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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 [FEE REQUIRED]
For the fiscal year ended December 31, 2002
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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 0-6906
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MEDICORE, INC.
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(Exact name of registrant as specified in its charter)
FLORIDA 59-0941551
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
2337 WEST 76TH STREET, HIALEAH, FLORIDA 33016
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (305) 558-4000
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Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Title of each class
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common stock, $.01 par value
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 this Form 10-K. [X]
Indicate by check mark whether the registrant is an accelerated filer
(as defined in Exchange Act Rule 12b-2). Yes [ ] No [X]
The aggregate market value of the voting stock held by non-affiliates
of the registrant based upon the closing price of the common stock on March 13,
2003 was approximately $6,042,000.
As of March 13, 2003 the company had outstanding 6,524,275 shares of
common stock.
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DOCUMENTS INCORPORATED BY REFERENCE
Part III incorporating information by reference from the Proxy
Statement in connection with the Registrant's Annual Meeting of Shareholders
anticipated to be on May 29, 2003.
Registrant's Annual Reports, Forms 10-K, for the years ended December
31, 1994, 1997 to 1999 and 2001 Part IV, Exhibits, incorporated in Part IV of
this Annual Report.
Annual Report for Registrant's Subsidiary Dialysis Corporation of
America, Form 10-K for the years ended December 31, 1996 to 2002, Part IV,
Exhibits, incorporated in Part IV of this Annual Report.
MEDICORE, INC.
Index to Annual Report on Form 10-K
Year Ended December 31, 2002
Page
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PART I
Item 1. Business ......................................................... 1
Item 2. Properties ....................................................... 29
Item 3. Legal Proceedings ................................................ 31
Item 4. Submission of Matters to a Vote
of Security Holders .............................................. 32
PART II
Item 5. Market for the Registrant's Common Equity
and Related Stockholder Matters .................................. 32
Item 6. Selected Financial Data .......................................... 33
Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations .................... 34
Item 7A. Quantitative and Qualitative Disclosures About Market Risk ....... 42
Item 8. Financial Statements and Supplementary Data ...................... 43
Item 9. Changes in and Disagreements with Accountants
on Accounting and Financial Disclosure ........................... 43
PART III
Item 10. Directors and Executive Officers
of the Registrant ................................................ 44
Item 11. Executive Compensation ........................................... 45
Item 12. Security Ownership of Certain Beneficial Owners and
Management and Related Stockholder Matters ....................... 45
Item 13. Certain Relationships and Related Transactions ................... 45
Item 14. Controls and Procedures .......................................... 46
PART IV
Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K . 46
PART I
Cautionary Notice Regarding Forward-Looking Information
The statements contained in this Annual Report on Form 10-K that are
not historical are forward-looking statements within the meaning of Section 27A
of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of
the 1934. The Private Securities Litigation Reform Act of 1995 contains certain
safe harbors regarding forward-looking statements. Certain of the
forward-looking statements include management's expectations, intentions and
beliefs with respect to the growth of our company, the nature of and future
development of the dialysis industry in which our 61% owned public subsidiary,
Dialysis Corporation of America, is engaged, anticipated revenues, our need for
sources of funding for expansion, our business strategies and plans for future
operations, our needs for capital expenditures, capital resources, liquidity and
operating results, and similar matters that are not considered historical facts.
See Item 7, "Management's Discussion and Analysis of Financial Condition and
Results of Operations." Words such as "anticipate," "estimate," "expects,"
"projects," "intends," "plans" and "believes," and words and terms of similar
import used in connection with any discussions of future operating or financial
performance identify forward-looking statements. Such forward-looking
statements, like all statements about expected future events, are subject to
substantial risks and uncertainties that could cause actual results to
materially differ from those expressed in the statements, including general
economic, market and business conditions, opportunities pursued or abandoned,
competition, changes in federal and state laws or regulations affecting the
company and our operations, and other factors discussed periodically in our
filings. Many of the foregoing factors are beyond our control. Among the factors
that could cause actual results to differ materially are the factors detailed in
the risks discussed in the "Risk Factors" section below. If any such events
occur or circumstances arise that we have not assessed, they could have a
material adverse effect upon our revenues, earnings, financial condition and
business, as well as the trading price of our common stock, which could
adversely affect your investment in the company. Accordingly, readers are
cautioned not to place too much reliance on such forward-looking statements
which speak only as of the date made and which the company undertakes no
obligation to revise to reflect events after the date made.
Item 1. Business
General
Medicore, Inc., incorporated in Florida in 1961, has three business
segments: (i) the medical products division which distributes medical products;
(ii) the operation of kidney dialysis centers and other dialysis services
through our 61% owned public subsidiary, Dialysis Corporation of America; and
(iii) the investment in technology companies through our approximately 14%
interest in Linux Global Partners, Inc. (and in which Dialysis Corporation of
America has an approximately 2% interest), a private speculative company that
has developed and recently commenced marketing a Linux desktop system and which
invests in developing Linux software companies. We had outstanding loans since
2000 to Linux Global Partners which aggregated approximately $2,742,000 at
December 31, 2002, upon which we declared a default and sold certain collateral
at public auction on January 24, 2003 to satisfy the indebtedness. The
collateral, 4,115,815 shares of Ximian, Inc.'s series A convertible preferred
stock, was purchased by Xandros, Inc., a 95% owned subsidiary of Linux Global
Partners, which company failed to meet the purchase terms resulting in our
company keeping the down payment of 775,000 shares of common stock
(approximately 1.5%) of Xandros and obtaining the Ximian preferred shares. See
"Linux Division," "Risk Factors" under this Item 1, "Business," Item 13,
"Certain Relationships and Related Transactions," and Notes 6, 12 and 15 to
"Notes to Consolidated Financial Statements." We sold our
71% owned public subsidiary, Techdyne, Inc., in June, 2001, subsequent to which
we have no continuing operations as a contract manufacturer of electronic
components. The dialysis operations are the most significant of our operations,
accounting for approximately 97% of our sales revenues. Our investment in
technology companies, currently limited to Linux Global Partners and since March
21, 2003, Ximian, Inc., the latter a private company providing desktop and
server solutions, has not generated any revenues other than interest income, and
our medical products division accounts for approximately 3% of our sales
revenues.
Our executive offices are located at 2337 West 76th Street, Hialeah,
Florida 33016 and at 777 Terrace Avenue, Hasbrouck Heights, New Jersey 07604.
Our telephone number in Florida is (305) 558-4000 and in New Jersey is (201)
288-8220. You may further communicate with us at the following:
Florida New Jersey
Fax: (305) 825-0961 Fax: (201) 288-8208
Email: medicore@compuserve.com
Medical Products
We develop and distribute medical products, primarily disposables, both
domestically and internationally, to hospitals, blood banks, laboratories and
retail pharmacies. Products distributed include exam gloves, prepackaged swabs
and bandages and glass tubing products for laboratories. We additionally
distribute a line of blood lancets used to draw blood for testing. The lancets
are distributed under the names Producers of Quality Medical Disposables(TM),
Lady Lite(TM), our brand name Lite Touch, or under a private label if requested
by the customer. Medical devices are required by the FDA, as a condition of
marketing, to secure a 510(k) premarket notification clearance or a Premarket
Approval Application. A product will be cleared by the FDA under a 510(k) if it
is found to be substantially equivalent in terms of safety, effectiveness and
intended use to another legally marketed product. We received 510(k) clearance
for our blood lancet line and insulin syringes, and for the sterile products.
Our medical products are subject to continuing FDA oversight, including
labeling, "good manufacturing practices," as defined in FDA regulations, and
adverse event reporting, none of which adverse events have occurred to date.
Although we hold three patents related to our lancets (see "Patents and Trade
Names" below), and obtained required FDA approval relating to the production of
lancets, we are no longer manufacturing these products. As of April 1, 2001, we
commenced purchasing lancets from manufacturers in the Far East. Marketing of
medical products is conducted by independent manufacturer representatives and
our employees.
Dialysis Operations
Dialysis Corporation of America currently operates 16 outpatient
dialysis facilities in Pennsylvania, New Jersey, Georgia, Maryland and Ohio,
including Dialysis Corporation of America's management of an Ohio center in
which it has a 40% interest and an unaffiliated Georgia center pursuant to
management services agreements. Dialysis Corporation of America also provides
acute dialysis services through contractual relationships with nine hospitals
and medical centers. In addition, it provides homecare services through its
wholly owned subsidiary, DCA Medical Services, Inc. Management believes the
company distinguishes itself on the basis of quality patient care, and a
patient-focused, courteous, highly trained professional staff.
