994. PD-PLUS(R) therapy can only be performed using the Fresenius
Freedom(TM) Cycler and special tubing using Safe-Lock(R) connectors;
and
- IQcard(TM), for use with the Freedom(TM) Cycler PD-PLUS(R) to
monitor CCPD therapy for a full treatment history and improved
therapy compliance.
Other Peritoneal Dialysis Products. The Company also manufactures and
distributes pediatric treatment systems for administration of low volumes of
dialysis solutions, assist devices to facilitate automated bag exchange for
handicapped patients, catheters, catheter implantation instruments, silicon
glue, Pack-PD(R) (a computer program which analyzes patient and peritoneal
characteristics to present a range of treatment options for individual
therapies), disinfectants, bag heating plates, adapters, and products to assist
and enhance connector sterility. The Company also provides scientific and
patient information products, including support materials, such as brochures,
slides, videos, instructional posters and training manuals.
MARKETING, DISTRIBUTION AND SERVICE
Most of the Company's products are sold to hospitals, clinics and
specialized treatment centers. With its comprehensive product line and years of
experience in dialysis, the Company believes that it has been able to establish
and maintain very close relationships with its clinic customer base. The Company
maintains a direct sales force of trained salespersons engaged in the sale of
both hemodialysis and peritoneal dialysis products.
In the Company's distribution system, products are shipped from
factories to central warehouses. Dialysis products are distributed from these
central warehouses to regional warehouses. The Company then distributes
peritoneal dialysis products to the patient at home, and ships hemodialysis
products directly to dialysis clinics and other customers.
The Company offers customer service, training and education, and technical
support such as field service, spare parts, repair shops, maintenance, and
warranty regulation. The Company also provides training sessions on the
Company's equipment.
MANUFACTURING OPERATIONS
The Company assembles, tests, and calibrates equipment, including
hemodialysis machines, dialyzer reuse devices and peritoneal dialysis cyclers,
at its facility in Walnut Creek, California. Components of the Company's
hemodialysis machines are supplied by FMCAG as well as other suppliers. The
Company has experienced no difficulties in obtaining sufficient quantities of
such components.
The Company owns a 590,000 square-foot facility in Ogden, Utah which
operates as a fully integrated manufacturing and research and development
facility for polysulfone dialyzers and peritoneal dialysis solutions. This
facility uses automated equipment for the production of polysulfone dialyzers
and sterile solutions in flexible plastic containers. The Company believes that
it is the principal manufacturer of polysulfone dialyzers in the U.S. The
Company has nearly completed a $65 million capital commitment to significantly
expand the capacity of its dialyzer manufacturing plant in Ogden, Utah through
the addition of three new dialyzer assembly lines.
15
While the Company obtains the film used in the manufacture of its plastic
bags used with its peritoneal solutions from one supplier located in the
Netherlands, the Company believes that there are readily available alternative
sources of supply for which the FDA could grant expedited approval.
The Company also manufactures dialysis products at additional plants.
Bloodlines and PD sets are produced at a facility in Reynosa, Mexico, and
concentrates are produced at five facilities in the U.S.
Each step in the manufacture of the Company's products, from the initial
processing of raw materials through the final packaging of the completed
product, is carried out under controlled quality assurance procedures required
by law and under Good Manufacturing Practices ("GMP"), as well as under
comprehensive quality management systems, such as the internationally recognized
ISO 9000-9004 and CE Mark standards, which are mandated by regulatory
authorities in the countries in which the Company operates. The facilities in
Ogden, Utah and Reynosa, Mexico received ISO 9001 certification in 1999. The
facility in Walnut Creek, California received ISO 9001 certification in 2000.
SOURCES OF SUPPLY
Raw materials essential to the Company's dialysis products business are
purchased worldwide from numerous suppliers and no serious shortages or delays
in obtaining raw materials have been encountered. To assure continuous high
quality, the Company has single supplier agreements for many of its polymers,
including polysulfone, polyvinylpyrrolidone, and polyurethane for dialyzer
production, and for certain other raw materials. Wherever single supplier
agreements exist, the Company believes alternative suppliers are available.
However, use of raw materials obtained from alternative suppliers could cause
costs to rise due to necessary adjustments in the production process or
interruptions in supply.
Incoming raw materials for solutions undergo tests, such as, infrared,
ultraviolet and physical and chemical analyses to assure quality and
consistency. During the production cycle, sampling and testing take place in
accordance with established quality assurance procedures to ensure the finished
product's sterility, safety and potency. Pressure, temperature and time for
various processes are monitored to assure consistency of semi-finished goods.
Environmental conditions are monitored to assure that particulate and
bacteriological levels do not exceed specified maximums. The Company maintains
continuing quality control and Good Manufacturing Policies education and
training programs for its employees. See "Regulatory and Legal Matters."
Dialysis Products Material Management Department (MMD) is responsible for
providing production plans to the manufacturing facilities and supplying
products to the Company's distribution centers. The Distribution department
operates a national network of distribution centers that are strategically
located in the U.S. to ensure high service levels to the Company's own clinics,
external customers, home-based patients and hospitals. The Company's routing
software enables it to distribute its supplies to best accommodate customer
requests while maintaining operational efficiency.
NEW PRODUCT INTRODUCTIONS
The Company remains strongly focused on the development of new products,
technologies, and treatment concepts to optimize the quality of treatment for
dialysis patients in coordination with the FMCAG research and development team.
The Company's research and development expenditures were $9.2 million and $5.5
million in 2002 and 2001, respectively.
The Company introduced the following new or enhanced products in 2002:
- High performance, single use Optiflux series dialyzer at the end of
2001. Optiflux polusulfone dialyzers are engineered to deliver
superior small (urea) and middle molecular weight solute clearance
through the use of NCS coupled with superior membrance composition
and biocompatability. Optiflux dialyzers accounted for 18% of the
dialyzers the Company sold in the U.S. during 2002. Two new models
of Optiflux dialyzers were introduced this year. The Optiflux
dialyzer is the fastest growing, best selling dialyzer in the U.S.
- UltraCare 2008 enhancements. Added auto flow and idle modes to the
2008 series of machines, as well as special display screens user
interface.
- Newton IQ for Peritoneal Dialysis. Cycler designed to take advantage
of higher flow rates available with gravity flow and drain. Improved
software includes persciption upload, evaluated through clinical
studies in 2002.
- Online Clearence Monitor. Monitors patient access flow rate without
the need for additional equipment or specially trained personnel.
Provides immediate information on treatment efficiency.
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- Premier(TM) Plus Double Bag for Peritoneal Dialysis. Twin bag system
incorporating solution, bag, and tubing. Uses Safe-lock(TM) connect
and Snap(TM) disconnect features. Fewer connections lower patient
risk of infection.