2
General
Dialysis Corporation of America's growth depends primarily on the
availability of suitable dialysis centers for development or acquisition or
development in appropriate and acceptable areas, and management's ability to
develop new potential dialysis centers at costs within Dialysis Corporation of
America's budget while competing with larger companies, some of which are public
companies or divisions of public companies with much more personnel and
financial resources. We opened a dialysis center in the first quarter of 2002 in
Pennsylvania. We acquired a center in Georgia in April 2002. We opened two new
centers in February 2003, one in Maryland and one in Ohio. We are in the
development stage for two new centers, one in Indiana and one in Virginia, and
in the negotiating stage for several others, currently in Ohio and Georgia.
Dialysis Corporation of America's medical service revenues are derived
primarily from four sources: (i) outpatient hemodialysis services (49%, 47% and
51% of medical services revenues for 2002, 2001 and 2000, respectively); (ii)
home peritoneal dialysis services, including method II services (3%, 3% and 6%
of medical services revenues for 2002, 2001 and 2000, respectively); (iii)
inpatient hemodialysis services for acute patient care provided through
agreements with hospitals and medical centers (10%, 15% and 10% of medical
services revenues for 2002, 2001 and 2000, respectively); and (iv) ancillary
services associated with dialysis treatments, primarily the administration of
erythropoietin ("EPO"), a bio-engineered protein that stimulates the production
of red blood cells (a deteriorating kidney loses its ability to regulate red
blood cell count, resulting in anemia) (38%, 35% and 33% of medical services
revenue for 2002, 2001 and 2000, respectively). Dialysis is an ongoing and
necessary therapy to sustain life for kidney dialysis patients. ESRD patients
normally receive 156 dialysis treatments each year.
Essential to Dialysis Corporation of America's operations and income is
Medicare reimbursement which is a fixed rate determined by the Center for
Medicare and Medicaid Services ("CMS") of the Department of Health and Human
Services ("HHS"). The level of our revenues and profitability may be adversely
affected by future legislation that could result in rate cuts. Further, Dialysis
Corporation of America's operating costs tend to increase over the years in
excess of increases in the prescribed dialysis treatment rates. The inpatient
dialysis service agreements for treating acute kidney disease are not subject to
government fixed rates, but rather are negotiated with hospitals, and typically
the rates are at least equivalent or higher on a per treatment basis.
Dialysis Industry
Kidneys act as a filter removing harmful substances and excess water
from the blood, enabling the body to maintain proper and healthy balances of
chemicals and water. Chronic kidney failure, End Stage Renal Disease, results
from chemical imbalance and buildup of toxic chemicals, and is a state of kidney
disease characterized by advanced irreversible renal impairment. ESRD patients,
in order to survive, must either obtain a kidney transplant, which procedure is
limited due to lack of suitable kidney donors and the incidence of rejection of
transplanted organs, or obtain regular dialysis treatment for the rest of their
lives.
Based upon information published by the CMS, the number of ESRD
patients requiring dialysis treatments in the United States is approximately
286,000, and continues to grow at a rate of approximately 5% a year. This is
thought to be attributable primarily to the aging of the population and greater
patient longevity as a result of improved dialysis technology. The statistics
further reflect approximately 4,200 dialysis facilities, and the current annual
cost of treating ESRD in the United States is approximately $22 billion.
3
ESRD Treatment Options
Treatment options for ESRD patients include (1) hemodialysis, performed
either at (i) an outpatient facility, or (ii) inpatient hospital facility, or
(iii) the patient's home; (2) peritoneal dialysis, either continuous ambulatory
peritoneal dialysis or continuous cycling peritoneal dialysis; and/or (3) kidney
transplant. A significant portion of ESRD patients receive treatments at
non-hospital owned outpatient dialysis facilities (according to CMS,
approximately 80%) with most of the remaining patients treated at home through
hemodialysis or peritoneal dialysis. Patients treated at home are monitored by a
designated outpatient facility.
The most prevalent form of treatment for ESRD patients is hemodialysis,
which involves the use of an artificial kidney, known as a dialyzer, to perform
the function of removing toxins and excess fluids from the bloodstream. This is
accomplished with a dialysis machine, a complex blood filtering device which
takes the place of certain functions of the kidney and which machine also
controls external blood flow and monitors the toxic and fluid removal process.
The dialyzer has two separate chambers divided by a semi-permeable membrane, and
simultaneously with the blood circulating through one chamber, dialyzer fluid
circulates through the other chamber. The toxins and excess fluid pass through
the membrane into the dialysis fluid. On the average, patients usually receive
three treatments per week with each treatment taking three to five hours.
Dialysis treatments are performed by teams of licensed nurses and trained
technicians pursuant to the staff physician's instructions.
Home hemodialysis treatment requires the patient to be medically
suitable and have a qualified assistant. Additionally, home hemodialysis
requires training for both the patient and the patient's assistant, which
usually encompasses four to eight weeks. Dialysis Corporation of America does
not currently provide home hemodialysis (non-peritoneal) services. The use of
conventional home hemodialysis has declined and is minimal due to the patient's
suitability and lifestyle, the need for the presence of a partner and a dialysis
machine at home, and the higher expense involved over continuous ambulatory
peritoneal dialysis.
A second home treatment for ESRD patients is peritoneal dialysis. There
are several variations of peritoneal dialysis, the most common being continuous
ambulatory peritoneal dialysis and continuous cycling peritoneal dialysis. All
forms of peritoneal dialysis use the patient's peritoneal (abdominal) cavity to
eliminate fluid and toxins from the patient. Continuous ambulatory peritoneal
dialysis utilizes dialysis solution infused manually into the patient's
peritoneal cavity through a surgically-placed catheter. The solution is allowed
to remain in the abdominal cavity for a three to five hour period and is then
drained. The cycle is then repeated. Continuous cycling peritoneal dialysis is
performed in a manner similar to continuous ambulatory peritoneal dialysis, but
utilizes a mechanical device to cycle the dialysis solution while the patient is
sleeping. Peritoneal dialysis is the third most common form of ESRD therapy
following center hemodialysis and renal transplant.
The third modality for patients with ESRD is kidney transplantation.
While this is the most desirable form of therapeutic intervention, the scarcity
of suitable donors and possibility of donor rejection limits the availability of
this surgical procedure as a treatment option.
Dialysis Corporation of America's Business Strategy
Dialysis Corporation of America has 26 years' experience in developing
and operating dialysis treatment facilities. Its first priority is to provide
quality patient care. Dialysis Corporation of America intends to continue to
establish alliances with physicians and hospitals, attempts to initiate dialysis
service
4
arrangements with nursing homes and managed care organizations, and to continue
to emphasize its high quality patient care. Its smaller size allows it to focus
on each patient's individual needs while remaining sensitive to the physicians'
professional concerns.
Dialysis Corporation of America continues to actively seek and
negotiate with physicians and others to establish new outpatient dialysis
facilities. In 2002, Dialysis Corporation of America acquired a center in
Georgia and opened a new center in Pennsylvania; in 2003 has opened a dialysis
center in Maryland and a dialysis center in Ohio; and it is in the development
stages for two new centers, one in Indiana, and one in Virginia. Dialysis
Corporation of America is in different stages of negotiations with physicians
for potential new facilities in different areas of the country.
We sold our controlling interest in Techdyne, Inc. in June, 2001 for
$10,000,000 plus a three year earn-out which will amount to between $2,500,000
and $5,000,000. A substantial portion of our after tax proceeds from that sale
are available for expansion of Dialysis Corporation of America's dialysis
operations.
Development and Acquisition of Facilities
One of the primary elements in developing or acquiring facilities is
locating an area with an existing patient base under the current treatment of a
local nephrologist, since the proposed facility would primarily be serving such
patients. Other considerations in evaluating development of a dialysis facility
or a proposed acquisition are the availability and cost of qualified and skilled
personnel, particularly nursing and technical staff, the size and condition of
the facility and its equipment, the atmosphere for the patients, the area's
demographics and population growth estimates, state regulation of dialysis and
healthcare services, and the existence of competitive factors such as existing
outpatient dialysis facilities within reasonable proximity to the proposed
center.
Expansion is accomplished primarily through the development of Dialysis
Corporation of America's own dialysis facilities. Acquisition of existing
outpatient dialysis centers is a faster but more costly means of growth. To
construct and develop a new facility ready for operations takes an average of
six to eight months, and approximately 12 months or longer to generate income,
all of which are subject to variations based on location, size and competitive
elements. Some of our centers are in the developmental stage, since they have
not reached the point where the patient base is sufficient to generate and
sustain earnings. See Item 7, "Management's Discussion and Analysis of Financial
Condition and Results of Operations." Construction of a 15 station facility
typically costs in a range of $600,000 to $750,000 depending on location, size
and related services to be provided by the proposed facility. Acquisition of
existing facilities is substantially more expensive, and is usually based
primarily upon its patient base and earnings, and to a lesser extent, location
and competition. Any significant expansion, whether through acquisition or
development of new facilities, is dependent upon existing funds or financing
from other sources
Inpatient Services
Management is also seeking to increase acute dialysis care contracts
with hospitals for inpatient dialysis services. These contracts are sought with
hospitals in areas serviced by our facilities. The contract rates are
individually negotiated with each hospital and are not fixed by government
regulation as is the case with Medicare reimbursement fees for ESRD patient
treatment. In 2002, Dialysis Corporation of America entered into new acute
inpatient dialysis services agreements with hospitals in Georgia.
5
There is no certainty as to when any additional centers or service
contracts will be implemented, or the number of dialysis stations or patient
treatments such may involve, or if such will ultimately be profitable. There is
no assurance that we will be able to continue to enter into favorable
relationships with physicians who would become medical directors of such
proposed dialysis facilities, or that our company will be able to acquire or
develop any new dialysis centers within a favorable geographic area. Newly
established dialysis centers, although contributing to increased revenues,
initially adversely affect results of operations due to start-up costs and
expenses and due to their having a smaller and slower developing patient base.
See "Dialysis Corporation of America's Business Strategy," "Operations" and
"Competition" of Item 1, "Business," and Item 7, "Management's Discussion and
Analysis of Financial Condition and Results of Operations."
Operations
Location, Capacity and Use of Facilities
Dialysis Corporation of America operates 16 outpatient dialysis
facilities in Pennsylvania, New Jersey, Georgia, Maryland and Ohio, including an
Ohio dialysis center in which it holds a 40% interest and which it operates in
conjunction with the majority owner, the medical director of that center, and an
unaffiliated center in Georgia which we manage. These dialysis facilities have a
total designed capacity of 230 licensed stations.
The owner of the facility we manage in Georgia is involved in
litigation and subject to its success in that litigation and continuing to be
the sole owner of that facility, Dialysis Corporation of America has given the
owner a put option to sell to Dialysis Corporation of America, and Dialysis
Corporation of America has a call option to purchase, all the assets of that
Georgia dialysis facility. Each of the options are exercisable for two years
commencing September 11, 2003. The put is not exercisable unless that Georgia
dialysis facility has $100,000 in pre-tax income. Upon exercise the owner would
receive a 20% interest in our Georgia facility with the remainder of the
purchase price in cash, determined on a formula based upon a multiple of EBITDA.
Dialysis Corporation of America owns and operate its centers through
subsidiaries some of which are 100% owned, with the balance owned in conjunction
with the medical directors of each center who hold interests ranging from 20% to
49%. We have a minority 40% interest in a center in Ohio which we manage. The
Lemoyne, Pennsylvania, and one of the South Georgia dialysis facilities are
located on properties owned by Dialysis Corporation of America and leased to
those subsidiaries. Our Ohio dialysis center is leased from a corporation owned
by the medical director of that facility who, together with his wife's
corporation, owns 40% of the center. See Item 2, "Properties." We also manage an
un-affiliated dialysis center in Georgia.
Additionally, Dialysis Corporation of America provides acute care
inpatient dialysis services to nine hospitals in areas serviced by our dialysis
facilities, and we are in the process of negotiating additional acute dialysis
services contracts in the areas surrounding our facilities and in tandem with
development of future proposed sites. Each of our dialysis facilities has the
capacity to provide training, supplies and on-call support services for home
peritoneal patients. Dialysis Corporation of America provided approximately
80,000 hemodialysis treatments in 2002.
Management estimates that on average its centers were operating at
approximately 50% of capacity as of December 31, 2002, based on the assumption
that a dialysis center is able to provide up to three treatments a day per
station, six days a week. Management of Dialysis Corporation of America believes
it can increase the number of dialysis treatments at its centers without making
additional capital expenditures.
6
Operations of Dialysis Facilities
Our dialysis facilities are designed specifically for outpatient
hemodialysis and generally contain, in addition to space for dialysis
treatments, a nurses' station, a patient weigh-in area, a supply room, water
treatment space used to purify the water used in hemodialysis treatments, a
dialyzer reprocessing room (where, with both the patient's and physician's
consent, the patient's dialyzer is sterilized for reuse), staff work area,
offices and a staff lounge. Our facilities also have a designated area for
training patients in home dialysis. Each facility also offers amenities for the
patients, such as a color television with headsets for each dialysis station, to
ensure the patients are comfortable and relaxed.
Dialysis Corporation of America maintains a team of dialysis
specialists to provide for the individual needs of each patient. In accordance
with participation requirements under the Medicare ESRD program, each facility
retains a medical director qualified and experienced in the practice of
nephrology and the administration of a renal dialysis facility. See "Physician
Relationships" below. Each facility is overseen by a nurse administrator who
supervises the daily operations and the staff, which consists of registered
nurses, licensed practical nurses, patient care technicians, a part-time social
worker to assist the patient and family to adjust to dialysis treatment and to
provide help in financial assistance and planning, and a part-time registered
dietitian. These individuals supervise the patient's needs and treatments. See
"Employees" below. Dialysis Corporation of America must continue to attract and
retain skilled nurses and other staff, competition for whom is intense.
Our facilities also offer home dialysis, primarily continuous
ambulatory peritoneal dialysis and continuous cycling peritoneal dialysis.
Training programs for continuous ambulatory peritoneal dialysis or continuous
cycling peritoneal dialysis generally encompass two to three weeks at the
dialysis facility, and such training is conducted by the facility's home
training nurse. After the patient completes training, they are able to perform
treatment at home with equipment and supplies provided by the company.
Inpatient Dialysis Services
Dialysis Corporation of America presently provides inpatient dialysis
services to nine hospitals in Pennsylvania, Georgia and Ohio, under agreements
either with it or with one of its subsidiaries in the area. The agreements are
for a term ranging from one to five years, with automatic renewal terms, subject
to termination by notice of either party. Inpatient services are typically
necessary for patients with acute kidney failure resulting from trauma or
similar causes, patients in the early stages of ESRD, and ESRD patients who
require hospitalization for other reasons.
Ancillary Services
Our dialysis facilities provide certain ancillary services to ESRD
patients, including the administration of certain prescription drugs, such as
EPO upon a physician's prescription. EPO is a bio-engineered protein which
stimulates the production of red blood cells and is used in connection with
dialysis to treat anemia, a medical complication frequently experienced by ESRD
patients. EPO decreases the necessity for blood transfusions in ESRD patients.
There is only one supplier of EPO in the United States without alternative
products available to dialysis treatment providers. Although we have a good
relationship with the manufacturer and have not experienced any problems in
receipt of our supply of EPO, any loss or limitation of supply of this product
could have a material adverse effect on our operating revenue and income.
7
Physician Relationships
An integral element to the success of a facility is its association
with area nephrologists. A dialysis patient generally seeks treatment at a
facility near the patient's home where the patient's nephrologist has an
established practice.
The conditions of a facility's participation in the Medicare ESRD
program mandate that treatment at a dialysis facility be under the general
supervision of a medical director who is a physician. We retain by written
agreement qualified physicians or groups of qualified physicians to serve as
medical directors for each of our facilities. The medical directors are
typically a source of patients treated at the particular center served. The
medical directors of nine of our centers have acquired an ownership interest in
the center they service ranging from 20% to 49%. Our Ohio affiliate is owned 60%
by the physician. We make every effort to comply with federal and state
regulations concerning our relationship with the physicians and the medical
directors treating patients at our facilities. See Item 1, "Business -
Regulation - Dialysis Corporation of America."
Agreements with medical directors typically range from a term of five
years to 10 years, with renewal provisions. Each agreement specifies the duties,
responsibilities and compensation of the medical director. Under each agreement,
the medical director or professional association maintains his, her or its own
medical malpractice insurance. The agreements also provide for non-competition
in a limited geographic area surrounding that particular dialysis center during
the term of the agreement and upon termination for a limited period. However,
the agreements do not prohibit physicians providing services at our facilities
from providing direct patient care services at other locations; and consistent
with the federal and state law, such agreements do not require a physician to
refer patients to our dialysis centers. Usually, physician's professional fees
for services are billed directly to the patient or the government payment
authorities on a direct basis by the treating physician and paid directly to the
physician or the professional association.