PATENTS, TRADEMARKS AND LICENSES
The Company believes that its success will depend, in large part, on
FMCAG's technology. While FMCAG, as a standard practice, obtains such legal
protections it believes are appropriate for its intellectual property, such
intellectual property may be subject to infringement or invalidation claims. In
addition, technological developments in ESRD therapy could reduce the value of
FMCAG's existing intellectual property. This reduction could be rapid and
unanticipated.
COMPETITION
The markets in which the Company sells its dialysis products are highly
competitive. Among the Company's competitors in the sale of hemodialysis and
peritoneal dialysis products are Gambro AB, Baxter International Inc., Asahi
Medical Co., Ltd., B. Braun Melsungen AG, Nissho Corporation (including Nissho
Nipro Corporation Ltd.), Nikkiso Co., Ltd., Terumo Medical Corporation and Toray
Medical Co., Ltd. Some the Company's competitors possess greater financial,
marketing and research and development resources than the Company.
EMPLOYEES
At December 31, 2002, the Company employed approximately 31,183 employees,
including part-time and per diem employees. Such persons are employed by the
Company's principal businesses as follows: dialysis treatment and laboratory
services, approximately 26,623 employees; and dialysis products, approximately
4,560 employees. Medical Directors of the Company's dialysis centers are
retained as independent contractors and are excluded from the employee total.
Management believes that its relations with its employees are good.
Approximately 1,946 or 6% of the Company's employees are covered by union
agreements.
17
REGULATORY AND LEGAL MATTERS
REGULATORY OVERVIEW
The operations of the Company are subject to extensive governmental
regulation at the federal, state and local levels regarding the operation of
dialysis centers, laboratories and manufacturing facilities, the provision of
quality health care for patients, the maintenance of occupational, health,
safety and environmental standards and the provision of accurate reporting and
billing for governmental payments and/or reimbursement.
Any failure by the Company or its subsidiaries to receive required
licenses, certifications or other approvals for new facilities, significant
delays in such receipt, loss of its various federal certifications, termination
of licenses under the laws of any state or other governmental authority or
changes resulting from health care reform or other government actions that
reduce reimbursement or reduce or eliminate coverage for particular services
rendered by the Company or its subsidiaries could have a material adverse effect
on the business, financial condition and results of operations of the Company.
The Company must comply with legal and regulatory requirements under which
it operates, including the federal Medicare and Medicaid Fraud and Abuse
Amendments of 1977, as amended (the "anti-kickback statute"), the federal
restrictions on certain physician referrals (commonly known as the "Stark Law"),
federal rules under the Health Insurance Portability and Accountability Act of
1996 that protect the privacy of patient medical records and prohibit
inducements to patients to select a particular health care provider (commonly
known as "HIPAA") and other fraud and abuse laws and similar state statutes, as
well as similar laws in other countries. Moreover, there can be no assurance
that applicable laws, or the regulations thereunder, will not be amended, or
that enforcement agencies or the courts will not make interpretations
inconsistent with those of the Company, any one of which could have a material
adverse effect on its business, reputation, financial condition and results of
operations of the Company. Sanctions for violations of these statutes may
include criminal or civil penalties, such as imprisonment, fines or forfeitures,
denial of payments, and suspension or exclusion from the Medicare and Medicaid
programs. In the U.S., these laws have been broadly interpreted by a number of
courts, and significant government funds and personnel have been devoted to
their enforcement because such enforcement has become a high priority for the
federal government and some states. The Company, and the health care industry in
general, will continue to be subject to extensive federal, state and foreign
regulation, the full scope of which cannot be predicted.
The Company has entered into a corporate integrity agreement with the U.S.
government which requires that the Company staff and maintain a comprehensive
compliance program, including a written code of conduct, training program and
compliance policies and procedures. The corporate integrity agreement requires
annual audits by an independent review organization and periodic reporting to
the government. The corporate integrity agreement permits the U.S. government to
exclude the Company and its subsidiaries from participation in U.S. federal
health care programs if there is a material breach of the agreement that is not
cured by the Company within thirty days after the Company receives written
notice of the breach.
PRODUCT REGULATION
In the U.S., the FDA and comparable state regulatory agencies impose
requirements on certain subsidiaries of the Company as a manufacturer and a
seller of medical products and supplies under their jurisdiction. These require
that products be manufactured in accordance with GMP and that the Company comply
with FDA requirements regarding the design, safety, advertising, labeling,
recordkeeping, distribution, and reporting of adverse events related to the use
of its products. In addition, in order to clinically test, produce and market
certain medical products and other disposables (including hemodialysis and
peritoneal dialysis equipment and solutions, dialyzers, bloodlines and other
disposables) for human use, the Company must satisfy mandatory procedures and
safety and efficacy requirements established by the FDA or comparable state and
foreign governmental agencies. Such rules generally require that products be
approved by the FDA as safe and effective for their intended use prior to being
marketed. The Company's peritoneal dialysis solutions have been designated as
drugs by the FDA and, as such, are subject to additional FDA regulation under
the Food, Drug and Cosmetic Act of 1938 ("FDC Act").
FACILITIES AND OPERATIONAL REGULATION
The Clinical Laboratory Improvement Amendments of 1988 ("CLIA") subject
virtually all clinical laboratory testing facilities, including those of the
Company, to the jurisdiction of HHS. CLIA establishes national standards for
assuring the quality of laboratories based upon the complexity of testing
performed by a laboratory. Certain operations of the Company
18
are also subject to federal laws governing the repackaging and dispensing of
drugs and the maintenance and tracking of certain life sustaining and
life-supporting equipment.
The operations of the Company are subject to various U.S. Department of
Transportation, Nuclear Regulatory Commission and Environmental Protection
Agency requirements and other federal, state and local hazardous and medical
waste disposal laws. As currently in effect, laws governing the disposal of
hazardous waste do not classify most of the waste produced in connection with
the provision of dialysis, or laboratory services as hazardous, although
disposal of nonhazardous medical waste is subject to specific state regulation.
However, the Company's laboratory businesses do generate hazardous waste which
is subject to specific disposal requirements. The operations of the Company are
also subject to various air emission and wastewater discharge regulations.
Federal, state and local regulations require the Company to meet various
standards relating to, among other things, the management of facilities,
personnel qualifications and licensing, maintenance of proper records,
equipment, quality assurance programs, the operation of pharmacies, and
dispensing of controlled substances. All of the operations of the Company in the
U.S. are subject to periodic inspection by federal and state agencies and other
governmental authorities to determine if the operations, premises, equipment,
personnel and patient care meet applicable standards. To receive Medicare
reimbursement, the Company's dialysis centers, renal diagnostic support business
and laboratories must be certified by CMS. All of the Company's dialysis
centers, and laboratories that furnish Medicare services have the required
certification.