Dialysis Corporation of America's ability to establish a dialysis
facility in a particular area is significantly geared to the availability of a
qualified physician or nephrologist to serve as the medical director. The loss
of a medical director who could not be readily replaced would have a material
adverse effect on the operations of that facility, most likely resulting in
closure, and Dialysis Corporation of America. Compensation of medical directors
is separately negotiated for each facility and generally depends on competitive
factors such as the local market, the physician's qualifications and the size of
the facility.
Quality Assurance
Dialysis Corporation of America implements a quality assurance program
to maintain and improve the quality of dialysis treatment and care we provide to
our patients in every facility. Quality assurance activities involve the ongoing
examination of care provided, the identification of therapy deficiencies, the
need for any necessary improvements in the quality of care, and evaluation of
improved technology. Specifically, this program requires each center's staff,
including its medical director and/or nurse administrator to regularly review
quality assurance data and initiate programs for improvement, including dialysis
treatment services, equipment, technical and environmental improvements, and
staff-patient and personnel relationships. These evaluations are in addition to
assuring regulatory compliance with CMS and the Occupational Safety and Health
Administration. Our Vice President of Clinical Services, who is a certified
nephrology nurse, oversees this program in addition to ensuring that the company
meets federal and state compliance requirements for dialysis centers. See Item
1, "Business - Regulation - Dialysis Corporation of America."
8
Patient Revenues
A substantial amount of the fees for outpatient dialysis treatments are
funded under the ESRD Program established by the federal government under the
Social Security Act, and administered in accordance with rates set by CMS. A
majority of dialysis patients are covered under Medicare. The balance of the
outpatient charges are paid by private payors including the patient's medical
insurance, private funds or state Medicaid plans. Pennsylvania, New Jersey,
Georgia, Maryland and Ohio, presently the states in which we operate, provide
Medicaid or comparable benefits to qualified recipients to supplement their
Medicare coverage.
Under the ESRD Program, payments for dialysis services are determined
pursuant to Part B of the Medicare Act which presently pays 80% of the allowable
charges for each dialysis treatment furnished to patients. The maximum payments
vary based on the geographic location of the center. The remaining 20% may be
paid by Medicaid if the patient is eligible, from private insurance funds or the
patient's personal funds. If no secondary payor covers the remaining 20%,
Medicare may reimburse part of the balance as part of Dialysis Corporation of
America's cost report filings. Medicare and Medicaid programs are subject to
regulatory changes, statutory limitations and government funding restrictions,
which may adversely affect our revenues and dialysis services payments. See
"Medicare Reimbursement" below.
The inpatient dialysis services are paid for by the hospital pursuant
to contractual pre-determined fees for the different dialysis treatments.
Medicare Reimbursement
Dialysis Corporation of America is reimbursed primarily by Medicare
under a prospective reimbursement system for chronic dialysis services, and by
third party payors including Medicaid and commercial insurance companies. Each
of our dialysis facilities is certified to participate in the Medicare program.
Under the Medicare system, the reimbursement rates are fixed in advance and
limit the allowable charge per treatment, but provides us with predictable and
recurring per treatment revenues and allows us to retain any profit earned. An
established composite rate set by CMS governs the Medicare reimbursement
available for a designated group of dialysis services, including dialysis
treatments, supplies used for such treatments, certain laboratory tests and
medications. The Medicare composite rate is subject to regional differences.
Dialysis Corporation of America receives reimbursement for outpatient
dialysis services provided to Medicare-eligible patients at rates that are
currently between approximately $121 and $136 per treatment, depending upon
regional wage variations. The Medicare reimbursement rate is subject to change
by legislation. An average ESRD reimbursement rate is approximately $124 per
treatment for outpatient dialysis services. The current maximum composite
reimbursement rate is $144 per treatment. Congress has requested studies of the
ESRD composite rate structure as well as other related ancillary services to
determine whether the composite rate is subject to an annual inflationary
increase. To date this issue is still pending.
Other ancillary services and items are eligible for separate
reimbursement under Medicare and are not part of the composite rate, including
certain drugs such as EPO, the allowable rate of which is currently $10 per 1000
units for amounts in excess of three units per patient per year, and certain
physician-ordered tests provided to dialysis patients. Approximately 26% of
Dialysis Corporation of America's medical services revenues in 2002 was derived
from providing dialysis patients with EPO.
9
CMS limits the EPO reimbursement based upon patients' hematocrit levels. Other
ancillary services, mostly other drugs, account for approximately an additional
10% of our medical services revenues. We submit claims monthly and are usually
paid by Medicare within 14 days of the submission.
There have been a variety of proposals to Congress for Medicare reform.
We are unable to predict what, if any, future changes may occur in the rate of
reimbursement. Any reduction in the Medicare composite reimbursement rate would
have a material adverse effect on Dialysis Corporation of America's and our
business, revenues and net earnings.
Medicaid Reimbursement
Medicaid programs are state administered programs partially funded by
the federal government. These programs are intended to provide coverage for
patients whose income and assets fall below state defined levels and who are
otherwise uninsured. The programs also serve as supplemental insurance programs
for the Medicare co-insurance portion and provide certain coverages (e.g., oral
medications) that are not covered by Medicare. State regulations generally
follow Medicare reimbursement levels and coverages without any co-insurance
amounts. Certain states, however, require beneficiaries to pay a monthly share
of the cost based upon levels of income or assets. Pennsylvania and New Jersey
have Medical Assistance Programs comparable to Medicaid, with primary and
secondary insurance coverage to those who qualify. We are a licensed ESRD
Medicaid provider in New Jersey, Pennsylvania, Ohio and Georgia.
Dialysis Corporation of America
Sources of Medical Service Revenues
Year Ended December 31,
2002 2001
---- ----
Medicare 49% 48%
Medicaid and Comparable Programs 9% 11%
Hospital inpatient dialysis services 10% 15%
Commercial and private payors 32% 26%
Management Services
Dialysis Corporation of America has a management services agreement
with each subsidiary and with its 40% owned affiliate DCA of Toledo, LLC, and
with an unaffiliated Georgia dialysis center, providing them with administrative
and management services, including but not limited to providing capital
equipment, preparing budgets, bookkeeping, accounting, data processing, and
other corporate based information services, materials and human resource
management, billing and collection, and accounts receivable and payable
processing. These services are provided for a percentage of net revenues of each
facility.
Corporate Integrity Program
Medicore and Dialysis Corporation of America have developed Corporate
Integrity Programs to assure we continue to achieve our goal of providing the
highest level of care and service in a professional and ethical manner
consistent with applicable federal and state laws and regulations. This program
is intended to reinforce our management's, employees' and professional
affiliates' awareness of their responsibilities to comply with applicable laws
in the increased and complex regulatory environment
10
relating to the operations of our company. This should benefit the overall care
and services for our dialysis patients, assure our operations are in compliance
with the law, which should also assist in operating in a cost-effective manner,
and accordingly, benefit our shareholders.
The board of directors of both Medicore and Dialysis Corporation of
America have established audit committees each consisting of three independent
members of the board who oversee audits, accounting, financial reporting, and
who have established procedures for receipt, retention and resolution of
complaints relating to those areas (none to date), among other responsibilities.
The audit committees operate under charters providing for their detailed
responsibilities.
Dialysis Corporation of America has developed a Compliance Program to
assure compliance with fraud and abuse laws, enhance communication of
information, and provide a mechanism to quickly identify and correct any
problems that may arise. This Compliance Program supplements and enhances our
existing policies, including those applicable to claims submission, cost report
preparation, internal audit and human resources.
As part of our Corporate Integrity Programs, Medicore and Dialysis
Corporation of America have developed Codes of Ethics and Business Conduct
covering management and all employees to assure all persons affiliated with our
company and our operations act in an ethical and lawful manner. The Codes of
Ethics and Business Conduct cover relationships among and between affiliated
persons, patients, payors, and relates to information processing, compliance,
workplace conduct, environmental practices, training, education, development,
among other areas. In its commitment to delivering quality care to dialysis
patients, Dialysis Corporation of America has mandated rigorous standards of
ethics and integrity.
The Corporate Integrity Programs are implemented and upgraded to
provide a highly professional work environment and lawful and efficient business
operations to better serve our patients and our shareholders.
Potential Liability and Insurance
Participants in the health care industry are subject to lawsuits based
upon alleged negligence, many of which involve large claims and significant
defense costs. We are very proud of the fact that, although Dialysis Corporation
of America has been involved in chronic and acute kidney dialysis services for
approximately 26 years, that subsidiary has never been subject to any suit
relating to its dialysis operations. Dialysis Corporation of America initiated
and is involved in a breach of contract dispute. See Item 3, "Legal
Proceedings." We currently have general and umbrella liability insurance, as
well as professional and products liability coverage. Our insurance policies
provide coverage on an "occurrence" basis and are subject to annual renewal. A
hypothetical successful claim against Dialysis Corporation of America in excess
of our insurance coverage could have a material adverse effect upon Dialysis
Corporation of America's and our business and results of operations. The medical
directors supervising our dialysis operations and other physicians practicing at
the facilities are required to maintain their own professional malpractice
insurance coverage.