Certain facilities of the Company and certain of their employees are also
subject to state licensing statutes and regulations. These statutes and
regulations are in addition to federal and state rules and standards that must
be met to qualify for payments under Medicare, Medicaid and other government
reimbursement programs. Licenses and approvals to operate these centers and
conduct certain professional activities are customarily subject to periodic
renewal and to revocation upon failure to comply with the conditions under which
they were granted.
The Occupational Safety and Health Administration ("OSHA") regulations
require employers to provide employees who work with blood or other potentially
infectious materials with prescribed protections against blood-borne and
air-borne pathogens. The regulatory requirements apply to all health care
facilities, including dialysis centers and laboratories, and require employers
to make a determination as to which employees may be exposed to blood or other
potentially infectious materials and to have in effect a written exposure
control plan. In addition, employers are required to provide hepatitis B
vaccinations, personal protective equipment, blood-borne pathogens training,
post-exposure evaluation and follow-up, waste disposal techniques and
procedures, engineering and work practice controls and other OSHA-mandated
programs for blood-borne and air-borne pathogens.
Some states in which the Company operates have Certificate of Need ("CON")
laws that require any person or entity seeking to establish a new health care
service or to expand an existing service to apply for and receive an
administrative determination that the service is needed. The Company currently
operates in 13 states, including the District of Columbia and Puerto Rico that
have CON laws applicable to dialysis centers. These requirements may, as a
result of a state's internal determination of its dialysis services needs,
prevent entry to new companies seeking to provide services in these states, and
may constrain the Company's ability to expand its operations in these states.
New York law prohibits ownership by a corporation of any stock in another
corporation that is licensed in New York to operate certain health facilities,
including dialysis providers. Therefore, the Company does not own dialysis
facilities in New York, but rather works within the framework of New York's laws
to establish alternative contractual arrangements with New York dialysis
facilities.
REIMBURSEMENT
DIALYSIS SERVICES. The Company's dialysis centers provide outpatient
hemodialysis treatment and related services for ESRD patients. In addition, some
of the Company's centers offer services for the provision of peritoneal dialysis
and hemodialysis treatment at home, and dialysis for hospitalized patients
The Medicare program is the primary source of Dialysis Services revenues
from dialysis treatment. For example, in 2002, approximately 61% of Dialysis
Services revenues resulted from Medicare's ESRD program. As described below,
Dialysis Services is reimbursed by the Medicare program in accordance with the
Composite Rate for certain products and services rendered at the Company's
dialysis centers. As described hereinafter, other payment methodologies apply to
Medicare reimbursement for other products and services provided at the Company's
dialysis centers and for products (such as those sold by the Company) and
support services furnished to ESRD patients receiving dialysis treatment at home
(such as those of Dialysis Products). Medicare reimbursement rates are fixed in
advance and are subject to adjustment from time to time by the U.S. Congress.
Although this form of reimbursement limits the allowable charge per treatment,
it provides the Company with predictable per treatment revenues.
Certain items and services that the Company furnishes at its dialysis
centers are not included in the Composite Rate and are eligible for separate
Medicare reimbursement, typically on the basis of established fee schedule
amounts. Such items and services include certain drugs (such as EPO), blood
transfusions and certain diagnostic tests.
19
Medicare payments are subject to change by legislation, regulations and
pursuant to deficit reduction measures. The Composite Rate was unchanged from
commencement of the ESRD program in 1972 until 1983. From 1983 through December
1990, numerous congressional actions resulted in a net reduction of the average
reimbursement rate from $138 per treatment in 1983 to approximately $125 per
treatment in 1990. Congress increased the ESRD reimbursement rate, effective
January 1, 1991, to an average rate of $126 per treatment. Effective January 1,
2000, the reimbursement rate was increased by 1.2%. In December 2000 an
additional increase of 2.4% was approved for the year 2001. Accordingly, there
was a 1.2% reimbursement increase on January 1, 2001. A second increase was
delayed until April 1, 2001, when rates were increased 1.6% to make up for the
delay.
The Company is unable to predict what, if any, future changes may occur in
the rate of Medicare reimbursement. Any significant decreases in the Medicare
reimbursement rates could have a material adverse effect on the Company's
provider business and, because the demand for products is affected by Medicare
reimbursement, on its products business. Increases in operating costs that are
affected by inflation, such as labor and supply costs, without a compensating
increase in reimbursement rates, also may adversely affect the Company's
business and results of operations.
For Medicare-primary patients, the patient or third-party insurance
payors, including employer-sponsored health insurance plans, commercial
insurance carriers and the Medicaid program, are responsible for paying any
co-payment amounts for approved services not paid by Medicare (typically the
annual deductible and 20% co-insurance), subject to the specific coverage
policies of such payors. Each third-party payor, including Medicaid, makes
payment under contractual or regulatory reimbursement provisions which may or
may not cover the full 20% co-payment or annual deductible. Where the patient
has no third-party insurance or the third party insurance does not cover
copayment or deductible and the patient is responsible for paying the
co-payments or the deductible, which the Company frequently does not collect
fully despite reasonable collection efforts. Under an advisory opinion from the
Office of the Inspector General, subject to specified conditions, the Company
and the other similarly situated providers may make contributions to a
non-profit organization that has agreed to make premium payments for
supplemental medical insurance and/or medigap insurance on behalf of indigent
ESRD patients, including patients of the Company.
LABORATORY TESTS. A substantial portion of SRM's net revenues are derived
from Medicare, which pays for clinical laboratory services provided to dialysis
patients in two ways.
First, payment for certain routine tests is included in the Composite Rate
paid to the centers. As to such services, the dialysis centers obtain the
services from a laboratory and pay the laboratory for such services. In
accordance with industry practice, SRM usually provides such testing services
under capitation agreements with its customers pursuant to which it bills a
fixed amount per patient per month to cover the laboratory tests included in the
Composite Rate at the designated frequencies. In October 1994, the OIG issued a
special fraud alert in which it stated its view that the industry practice of
providing tests covered by the Composite Rate at below fair market value raised
issues under the anti-kickback statutes, as such an arrangement with an ESRD
facility appeared to be an offer of something of value (Composite Rate tests at
below market value) in return for the ordering of additional tests billed
directly to Medicare. See "--Anti-kickback Statutes, False Claims Act, Stark Law
and Fraud and Abuse Laws" for a description of this statute.