Technology Companies
In January, 2000, we established a new division with the purpose of
investing in and incubating new technology companies, primarily involved with
Internet technology. Our initial investment was in Linux Global Partners, a
private company which has developed and recently commenced marketing its Linux
11
desktop system. Linux Global Partners has investments in a variety of other
Linux-related software companies, with certain of which it is attempting to
negotiate strategic alliances to employ their systems in conjunction with Linux
Global Partner's desktop system.. We hold an approximately 14% interest in Linux
Global Partners, and Dialysis Corporation of America holds an approximately 2%
interest. During 2000, we loaned Linux Global Partners $2,200,000 at an annual
rate of interest of 10%, which funds we borrowed from our subsidiary, Dialysis
Corporation of America. In May and June, 2001, we fully repaid this loan and
accrued interest to Dialysis Corporation of America. In 2001, Linux Global
Partners paid us $215,000 of which $200,000 was principal of the indebtedness.
The loan had been extended on various occasions. In 2002 we advanced another
$250,000 to Linux Global Partners under the same terms as the original loan. At
December 31, 2002, the principal and accrued interest on the loans aggregated
approximately $2,742,000. The indebtedness was collateralized by Linux Global
Partner's portfolio consisting of several companies that focus on the software
capabilities of the Linux operating system. Some of its investments, which range
from 6% to 90% ownership, included Ximian (which investment we now own), which
is involved in producing a Linux desktop environment and productivity
application suite, and enterprise software management solutions; Code Weavers, a
software development service and porting company; and Metro Link, involved in
Linux graphics and the embedded sector. All of these companies are private and
are in the developmental stages, several with limited revenues, and their
success remains speculative.
We were to receive $100,000 per month or 25% of the proceeds of Linux
Global Partners' private financings, whichever first occurred, and until such
repayment, Linux Global Partners had been issuing 50,000 shares of its common
stock to us every month. We declared the loan in default and sold, under the
requirements of the Uniform Commercial Code, certain of the collateral at public
auction on January 24, 2003. The sale consisted of 4,115,815 shares of Ximian
series A convertible preferred stock, which was purchased for $2,992,000 by
Xandros, Inc., a 95% owned subsidiary of Linux Global Partners. Xandros failed
to meet the conditions of purchase and forfeited its down payment of 775,000
shares of its common stock and we obtained the 4,115,815 preferred shares of
Ximian, which has become our second investment in new technology companies. See
Item 1, "Business - Risk Factors - Investment in Technology Companies," Item 7,
Management's Discussion and Analysis of Financial Condition and Results of
Operations" and Notes 6, 12, and 15 to "Notes to Consolidated Condensed
Financial Statements."
Linux is a free operating system, with its source code openly
published, developed and improved over the years by a worldwide community of
programmers. Linux has become an increasingly popular operating system posing a
potential challenge to the current major operating systems, such as Microsoft's
Windows NT and Sun Microsystems' Solaris, two of the leading operating systems
used on server computers, the data-serving machines that are the engines of
corporate networks and the Internet. In August, 2001, Linux Global Partners
purchased Corel Corporation's Canadian Linux Business Division, which Linux
Global Partners is operating through its subsidiary, Xandros. Corel, the world's
second largest desktop software company, holds a 5% interest in that subsidiary.
Xandros, building on Corel's $25 million in research and development of the
Linux desktop system, has improved the system and in October, 2002, initiated
the marketing of the Linux operating system and suite of applications for
desktop computing. The Linux operating system has received high accolades from a
variety of technical software publications and was among five prize winners for
desktop software technology awarded by Norge, a pc magazine. Xandros has been
obtaining limited financing for its operations, and is in need of substantial
capital to continue its marketing and further development of the Linux desktop
operating system. Although Xandros is in discussions with a variety of
investors, some of whom have already provided funding to its parent, Linux
Global Partners, and itself, there is no assurance such capital will be
available or, if so, on favorable terms. We recognize Xandros is subject to all
the risks of a startup company, including the ability to continue operations,
and whether the Linux desktop system will be accepted, the extent of sales, its
ability to generate revenues, and whether such revenues will be sufficient to
reflect income, and the overall ability of
12
management to operate and grow that company. Ximian is a new private technology
company, facing similar start-up company risks, and is engaged in funding
efforts for its operations.
Although we continue to evaluate new technologies, the economy and
marketplace during 2001 and 2002 and thus far in 2003 have not been friendly to
many industries, particularly the technology sector.
Discontinued Operations
We formerly were engaged as a contract manufacturer of electronic and
electro-mechanical products, primarily for the data processing,
telecommunications, instrumentation and food preparations equipment industries,
accomplished through our 71% owned public subsidiary, Techdyne, Inc. We sold our
71% interest in Techdyne on June 27, 2001. Accordingly Techdyne is presented as
a discontinued operation.
Government Regulation
Dialysis Corporation of America
Regulation of healthcare facilities, including dialysis facilities, is
extensive, with legislation continually proposed relating to safety, maintenance
of equipment and proper records, quality assurance programs, reimbursement
rates, confidentiality of medical records, licensing and other areas of
operations. Each of the dialysis facilities must be certified by CMS, and we
must comply with certain rules and regulations established by CMS regarding
charges, procedures and policies. Each dialysis center is also subject to
periodic inspections by federal and state agencies to determine the satisfaction
of regulatory standards to its operations. Our operations are also subject to
the Occupational Safety and Health Administration, known as OSHA, relating to
workplace safety and employee exposure to blood and other potentially infectious
material.
Many states have eliminated the requirement to obtain a certificate of
need prior to the establishment or expansion of a dialysis center. There are no
certificate of need requirements in the states in which we are presently
operating.
Our record of compliance with federal, state and local governmental
laws and regulations remains excellent. We are unable to predict the scope and
effect of any changes in government regulations, particularly any modifications
in the reimbursement rate for medical services or requirements to obtain
certification from CMS. Enforcement, both privately and by the government, has
become more stringent, particularly in attempts to combat fraud and waste,
adding to compliance costs as well as potential sanctions. Since inception in
1976, we have maintained all of our licenses, including our Medicare and
Medicaid and equivalent certifications. The loss of any licenses and
certifications would have a material adverse effect on our company, revenues and
earnings.
We regularly review legislative and regulatory changes and developments
and will restructure a business arrangement if we determine such might place our
operations in material noncompliance with such law or regulation. See "Fraud and
Abuse" and "Stark II" below. To date, none of our business arrangements with
physicians, patients or others have been the subject of investigation by any
governmental authority. No assurance can be given, however, that our business
arrangements will not be the subject of future investigation or prosecution by
federal or state governmental authorities which could result in civil and/or
criminal sanctions.
13
Fraud and Abuse
Certain aspects of our dialysis business are subject to federal and
state laws governing financial relationships between health care providers and
referral sources and the accuracy of information submitted in connection with
reimbursement. These laws, collectively referred to as "fraud and abuse" laws,
include the Anti-Kickback Statute, Stark II, other federal fraud laws, and
similar state laws.
The fraud and abuse laws apply because our medical directors have
financial relationships with the dialysis facilities and also refer patients to
those facilities for items and services reimbursed by federal and state health
care programs. Financial relationships with patients who are federal program
beneficiaries also implicate the fraud and abuse laws. Other financial
relationships which bear scrutiny under the fraud and abuse laws include
relationships with hospitals, nursing homes, and various vendors.
Anti-Kickback Statutes
The federal Anti-Kickback Statute prohibits the knowing and willful
solicitation, receipt, offer, or payment of any remuneration, directly or
indirectly, in return for or to induce the referral of patients or the ordering
or purchasing of items or services payable under the Medicare, Medicaid, or
other federal health care program.
Sanctions for violations of the Anti-Kickback Statute include criminal
penalties, such as imprisonment and fines of up to $25,000 per violation, and
civil penalties, of up to $50,000 per violation, and exclusion from Medicare,
Medicaid, and other federal health care programs.
The language of the Anti-kickback Statute has been construed broadly by
the courts. Over the years, the federal government has published regulations
that established "safe harbors" to the Anti-Kickback Statute. An arrangement
that meets all of the elements of the safe harbor is immunized from prosecution
under the Anti-Kickback Statute. The failure to satisfy all elements, however,
does not necessarily mean the arrangement violates the Anti-Kickback Statute.
Some states have enacted laws similar to the Anti-Kickback Statute.
These laws may apply regardless of payor source, may include criminal and civil
penalties, and may contain exceptions that differ from the safe harbors to the
Anti-Kickback Statute.
As required by Medicare regulations, each of our dialysis centers is
supervised by a medical director, who is a licensed nephrologist or otherwise
qualified physician. The compensation of Dialysis Corporation of America's
medical directors, who are independent contractors, is fixed by a medical
director agreement and reflects competitive factors in each respective location,
the size of the center, and the physician's professional qualifications. The
medical director's fee is fixed in advance, typically for periods of one to five
years and does not take into account the volume or value of any referrals to the
dialysis center. Eight of our outpatient dialysis centers are owned jointly
between Dialysis Corporation of America and physicians, usually professional
associations, who hold a minority position. Our Ohio affiliate is majority-owned
by a physician. These physicians, except in one instance, also act as the
medical directors for those facilities. We attempt to structure our arrangements
with our physicians to comply with the Anti-Kickback Statute. Many of these
physicians' patients are treated at our facilities. We have never been
challenged under the fraud and abuse laws and believe our arrangements with our
medical directors are in material compliance with applicable law. Several states
in which we operate have laws prohibiting physicians from holding financial
interests in various types of medical facilities. If these statutes are
interpreted to apply to relationships Dialysis Corporation of America has with
its
14
medical directors who hold joint ownership in the dialysis facilities, Dialysis
Corporation of America would restructure its relationship with these physicians,
but it could be subject to penalties.
Management believes that the Anti-Kickback Statute and other fraud and
abuse laws are primarily directed at abusive practices that increase the
utilization and cost of services covered by governmentally funded programs. The
dialysis services provided by the company generally cannot by their very nature
be over-utilized, since dialysis treatment is not elective, and is only
indicated when there is temporary or permanent kidney failure. Medical necessity
is capable of objective documentation, drastically reducing the possibility of
over utilization. There are safe harbors for certain arrangements. Relationships
with medical director ownership of minority interests in our facilities satisfy
many but not all of the criteria for the safe harbor, and there can be no
assurance that these relationships will not subject Dialysis Corporation of
America to investigation or prosecution by enforcement agencies. In an effort to
further our compliance with the law, Dialysis Corporation of America has adopted
a corporate compliance plan that addresses medical necessity and medical chart
audits to confirm medical necessity of referrals.
With respect to its inpatient dialysis services, Dialysis Corporation
of America provides hospitals with dialysis services, including qualified
nursing and technical personnel, supplies, equipment and technical services. In
certain instances, medical directors of a company facility who have a minority
interest in that facility may refer patients to hospitals with which Dialysis
Corporation of America has an inpatient dialysis services arrangement. Although
these arrangements may implicate the federal fraud and abuse laws, we believe
our acute inpatient hospital services are in compliance with the law. See "Stark
II" below.
We endeavor in good faith to comply with all governmental regulations.
However, there can be no assurance that we will not be required to change our
practices or experience a material adverse effect as a result of any such
potential challenge. We cannot predict the outcome of the rule-making process,
enforcement procedures, or whether changes in the safe harbor rules will affect
our position with respect to the Anti-Kickback Statute, but we do believe we
will remain in compliance.
Stark II
The Physician Ownership and Referral Act, known as Stark II, bans
physician referrals, with certain exceptions, for certain "designated health
services" as defined in the statute to entities in which a physician or an
immediate family member has a "financial relationship" which includes an
ownership or investment interest in, or a compensation arrangement between the
physician and the entity. For purposes of Stark II, "designated health services"
include, among others, clinical laboratory services, durable medical equipment,
parenteral and enteral nutrients, home health services, and inpatient and
outpatient hospital services. Dialysis treatments are not included in the
statutory list of "designated health services."
This ban is subject to several exceptions including personal service
arrangements, employment relationships and group practices meeting specific
conditions. If Stark II is found to be applicable to the facility, the entity is
prohibited from claiming payment for such services under the Medicare or
Medicaid programs, is liable for the refund of amounts received pursuant to
prohibited claims, is subject to civil penalties of up to $15,000 per referral
and can be excluded from participation in the Medicare and Medicaid programs.
HHS' regulations to Stark II became effective in January, 2002. These
regulations exclude from covered designated health services and referral
prohibitions, services included in the ESRD composite
15
rate and EPO and other drugs required as part of dialysis treatments under
certain conditions. Also excluded from "inpatient hospital services" are
dialysis services provided by a hospital not certified by CMS to provide
outpatient dialysis services, which would exclude Dialysis Corporation of
America's inpatient hospital services agreements from Stark II. Equipment and
supplies used in connection with home dialysis are excluded from the Stark II
definition of "durable medical equipment." HHS is revisiting its regulations and
intends to issue additional regulations to the Stark legislation. We are unable
to predict the extent or nature of such revised and/or new HHS regulations,
which may negatively impact our dialysis operations or require us to restructure
different aspects of our business. We believe, based upon the proposed rules and
the industry practice, that Congress did not intend to include dialysis services
and the services and items provided by the company incident to dialysis services
within the Stark II prohibitions.
If the provisions of Stark II were found to apply to our arrangements
however, we believe that we would be in compliance. We compensate our
nephrologist-physicians as medical directors of our dialysis centers pursuant to
medical director agreements, which we believe meet the exception for personal
service arrangements under Stark II. Non-affiliated physicians who send their
patients to or treat their patients at any of our facilities do not receive any
compensation from the company.
Medical directors of our dialysis facilities who hold a minority
investment interest in those subsidiaries may refer patients to hospitals with
which the company has an acute inpatient dialysis service arrangement. Stark II
may be interpreted to apply to these types of interests. We believe that
Dialysis Corporation of America's contractual arrangements with hospitals for
acute care inpatient dialysis services are in compliance with Stark II.
If CMS or any other government entity otherwise interprets the Stark II
regulations, we may be required to restructure certain existing compensation or
investment agreements with Dialysis Corporation of America's medical directors,
or, in the alternative, to refuse to accept referrals for designated health
services from certain physicians. Stark II prohibits Medicare or Medicaid
reimbursement of items or services provided pursuant to a prohibited referral,
and imposes substantial civil monetary penalties on facilities which submit
claims for reimbursement. If such were to be the case, Dialysis Corporation of
America could be required to repay amounts reimbursed for drugs, equipment and
services that CMS determines to have been furnished in violation of Stark II, in
addition to substantial civil monetary penalties, which could adversely affect
our operations and future financial results. We believe that if Stark II is
interpreted by CMS or any other governmental entity to apply to our dialysis
arrangements, it is possible that we could be permitted to bring our financial
relationships with referring physicians into material compliance with the
provisions of Stark II on a prospective basis. However, prospective compliance
may not eliminate the amounts or penalties, if any, that might be determined to
be owed for past conduct, and there can be no assurance that such prospective
compliance, if permissible, would not have a material adverse effect on the
company.
Health Insurance Reform Act
Congress has taken action in recent legislative sessions to modify the
Medicare program for the purpose of reducing the amounts otherwise payable from
the program to healthcare providers. Future legislation or regulations may be
enacted that could significantly modify the ESRD program or substantially reduce
the amount paid to the company for its services, or impose further regulation or
restrictions on healthcare providers. Further, statutes or regulations may be
adopted which demand additional requirements in order for Dialysis Corporation
of America to be eligible to participate in the federal and state payment
programs. Any new legislation or regulations may adversely affect Dialysis
Corporation of America's business and operations, as well as our competitors.
16
The Health Insurance Portability and Accountability Act of 1996, known
as HIPAA, provided for health insurance reforms which included a variety of
provisions important to healthcare providers, such as significant changes to the
Medicare and Medicaid fraud and abuse laws, which were expanded. HIPAA
established two programs that coordinate federal, state and local healthcare
fraud and abuse activities, known as the "Fraud and Abuse Control Program" and
the "Medicare Integrity Program." The Fraud and Abuse Control Program is
conducted jointly by HHS and the Attorney General while the Medicare Integrity
Program enables HHS, the Department of Justice and the FBI to monitor and review
Medicare fraud.
Under these programs, these governmental entities undertake a variety
of monitoring activities previously left to providers to conduct, including
medical utilization and fraud review, cost report audits and secondary payor
determinations. The Incentive Program for Fraud and Abuse Information rewards
Medicare recipients 10% of the overpayment up to $1,000 for reporting Medicare
fraud and abuse. HIPAA further created several new Health Care Fraud Crimes and
extended their applicability to private health plans.