Second, laboratory tests performed by SRM for Medicare beneficiaries that
are not included in the Composite Rate are separately billable directly to
Medicare. Such tests are paid at 100% of the Medicare fee schedule amounts,
which are limited by national ceilings on payment rates, called National
Limitation Amounts ("NLAs"). Congress has periodically reduced the fee schedule
rates and the NLAs, with the most recent reductions in the NLAs occurring in
January 1998. (As part of the Balanced Budget Act of 1997, Congress lowered the
NLAs from 76% to 74% effective January 1, 1998.) Congress has also approved a
five year freeze on the inflation updates based on the Consumer Price Index
(CPI) for 1998-2002.
EPO. Future changes in the EPO reimbursement rate, inclusion of EPO in the
Medicare Composite Rate, changes in the typical dosage per administration or
increases in the cost of EPO purchased by NMC could adversely affect the
Company's business and results of operations, possibly materially.
COORDINATION OF BENEFITS. Medicare entitlement begins for most patients in
the fourth month after the initiation of chronic dialysis treatment at a
dialysis center. During the first three months, considered to be a waiting
period, the patient or patient's insurance, Medicaid or a state renal program
are responsible for payment.
Patients who are covered by Medicare and are also covered by an employer
group health plan ("EGHP") are subject to a 30 month coordination period during
which the EGHP is the primary payor and Medicare the secondary payor. During
20
this coordination period the EGHP pays a negotiated rate or in the absence of
such a rate, the Company's standard rate or a rate defined by its plan
documents. The payments are generally higher than the Medicare Composite Rate.
Employee group health insurance will therefore generally cover a total of 33
months, the 3 month waiting period plus the 30 month coordination period.
POSSIBLE CHANGES IN MEDICARE. Legislation or regulations may be enacted in
the future that could substantially modify or reduce the amounts paid for
services and products offered by the Company and its subsidiaries. It is also
possible that statutes may be adopted or regulations may be promulgated in the
future that impose additional eligibility requirements for participation in the
federal and state health care programs. Such new legislation or regulations may
adversely affect the Company's businesses and results of operations, possibly
materially.
HEALTH CARE LAWS
Various operations of the Company are subject to federal and state
statutes and regulations governing financial relationships between health care
providers and potential referral sources and reimbursement for services and
items provided to Medicare and Medicaid patients. Such laws include the
anti-kickback statute, health care fraud statutes, the False Claims Act, the
Stark Law, other federal fraud and abuse laws and similar state laws. These laws
apply because the Company's Medical Directors and other physicians with whom the
Company has financial relationships refer patients to, and order diagnostic and
therapeutic services from, the Company's dialysis centers and other operations.
As is generally true in the dialysis industry, at each dialysis facility a small
number of physicians account for all or a significant portion of the patient
referral base. An ESRD patient generally seeks treatment at a center that is
convenient to the patient and at which the patient's nephrologist has staff
privileges.
ANTI-KICKBACK STATUTES
The federal anti-kickback statute establishes criminal prohibitions
against and civil penalties for the knowing and willful solicitation, receipt,
offer or payment of any remuneration, whether direct or indirect, in return for
or to induce the referral of patients or the ordering or purchasing of items or
services payable in whole or in part under Medicare, Medicaid or other federal
health care programs. Sanctions for violations of the anti-kickback statute
include criminal and civil penalties, such as imprisonment or criminal fines of
up to $25,000 per violation, and civil penalties of up to $50,000 per violation,
and exclusion from the Medicare or Medicaid programs and other federal programs.
In addition, certain provisions of federal criminal law that may be applicable
provide that if a corporation is found guilty of a criminal offense it may be
fined no more than twice any pecuniary gain to the corporation, or, in the
alternative, no more than $500,000 per offense.
Some states also have enacted statutes similar to the anti-kickback
statute, which may include criminal penalties, applicable to referrals of
patients regardless of payor source, and may contain exceptions different from
state to state and from those contained in the federal anti-kickback statute.
FALSE CLAIMS ACT AND RELATED CRIMINAL PROVISIONS
The federal False Claims Act (the "False Claims Act") imposes civil
penalties for knowingly making or causing to be made false claims with respect
to governmental programs, such as Medicare and Medicaid, for services not
rendered, or for misrepresenting actual services rendered, in order to obtain
higher reimbursement. Moreover, private individuals may bring qui tam or
"whistle blower" suits against providers under the False Claims Act, which
authorizes the payment of a portion of any recovery to the individual bringing
suit. Such actions are initially required to be filed under seal pending their
review by the Department of Justice. A few federal district courts have recently
interpreted the False Claims Act as applying to claims for reimbursement that
violate the anti-kickback statute or federal physician self-referral law under
certain circumstances. The False Claims Act generally provides for the
imposition of civil penalties of $5,500 to $11,000 per claim and for treble
damages, resulting in the possibility of substantial financial penalties for
small billing errors that are replicated in a large number of claims, as each
individual claim could be deemed to be a separate violation of the False Claims
Act. Criminal provisions that are similar to the False Claims Act provide that
if a corporation is convicted of presenting a claim or
21
making a statement that it knows to be false, fictitious or fraudulent to any
federal agency it may be fined not more than twice any pecuniary gain to the
corporation, or, in the alternative, no more than $500,000 per offense. Some
states also have enacted statutes similar to the False Claims Act which may
include criminal penalties, substantial fines, and treble damages.
THE HEALTH INSURANCE PORTABILITY AND ACCOUNTABILITY ACT OF 1996
HIPAA was enacted in August 1996 and expanded federal fraud and abuse laws
by increasing their reach to all federal health care programs, establishing new
bases for exclusions and mandating minimum exclusion terms, creating an
additional exception to the anti-kickback penalties for risk-sharing
arrangements, requiring the Secretary of HHS to issue advisory opinions,
increasing civil money penalties to $10,000 (formerly $2,000) per item or
service and assessments to three times (formerly twice) the amount claimed,
creating a specific health care fraud offense and related health fraud crimes,
and expanding investigative authority and sanctions applicable to health care
fraud. It also prohibits provider payments which could be deemed an inducement
to patient selection of a provider.
The law expands criminal sanctions for health care fraud involving any
governmental or private health benefit program, including freezing of assets and
forfeiture of property traceable to commission of a health care offense.
HIPAA established a health care fraud statute which prohibits knowingly
and willfully executing a scheme or artifice to defraud any "health care benefit
program," which includes any public or private plan or contract affecting
commerce under which any medical benefit, item, or service is provided to any
individual, and includes any individual or entity who is providing a medical
benefit, item, or service for which payment may be made under the plan or
contract.
HIPAA regulations establish national standards for certain electronic
health care transactions, the use and disclosure of certain individually
identifiable patient health information, and the security of the electronic
systems maintaining this information. These are commonly known as the HIPAA
transaction and code set standards, privacy standards, and security standards.