As part of the administrative simplification provisions of HIPAA, final
regulations governing electronic transactions relating to healthcare information
were published by HHS. These regulations require a party transmitting or
receiving healthcare transactions electronically to send and receive data in
single format. This regulation applies to our submissions and processing of
healthcare claims and also applies to many of our payors. Dialysis Corporation
of America is in the process of developing the single format transmission, which
is required to be in place by October 16, 2003.
HHS also published regulations relating to the exchange of healthcare
information to comply with HIPAA privacy standards. HHS' privacy rules cover all
individually identifiable healthcare information known as "protected health
information" and apply to healthcare providers, health plans, and healthcare
clearing houses, known as "covered entities." Covered entities must be in
compliance no later than April 14, 2003. The regulations are quite extensive and
complex, but basically require companies to: (i) obtain patient acknowledgement
of receipt of a notice of privacy practices; (ii) obtain patient authorization
before certain uses and disclosures of protected health information; (iii)
respond to patient requests for access to their healthcare information; and (iv)
develop policies and procedures with respect to uses and disclosures of
protected health information. HHS proposed changes to these privacy regulations
to correct unintended consequences that threatened patients' access to quality
health care.
Dialysis Corporation of America has developed and continues to refine
its HIPAA compliance plan, and expects to be in material compliance by April 14,
2003. These regulations are complex, and require continued efforts, which add to
our administrative and financial obligations, to insure the privacy of protected
health information. It is anticipated that the HIPAA privacy rules will be
further amended, which could require additional resources to comply.
HIPAA significantly increased the civil and criminal penalties for
offenses related to healthcare fraud and abuse. HIPAA increased civil monetary
penalties from $2,000 plus twice the amount for each false claim to $10,000 plus
three times the amount for each false claim. HIPAA expressly prohibits four
practices, namely (1) submitting a claim that the person knows or has reason to
know is for medical items or services that are not medically necessary, (2)
transferring remuneration to Medicare and Medicaid beneficiaries that is likely
to influence such beneficiary to order or receive items or services, (3)
certifying the need for home health services knowing that all of the coverage
requirements have not been met, and (4) engaging in a pattern or practice of
upcoding claims in order to obtain greater reimbursement.
17
However, HIPAA creates a tougher burden of proof for the government by requiring
that the government establish that the person "knew or should have known" a
false or fraudulent claim was presented. The "knew or should have known"
standard is defined to require "deliberate ignorance or reckless disregard of
the truth or falsity of the information," thus merely negligent conduct or
billing errors should not violate the Civil False Claims Act.
As for criminal penalties, HIPAA adds healthcare fraud, theft,
embezzlement, obstruction of investigations and false statements to the general
federal criminal code with respect to federally funded health programs, thus
subjecting such acts to criminal penalties. Persons convicted of these crimes
face up to 10 years imprisonment and/or fines. Moreover, a court imposing a
sentence on a person convicted of federal healthcare offense may order the
person to forfeit all real or personal property that is derived from the
criminal offense. The Attorney General is also provided with a greatly expanded
subpoena power under HIPAA to investigate fraudulent criminal activities, and
federal prosecutors may utilize asset freezes, injunctive relief and forfeiture
of proceeds to limit fraud during such an investigation.
Although we believe we substantially comply with currently applicable
state and federal laws and regulations and to date have not had any difficulty
in maintaining our licenses and Medicare and Medicaid authorizations, the
healthcare service industry is and will continue to be subject to substantial
and continually changing regulation at the federal and state levels, and the
scope and effect of such and its impact on our operations cannot be predicted.
No assurance can be given that our dialysis operations will not be reviewed or
challenged by regulatory authorities. We continue to work with our healthcare
counsel in reviewing our policies and procedures and make every effort to comply
with HIPAA and other applicable federal and state laws and regulations.
Any loss by Dialysis Corporation of America of its various federal
certifications, its approval as a certified provider under the Medicare or
Medicaid programs or its licenses under the laws of any state or other
governmental authority from which a substantial portion of its revenues are
derived or a change resulting from healthcare reform, a reduction of dialysis
reimbursement or a reduction or complete elimination of coverage for dialysis
services, would have a material adverse effect on Dialysis Corporation of
America's, and accordingly, our business.
Environmental and Health Regulations
Our dialysis centers are subject to hazardous waste laws and
non-hazardous medical waste regulation. Most of our waste is non-hazardous. CMS
requires that all dialysis facilities have a contract with a licensed medical
waste handler for any hazardous waste. We also follow OSHA's Hazardous Waste
Communications Policy, which requires all employees to be knowledgeable of the
presence of and familiar with the use and disposal of hazardous chemicals in the
facility. Medical waste of each facility is handled by licensed local medical
waste sanitation agencies who are primarily responsible for compliance with such
laws.
There are a variety of regulations promulgated under OSHA relating to
employees exposed to blood and other potentially infectious materials requiring
employers, including dialysis centers, to provide protection. Dialysis
Corporation of America adheres to OSHA's protective guidelines, including
regularly testing employees and patients for exposure to hepatitis B and
providing employees subject to such exposure with hepatitis B vaccinations on an
as-needed basis, protective equipment, a written exposure control plan and
training in infection control and waste disposal.
18
Other Regulation
There are also federal and state laws prohibiting anyone from
presenting false claims or fraudulent information to obtain payments from
Medicare, Medicaid and other third-party payors, such as the federal False
Claims Act. These laws provide for both criminal and civil penalties, exclusion
from Medicare and Medicaid participation, repayment of previously collected
amounts and other financial penalties. The submission of Medicare cost reports
and requests for payment by dialysis centers are covered by these laws. The
False Claims Act has been used to prosecute for fraud, for coding errors,
billing for services not provided, and billing for services at a higher than
allowable billing rate. We believe Dialysis Corporation of America has the
proper internal controls and procedures for issuance of accounts and complete
cost reports and payment requests. Such reports and requests are subject to a
challenge under these laws.
Certain states have anti-kickback legislation and laws dealing with
self-referral provisions similar to the federal Anti-Kickback Statute and Stark
II. We have no reason to believe that we are not in compliance with such state
laws.
Dialysis Corporation of America has developed a Compliance Program as
part of its Corporate Integrity Program, designed to assure compliance with
fraud and abuse laws and regulations. See above under the caption "Corporate
Integrity Program." The establishment and implementation of our compliance
program, coupled with our existing policies and internal controls, could have
the effect of mitigating any civil or criminal penalties for potential
violations, none of which we have had since we commenced operations in 1976. We
will continue to use our best efforts to fully comply with federal and state
laws, regulations and requirements as applicable to our operations and business.
Patents and Trade Names
We sell certain of our medical supplies and products under the
trademark Medicore(TM). Certain of our lancets are marketed under the trademarks
Providers of Quality Medical Disposables(TM) and Lady Lite(TM) and under the
brand name Lite Touch.
We do not rely on patents or trademarks in our medical products
division. Rather, we place importance upon design, engineering, cost
containment, quality and marketing skills to establish or maintain market
position.
Competition
The medical products operations are extremely competitive and we are
not a significant competitive factor in this area.
The dialysis industry is highly competitive. There are numerous
providers who have dialysis facilities in the same areas as the company. Many
are owned by major corporations which operate dialysis facilities regionally,
nationally and internationally. Our dialysis operations are small in comparison
with those corporations. Some of Dialysis Corporation of America's major
competitors are public companies, including Fresenius Medical Care, Inc, A. G.,
Gambro Healthcare, Inc., Renal Care Group, Inc., and Davita, Inc. Most of these
companies have substantially greater financial resources, many more centers,
patients and services than Dialysis Corporation of America has, and by virtue of
such may have an advantage in competing for nephrologists and acquisitions of
dialysis facilities in areas and
19
markets we target. Fresenius and Gambro also manufacture and sell dialysis
equipment and supplies, which may provide them with an even greater competitive
edge. Competition for acquisitions has increased the cost of acquiring existing
dialysis facilities. Dialysis Corporation of America also faces competition from
hospitals and physicians that operate their own dialysis facilities.
Competitive factors most important in dialysis treatment are quality of
care and service, convenience of location and pleasantness of the environment.
Another significant competitive factor is the ability to attract and retain
qualified nephrologists. These physicians are a substantial source of patients
for the dialysis centers, are required as medical directors of the dialysis
facility for it to participate in the Medicare ESRD program, and are responsible
for the supervision of the medical operations of the center. Dialysis
Corporation of America's medical directors usually are subject to non-compete
restrictions within a limited geographic area from the center they administer.
Additionally, there is always substantial competition for obtaining qualified,
competent nurses and technical staff at reasonable labor costs.