Health insurance payers and healthcare providers like the Company must comply
with the new HIPAA standards. Violations of these HIPAA standards may include
civil money penalties and potential criminal sanctions.
BALANCED BUDGET ACT OF 1997
The Balanced Budget Act of 1997 ("the BBA") contained material adjustments
to both the Medicare and Medicaid programs, as well as further expansion of the
federal fraud and abuse laws. Specifically, the BBA created a civil monetary
penalty for violations of the federal anti-kickback statute whereby violations
will result in damages equal to three times the amount involved as well as a
penalty of $50,000 per violation. In addition, the new provisions expanded the
exclusion requirements so that any person or entity convicted of three health
care offenses is automatically excluded from federally funded health care
programs for life. Individuals or entities convicted of two offenses are subject
to mandatory exclusion of 10 years, while any provider or supplier convicted of
any felony may be denied entry into the Medicare program by the Secretary of HHS
if deemed to be detrimental to the best interests of the Medicare program or its
beneficiaries.
The BBA also provides that any person or entity that arranges or contracts
with an individual or entity that has been excluded from a federally funded
health care program will be subject to civil monetary penalties if the
individual or entity "knows or should have known" of the sanction.
STARK LAW
The original Stark Law, known as "Stark I" and enacted as part of the
Omnibus Budget Reconciliation Act of 1989, prohibits a physician from referring
Medicare patients for clinical laboratory services to entities with which the
physician (or an immediate family member) has a financial relationship, unless
an exception applies. Sanctions for violations of the Stark Law may include
denial of payment, refund obligations, civil monetary penalties and exclusion of
the provider from the Medicare and Medicaid programs. The Stark Law prohibits
the entity receiving the referral from filing a claim or billing for services
arising out of the prohibited referral.
Provisions of OBRA 93, known as "Stark II," amended Stark I to revise and
expand upon various statutory exceptions, to expand the services regulated by
the statute to a list of "Designated Health Services," and expanded the reach of
the statute to the Medicaid program. The provisions of Stark II generally became
effective on January 1, 1995, with the first phase of Stark II regulations
finalized on January 4, 2001. Most portions of the Phase I regulations became
effective in 2002. The additional Designated Health Services include: physical
therapy services; occupational therapy services; radiology services and certain
other imaging services; durable medical equipment and supplies; parenteral and
enteral nutrients, equipment and supplies; prosthetics, orthotics, and
prosthetic devices and supplies; home health services; outpatient prescription
drugs; and inpatient and outpatient hospital services. Phase I of the final
regulations implementing the Stark Law contains an exception for erythropoietin
(EPO) and certain other dialysis-related outpatient prescription drugs furnished
22
in or by an ESRD facility under many circumstances. Further, the final
regulations also adopt a definition of DME which effectively excludes ESRD
equipment and supplies from the category of Designated Health Services Phase II
of the final regulations to the Stark Law, which will address many of the
compensation exceptions, has not yet been released.
Several states in which the Company operates have enacted self-referral
statutes similar to the Stark Law. Such state self-referral laws may apply to
referrals of patients regardless of payor source and may contain exceptions
different from each other and from those contained in the Stark Law.
OTHER FRAUD AND ABUSE LAWS
The Company's operations are also subject to a variety of other federal
and state fraud and abuse laws, principally designed to ensure that claims for
payment to be made with public funds are complete, accurate and fully comply
with all applicable program rules.
The civil monetary penalty provisions are triggered by violations of
numerous rules under the Medicare statute, including the filing of a false or
fraudulent claim and billing in excess of the amount permitted to be charged for
a particular item or service. Violations may also result in suspension of
payments, exclusion from the Medicare and Medicaid programs, as well as other
federal health care benefit programs, or forfeiture of assets.
In addition to the statutes described above, other criminal statutes may
be applicable to conduct that is found to violate any of the statutes described
above.
HEALTH CARE REFORM
Health care reform is considered by many in the U.S. to be a national
priority. Members of Congress from both parties and officials from the executive
branch are continuing to consider many health care proposals, some of which are
comprehensive and far-reaching in nature. Several states are also currently
considering health care proposals. It cannot be predicted what additional
action, if any, the federal government or any state may ultimately take with
respect to health care reform or when any such action will be taken. Health care
reform may bring radical changes in the financing and regulation of the health
care industry, which could have a material adverse effect on the business of the
Company and the results of its operations.
23
ITEM 2. PROPERTIES
The table below describes the Company's principal facilities as of the
date hereof.
FLOOR AREA
(APPROXIMATE CURRENTLY OWNED
LOCATION SQUARE FEET) OR LEASED USE
-------- ------------ --------- ---
Lexington, Massachusetts 200,000 leased Corporate headquarters and administration.
Walnut Creek, California 85,000 leased Manufacture of hemodialysis machines and
peritoneal dialysis cyclers; research and
development.
17,500 leased Warehouse Space - Machine components
Ogden, Utah 590,000 owned Manufacture polysulfone membranes and dialyzers
and peritoneal dialysis solutions; research and
development.
Delran, New Jersey 42,000 leased Manufacture of liquid hemodialysis concentrate
solutions.
Perrysburg, Ohio 35,000 leased Manufacture of dry hemodialysis concentrates.
Livingston, California 32,000 leased Manufacture of liquid hemodialysis concentrates.
Irving, Texas 70,000 leased Manufacture of liquid hemodialysis solution.
Reynosa, Mexico 150,000 leased Manufacture of bloodlines.
Fremont, California 72,000 leased Clinical laboratory testing
Rockleigh, New Jersey 85,000 leased Clinical Laboratory testing
- ----------
The lease on the Walnut Creek facility expires in 2012. The Company leases
16 warehouses throughout the U.S. These warehouses are used as regional
distribution centers for the Company's peritoneal dialysis products business.
All such warehouses are subject to leases with remaining terms not exceeding ten
years. At December 31, 2002, the Company distributed its products through all
these 16 warehouse facilities.
The Company leases its corporate headquarters in Lexington, Massachusetts.
This lease expires on October 31, 2007.
The Company's subsidiaries lease most of the dialysis centers,
manufacturing, laboratory, distribution and administrative and sales facilities
in the U.S. on terms which the Company believes are customary in the industry.
24
ITEM 3. LEGAL PROCEEDINGS
COMMERCIAL LITIGATION
The Company was formed as a result of a series of transactions pursuant to
the Agreement and Plan of Reorganization (the "Merger") dated as of February 4,
1996 by and between W.R. Grace & Co. and Fresenius AG. At the time of the
Merger, a W.R. Grace & Co. subsidiary known as W.R. Grace & Co.-Conn. had, and
continues to have, significant potential liabilities arising out of
product-liability related litigation, pre-Merger tax claims and other claims
unrelated to NMC, which was Grace's dialysis business prior to the Merger. In
connection with the Merger, W.R. Grace & Co.-Conn. agreed to indemnify the
Company, FMCH and NMC against all liabilities of W.R. Grace & Co., whether
relating to events occurring before or after the Merger, other than liabilities
arising from or relating to NMC's operations. W.R. Grace & Co. and certain of
its subsidiaries filed for reorganization under Chapter 11 of the U.S.
Bankruptcy Code (the "Grace Chapter 11 Proceedings") on April 2, 2001.
Pre-Merger tax claims or tax claims that would arise if events were to
violate the tax-free nature of the Merger, could ultimately be the obligation of
the Company. In particular, W. R. Grace & Co. has disclosed in its filings with
the Securities and Exchange Commission that: its tax returns for the 1993 to
1996 tax years are under audit by the Internal Revenue Service (the "Service");
W. R. Grace & Co. has received the Service's examination report on tax periods
1993 to 1996; that during those years Grace deducted approximately $122,100 in
interest attributable to corporate owned life insurance ("COLI") policy loans;
that W.R. Grace & Co. has paid $21,200 of tax and interest related to COLI
deductions taken in tax years prior to 1993; that a U.S. District Court ruling
has denied interest deductions of a taxpayer in a similar situation and that
W.R. Grace & Co. is seeking a settlement of the Service's claims. Subject to
certain representations made by W.R. Grace & Co., the Company and Fresenius AG,
W.R. Grace & Co. and certain of its affiliates agreed to indemnify the Company
against this and other pre-Merger and Merger related tax liabilities.
Prior to and after the commencement of the Grace Chapter 11 Proceedings,
class action complaints were filed against W.R. Grace & Co. and the Company by
plaintiffs claiming to be creditors of W.R. Grace & Co.- Conn., and by the
asbestos creditors' committees on behalf of the W.R. Grace & Co. bankruptcy
estate in the Grace Chapter 11 Proceedings, alleging among other things that the
Merger was a fraudulent conveyance, violated the uniform fraudulent transfer act
and constituted a conspiracy. All such cases have been stayed and transferred
to or are pending before the U.S. District Court as part of the Grace Chapter
11 Proceedings.
On February 6, 2003, the Company reached a definitive agreement with the
asbestos creditors' committees on behalf of the W.R. Grace and Co. bankruptcy
estate in the matters pending in the Grace Chapter 11 Proceedings (the
"Settlement Agreement") for the settlement of all fraudulent conveyance claims
against it and other claims related to the Company that arise out of the
bankruptcy of W.R. Grace & Co. Under the terms of the Settlement Agreement,
fraudulent conveyance and other claims raised on behalf of asbestos claimants
will be dismissed with prejudice and the Company will receive protection against
existing and potential future W.R. Grace & Co. related claims, including
fraudulent conveyance and asbestos claims, and indemnification against income
tax claims related to the non-NMC members of the W.R. Grace & Co. consolidated
tax group upon confirmation of a W.R. Grace & Co. bankruptcy reorganization plan
that contains such provision. Under the Settlement Agreement, the Company will
pay a total of $115,000 to the W.R. Grace & Co. bankruptcy estate, or as
otherwise directed by the Court, upon plan confirmation. No admission of
liability has been or will be made. The Settlement Agreement is subject to the
approval of the U.S. District Court. The foregoing summary of the material
terms of the Settlement Agreement is qualified in its entirety by reference to
the full text of the Settlement Agreement. The Settlement Agreement has been
filed as an exhibit to the Company's annual report for 2002 to the Securities
and Exchange Commission.
Subsequent to the Merger, W.R. Grace & Co. was involved in a multi-step
transaction involving Sealed Air Corporation (formerly known as Grace Holding,
Inc.). The Company is engaged in litigation with Sealed Air Corporation ("Sealed
Air") to confirm the Company's entitlement to indemnification from Sealed Air
for all losses and expenses incurred by the Company relating to pre-Merger tax
liabilities and Merger-related claims. Under the Settlement Agreement, upon
confirmation of a plan that satisfies the conditions to the Company's payment
obligation, this litigation will be dismissed with prejudice.
Since 1997, the Company, NMC, and certain NMC subsidiaries have been
engaged in litigation with various insurance companies concerning allegations of
inappropriate billing practices for nutritional therapy and diagnostic and
clinical laboratory tests and misrepresentations. These claims against the
Company seek unspecified damages and costs. The Company, NMC and its
subsidiaries believe that there are substantial defenses to the claims asserted,
and intend to vigorously defend all lawsuits. The Company has filed
counterclaims against the plaintiffs in these matters based on inappropriate
claim denials and delays in claim payments. Other private payors have contacted
the Company and may assert
25
that NMC received excess payments and, similarly, may join the lawsuits or file
their own lawsuit seeking reimbursement and other damages. Although the ultimate
outcome on the Company of these proceedings cannot be predicted at this time, an
adverse result could have a material adverse effect on the Company's business,
financial condition and results of operations.
OTHER LITIGATION AND POTENTIAL EXPOSURES
From time to time, the Company is a party to or may be threatened with
other litigation arising in the ordinary course of its business. Management
regularly analyzes current information including, as applicable, the Company's
defenses and insurance coverage and, as necessary, provides accruals for
probable liabilities for the eventual disposition of these matters.
The Company, like other health care providers, conducts its operations
under intense government regulation and scrutiny. The Company must comply with
regulations which relate to or govern the safety and efficacy of medical
products and supplies, the operation of manufacturing facilities, laboratories
and dialysis clinics, and environmental and occupational health and safety. The
Company must also comply with the Anti-Kickback Statute, the False Claims Act,
the Stark Statute, and other federal and state fraud and abuse laws. Applicable
laws or regulations may be amended, or enforcement agencies or courts may make
interpretations that differ from the Company's or the manner in which the
Company conduct its business. Enforcement has become a high priority for the
federal government and some states. In addition, the provisions of the False
Claims Act authorizing payment of a portion of any recovery to the party
bringing the suit encourage private plaintiffs to commence "whistle blower"
actions. By virtue of this regulatory environment, as well as our corporate
integrity agreement with the government, the Company expects that its business
activities and practices will continue to be subject to extensive review by
regulatory authorities and private parties, and expects continuing inquiries,
claims and litigation relating to its compliance with applicable laws and
regulations. The Company may not always be aware that an inquiry or action has
begun, particularly in the case of "whistle blower" actions, which are initially
filed under court seal.
The Company operates large number facilities throughout the U.S. In such a
decentralized system, it is often difficult to maintain the desired level of
oversight and control over the thousands of individuals employed by many
affiliated companies. The Company relies upon its management structure,
regulatory and legal resources, and the effective operation of its compliance
program to direct, manage and monitor the activities of these employees. On
occasion, the Company may identify instances where employees, deliberately or
inadvertently, have submitted inadequate or false billings. The actions of such
persons may subject the Company and its subsidiaries to liability under the
Anti-Kickback Statute, the Stark Statute and False Claims Act, among other laws.
Physicians, hospitals and other participants in the health care industry
are also subject to a large number of lawsuits alleging professional negligence,
malpractice, product liability, worker's compensation or related claims, many of
which involve large claims and significant defense costs. The Company has been
subject to these suits due to the nature of its business and the Company expects
that those types of lawsuits may continue. Although the Company maintains
insurance at a level which it believes to be prudent, the Company cannot assure
that the coverage limits will be adequate or that insurance will cover all
asserted claims. A successful claim against the Company or any of its
subsidiaries in excess of insurance coverage could have a material adverse
effect upon the Company and the results of its operations. Any claims,
regardless of their merit or eventual outcome, also may have a material adverse
effect on the Company's reputation and business.
The Company has also had claims asserted against it and has had lawsuits
filed against it relating to businesses that it has acquired or divested. These
claims and suits relate both to operation of the businesses and to the
acquisition and divestiture transactions. The Company has asserted its own
claims, and claims for indemnification. Although the ultimate outcome on the
Company cannot be predicted at this time, an adverse result could have a
material adverse effect upon the Company's business, financial condition, and
results of operations.
ACCRUED SPECIAL CHARGE FOR LEGAL MATTERS
At December 31, 2001, the Company recorded a pre-tax special charge of
$258,000 to reflect anticipated expenses associated with the continued defense
and resolution of pre-Merger tax claims, Merger-related claims, and commercial
insurer claims. The costs associated with the Settlement Agreement will be
charged against this accrual. While the Company believes that its remaining
accruals reasonably estimate the Company's currently anticipated costs related
to the continued defense and resolution of the remaining matters, no assurances
can be given that the actual costs incurred by the Company will not exceed the
amount of these accruals.
26
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
PART II
ITEM 5. MARKET PRICE FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
All of the Company's common stock is held by FMCAG. The NMC Credit
Facilities and the indentures pertaining to the Senior Subordinated Notes of
FMCAG and one of its subsidiaries impose certain limits on the Company's payment
of dividends. See Item 7 - "Management's Discussion and Analysis of Financial
Condition and Results of Operations".
FRESENIUS MEDICAL CARE HOLDINGS CLASS D PREFERRED SHARES
On February 4, 2003, the Company announced it was exercising its right to
redeem all of its outstanding shares of the Class D Preferred Stock ("Class D
Shares"). The Class D Shares were issued to the common shareholders of W.R.
Grace & Co. in connection with the 1996 reorganization involving W.R. Grace and
Fresenius AG.
Class D Shares that have been properly transferred to, and received by,
the redemption agent will be redeemed commencing on March 28, 2003 at a
redemption price of $0.10 per share. The Company intends to redeem the 89
million outstanding Class D Shares at a total cash outflow of approximately
$8,900. This transaction will have no earnings impact on the Company. After
March 28, 2003 the Class D Shares will cease to be deemed issued and outstanding
shares of the Company's capital stock and will be restored to the status of
authorized but unissued shares of preferred stock.
27
ITEM 6. SELECTED FINANCIAL DATA
YEAR ENDED DECEMBER 31,
--------------------------------------------------------
(Dollars in Millions, Except Shares and Per Share Data) 2002 2001 2000 1999 1998
-------- -------- -------- -------- --------
Statement of Operations Data
Continuing Operations
Net sales $ 3,750 $ 3,609 $ 3,089 $ 2,815 $ 2,571
Cost of Sales 2,650 2,510 2,109 1,880 1,707
-------- -------- -------- -------- --------
Gross Profit 1,100 1,099 980 935 864
Selling, general and administrative and
research and development 605 675 560 540 529
Special charge for settlement of investigation
and related costs -- -- -- 601 --
Special charge for legal matters -- 258 -- -- --
-------- -------- -------- -------- --------
Operating income (loss) 495 166 420 (206) 335
Interest expense (net) 210 226 187 202 209
Interest expense on settlement of investigation (net) -- -- 30 -- --
-------- -------- -------- -------- --------
Income (loss) from continuing operations before
income taxes, extraordinary item and cumulative
effect of changes in accounting for start up costs 285 (60) 203 (408) 126
Provision (benefit) for income tax 114 19 98 (81) 74
-------- -------- -------- -------- --------
Net income (loss) from continuing operations
before extraordinary item and cumulative
effect of changes in accounting for
start up costs 171 (79) 105 (327) 52
Extraordinary loss on early redemption of
borrowings from affiliates, net of tax benefit of $6 10 -- -- -- --
-------- -------- -------- -------- --------
Net income (loss) from continuing operations
before cumulative effect of change in accounting
for start up costs $ 161 $ (79) $ 105 $ (327) $ 52
-------- -------- -------- -------- --------
Discontinued Operations
Loss from discontinued operations, net of
income taxes -- -- -- -- (9)
Loss on disposal of discontinued operations,
net of income tax Benefit -- -- -- -- (97)
-------- -------- -------- -------- --------
Loss from discontinued operations -- -- -- -- (106)
-------- -------- -------- -------- --------
Cumulative effect of change in accounting for start
up costs, net of tax benefit -- -- -- -- (5)
Net income (loss) $ 161 $ (79) $ 105 $ (327) $ (59)
======== ======== ======== ======== ========
Net Income (loss) Per Common and Common
Equivalent Share:
Continuing Operations $ 1.89 $ (0.89) $ 1.16 $ (3.64) $ 0.57
Extraordinary loss (0.10) -- -- -- --
Discontinued Operations -- -- -- -- (1.18)
Cumulative effect of accounting change -- -- -- -- (0.05)
Net Income 1.79 (0.89) 1.16 (3.64) (0.66)
Weighted average number of shares of
Common stock and common stock equivalents:
90,000 90,000 90,000 90,000 90,000
Primary (000's)
AT DECEMBER 31,
--------------------------------------------------------
2002 2001 2000 1999 1998
-------- -------- -------- -------- --------
Balance Sheet Data:
Working capital (deficit) $ (73) $ (176) $ (154) $ (456) $ 294
Total assets 5,010 5,003 4,553 4,645 4,613
Total long term debt and capital lease obligations 618 302 589 616 1,014
Mandatorily redeemable preferred securities 771 692 305 -- --
Stockholders' equity 1,723 1,598 1,726 1,622 1,949
28
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following is a discussion of the financial condition and results of
operations of the Company. The discussion should be read in conjunction with the
consolidated financial statements included elsewhere in this document.
This section contains certain forward-looking statements that are subject
to various risks and uncertainties. Such statements include, without limitation,
discussions concerning the outlook of the Company, government reimbursement,
future plans and management's expectations regarding future performance. Actual
results could differ materially from those contained in these forward-looking
statements due to certain factors including, without limitation, changes in
business, economic and competitive conditions, regulatory reforms, foreign
exchange rate fluctuations, uncertainties in litigation or investigative
proceedings, the realization of anticipated tax deductions, and the availability
of financing. These and other risks and uncertainties, which are more fully
described elsewhere in this Item 7 and in the Company's reports filed from time
to time with the Commission, could cause the Company's results to differ
materially from the results that have been or may be projected by or on behalf
of the Company.
OVERVIEW
The Company is primarily engaged in (a) providing kidney dialysis and
clinical laboratory testing services and (b) manufacturing and distributing
products and equipment for dialysis treatment. Throughout the Company's history,
a significant portion of the Company's growth has resulted from the development
of new dialysis centers and the acquisition of existing dialysis centers, as
well as from the acquisition and development of complementary businesses in the
health care field.
The Company derives a significant portion of its net revenues from
Medicare, Medicaid and other government health care programs (approximately 59%
in 2002). The reimbursement rates under these programs, including the Composite
Rate, the reimbursement rate for EPO, and the reimbursement rate for other
dialysis and non-dialysis related services and products, as well as other
material aspects of these programs, have in the past and may in the future be
changed as a result of deficit reduction and health care reform measures.
The Company also derives a significant portion of its net revenues from
reimbursement by non-government payors. Historically, reimbursement rates paid
by these payors generally have been higher than Medicare and other government
program rates. However, non-government payors are imposing cost containment
measures that are creating significant downward pressure on reimbursement levels
that the Company receives for its services and products.
SPECIAL CHARGE FOR LEGAL MATTERS
In the fourth quarter of 2001, the Company recorded a $258 million ($177
million after tax) special charge to address 1996 merger-related legal matters,
estimated liabilities and legal expenses arising in connection with the Grace
Chapter 11 Proceedings and the cost of resolving pending litigation and other
disputes with certain commercial insurers.
The Company accrued $172 million principally representing a provision for
income taxes payable for the years prior to the 1996 merger for which the
Company has been indemnified by W.R. Grace, but may ultimately be obligated to
pay as a result of Grace's Chapter 11 Proceedings. In addition, that amount
included the estimated costs of defending the Company in all litigation arising
out of Grace's Chapter 11 Proceedings.
The Company included $55 million in the special charge to provide for
settlement obligations, legal expenses and the resolution of disputed accounts
receivable relating to various insurance companies.
The remaining amount of the special charge ($31 million) was accrued
mainly for (i) assets and receivables that are impaired in connection with other
legal matters and (ii) anticipated expenses associated with the continued
defense and resolution of the legal matters.
At December 31, 2002, there is a remaining balance of $191 million for the
accrual for the special charge for legal matters. The Company believes that
these reserves are adequate for the settlement of all matters described above.
During the year ended December 31, 2002, $33 million in charges were applied
against the accrued special charge for legal matters. See also Note 17 -
"Commitments and contingencies - Accrued Special Charge for Legal Matters."
29
RESULTS OF OPERATIONS
The following table summarizes certain operating results of the Company by
principal business unit for the periods indicated. Intercompany eliminations
primarily reflect sales of medical supplies by Dialysis Products to Dialysis
Services.
YEAR ENDED DECEMBER 31,
-----------------------------
(DOLLARS IN MILLIONS)
2002 2001 2000
------- ------- -------
NET REVENUES
Dialysis Services ..................... $ 3,311 $ 3,149 $ 2,625
Dialysis Products ..................... 763 755 717
Intercompany Eliminations ............. (324) (295) (253)
------- ------- -------
Net Revenues .............................. $ 3,750 $ 3,609 $ 3,089
======= ======= =======
Operating Earnings:
Dialysis Services ..................... $ 411 $ 422 $ 403
Dialysis Products ..................... 143 138 118
------- ------- -------
Operating Earnings ........................ 554 560 521
------- ------- -------
Other Expenses:
General Corporate ..................... $ 50 $ 131 $ 97
Research & Development ................ 9 5 4
Interest Expense, Net ................. 210 226 187
Interest Expense on Settlement, Net ... -- -- 30
Special Charge for Legal Matters ...... -- 258 --
------- ------- -------
Total Other Expenses ...................... 269 620 318
------- ------- -------
Income (Loss) Before Income Taxes and
Extraordinary Item ..................... 285 (60) 203
Provision for Income Taxes ................ 114 19 98
------- ------- -------
Net Income (Loss) Before Extraordinary Item $ 171 $ (79) $ 105
------- ------- -------
Extraordinary Loss ........................ 10 -- --
------- ------- -------
Net Income (Loss) ......................... $ 161 $ (79) $ 105
------- ------- -------
30
YEAR ENDED DECEMBER 31, 2002 COMPARED TO YEAR ENDED DECEMBER 31, 2001
Net revenues for the year ended December 31, 2002 increased by $141
million (4%) over the year ended December 31, 2001. Excluding the extraordinary
loss on the early redemption of borrowings from affiliates of $10 million after
tax in 2002 and the special charge for the settlement of legal matters in 2001
of $258 million ($177 after tax), net income for 2002 increased by 74% to $171
million as compared to $98 million in 2001. This increase results from the
elimination of amortization for goodwill and intangible assets with indefinite
useful lives in accordance with SFAS No. 142 that was adopted effective January
1, 2002. Had SFAS No. 142 been adopted as of January 1, 2001 net earnings
would have decreased by 10% ($19 million) from $190 million in 2001.
DIALYSIS SERVICES
Dialysis Services net revenues increased by 5% to $3,294 million (net of
$17 million of intercompany sales) as compared to $3,132 million in 2001 due to
growth in base business. The growth in base business revenue is primarily
related to treatment growth. For the years ended 2002 and 2001, EPO represented
approximately 27% of dialysis services revenue.
At December 31, 2002, approximately 79,600 patients were being treated in
approximately 1,080 clinics that the Company owns, operates or manages compared
to approximately 76,600 patents treated in approximately 1,030 clinics at
December 31, 2001. The average revenue rate per treatment, excluding laboratory
testing revenue increased from $273 in 2001 to $274 in 2002. Including
laboratory testing revenues, th