Based upon advances in surgical techniques, immune suppression and
computerized tissue typing, cross-matching of donor cells and donor organ
availability, renal transplantation in lieu of dialysis is becoming a
competitive factor. It is presently the second most commonly used modality in
ESRD therapy. With greater availability of kidney donations, currently the most
limiting factor, renal transplantations could become a more significant
competitive aspect to the dialysis treatments we provide. Although kidney
transplant is a preferred treatment for ESRD, certain patients who have
undergone such transplants have lost their transplant function and returned to
dialysis treatments.
Employees
The company and its subsidiaries employ approximately 204 full time
employees of which 8 are administrative, 191 are with the dialysis operations
and 5 are engaged in the medical supply operations. In addition, Dialysis
Corporation of America employs approximately 11 part-time employees and retains
10 independent contractors, consisting of the social workers and dietitians at
certain of Dialysis Corporation of America's dialysis facilities in addition to
medical directors who supervise patient treatment at each facility. Dialysis
Corporation of America also uses approximately 60 "per diem" personnel to
supplement staffing.
Risk Factors
We have listed below certain of the risk factors relating to our
company and our securities. There may be other risks and uncertainties that the
company may face of which we are currently unaware which could also adversely
affect our business, operations and financial condition. If any of such risks or
uncertainties arise, or the risks listed below occur, our company, operations,
earnings and financial condition could be materially harmed, which, in turn,
would most likely adversely affect the trading price of our common stock. Any
such event could seriously impact a shareholder's investment in the company.
Our dialysis operations are the most significant business segment, and,
therefore, most of the risk factors will relate to that business.
20
Investment in Technology Companies
We only have two investments in development stage private Linux software
companies, which have recently initiated marketing of new products, and need
significant financing
In 2000, we initiated a new division which was to be investments in
technology companies. Until recently (see the immediately following Risk
Factor), Linux Global Partners, a private development stage company involved in
Linux software product development and investment, was our singular investment.
The following risks relate to Linux Global Partners
o no audited financial statements
o incurred losses in implementing through Xandros, Inc., its 95%
owned subsidiary, the production and marketing of its Linux
desktop system in December, 2002
o demand for its Linux desktop system has been minimal
o the recent launch of its Linux desktop system has not
generated sufficient revenues to cover expenses or reflect
income
o significant funding is required to continue its existence and
the marketing and further development of its product
- no assurance funding will be available, or if so, on
favorable terms
- presently has significant outstanding indebtedness,
some of which is due but not paid
o limited operating history; inability to evaluate future
prospects
o early stage company; rapidly evolving market; intense
competition
o reliance on prominent Linux developers of the Linux kernal
could impair it from upgrading its product
Linux Global Partners defaulted on our $2,250,000 loans, forcing a public sale
of certain collateral in January, 2003, resulting in our ownership of our second
Linux software company
In 2000, we made our investment in Linux Global Partners, obtaining an
8% interest and having loaned $2,200,000 to Linux Global Partners at an annual
interest rate of 10%. We borrowed those funds from Dialysis Corporation of
America, and fully repaid our subsidiary in June, 2001. In May, 2001, Linux
Global Partners paid us $215,500 of which $200,000 was principal. In August,
2001, we entered into an extension of our loan with Linux Global Partners based
upon repayment of $100,000 per month or 25% of any proceeds it received from its
financing attempts, none of which occurred. We also received 50,000 shares of
Linux Global Partners' common stock per month until our loan was repaid.
The Linux Global Partners debt had been extended on various occasions.
From September, 2002 through the fourth quarter of 2002, we loaned an additional
$250,000 to Linux Global Partners to assist its initiation of the marketing of
its Linux desktop software system, for which we received an additional 75,000
shares of common stock giving us an aggregate ownership of approximately 14% of
that company. Our subsidiary, Dialysis Corporation of America, owns
approximately 2% of Linux Global Partners. At December 31, 2002, Linux Global
Partners' indebtedness to us aggregated approximately $2,742,000. The loans were
in default and we sold certain of the collateral at a public auction in January,
2003. Xandros, Linux Global Partners' 95% owned subsidiary, purchased the
collateral for $2,992,000. Xandros deposited 775,000 shares of its common stock
as a down payment, which it forfeited to us upon its failure to pay the purchase
price for the Ximian collateral. We acquired the 4,115,815 shares of series A
convertible preferred
21
stock of Ximian in satisfaction of the Linux Global indebtedness, as we were the
next highest bidder at the public auction.
We now hold an approximately 14% interest in Ximian, a private company
providing Linux desktop and server solutions enabling enterprise Linux adoption.
Ximian indicates its products have been marketed for over one year, has revenues
but to date has experienced losses.
It too does not generate sufficient cash flow for development and
operations and faces similar risks of new enterprises, including:
o extent of demand for its products
o sufficient financing for operations, marketing and product
development
o limited operating history
o difficult to evaluate future prospects
o rapidly evolving market; intense competition
o reliance on its founders, prominent Linux developers
In October, 2002, Xandros launched its Linux desktop software system,
which to date has not generated sufficient cash flow to meet operating costs.
Xandros is subject to all the risks of a startup company, including its ability
to continue in business, whether its Linux desktop system will be commercially
accepted, the extent of sales, Xandros' ability to generate revenues and if so,
whether they will be sufficient to generate income. There is also the risk as to
the ability of Xandros' management to operate and develop its business. See Item
1, "Business - General - Linux Divisions," Item 7, "Management's Discussion and
Analysis of Financial Condition and Results of Operations," and Note 14 to
"Notes to Consolidated Condensed Financial Statements."
Based upon certain agreements Linux Global Partners entered into with
Ximian shortly after our initial loan to Linux Global in January, 2000, which
provided Ximian, its founders and investors with rights of first refusal to the
collateral, which they did not exercise upon the sale of the collateral, among
other issues which impacted the salability, and therefore the value, of the
collateral, the Ximian preferred shares, Linux Global Partners gave the company
a put to sell all or any portion of the Ximian preferred shares we now own to
Linux Global Partners at $.753 per share or an aggregate of $3,100,000,
exercisable from January 25, 2004 through March 4, 2004.
Dialysis Operations
Until fiscal 2001, Dialysis Corporation of America had experienced operational
losses
Since 1989, when Dialysis Corporation of America sold four of its five
dialysis centers, that subsidiary had experienced operational losses. Not until
fiscal 2001 did Dialysis Corporation of America reflect net income. Dialysis
Corporation of America initiated an expansion program in 1995, opening two new
dialysis centers that year, and to date operates and/or manages 16 centers in
New Jersey, Pennsylvania, Georgia, Ohio and Maryland, with two dialysis
facilities in the developmental stage in Indiana and Virginia. Some of our
dialysis centers have generated losses since their commencement of operations.
This is due to operational costs and time needed to reach full capacity of
dialysis treatments. See Item 7, "Management's Discussion and Analysis of
Financial Condition and Results of Operations."
22
Dialysis operations are subject to extensive government regulation
Our dialysis operations are subject to extensive federal and state
government regulations, which include:
o licensing requirements for each dialysis facility
o patient referral prohibitions
o false claims prohibitions for health care reimbursement and
other fraud and abuse regulations
o record keeping requirements
o health, safety and environmental compliance
o expanded protection of the privacy and security of personal
medical data
o establishing standards for the exchange of electronic health
information; electronic transactions and code sets; unique
identifiers for providers, employers, health plans and
individuals
Many of these laws and regulations are complex and open to a variety of
interpretations. If we are forced to change our method of operations because of
these regulations, our earnings, financial condition and business might be
adversely affected. In addition, any violation of these governmental regulations
could involve substantial civil and criminal penalties and fines, revocation of
licensure, closure of a facility, and exclusion from participating in Medicare
and Medicaid programs. Any loss of federal or state certifications or licenses
would adversely impact our business.
Dialysis Corporation of America arrangements with its physician medical
directors do not meet the safe harbor provisions of federal and state laws, and
may subject us to greater governmental scrutiny
Neither Dialysis Corporation of America's arrangements with the medical
directors of its dialysis facilities nor the minority ownership interests of
referring physicians in certain of Dialysis Corporation of America's dialysis
facilities meet all of the requirements of published safe harbors to the illegal
remuneration provisions of the Social Security Act and similar state laws. These
laws impose civil and criminal sanctions on persons who receive or make payments
for referring a patient for treatment that is paid for in whole or in part by
Medicare, Medicaid or similar state programs. Transactions that do not fall
within the safe harbor may be subject to greater scrutiny by enforcement
agencies.
Dialysis Corporation of America's operations are subject to Medicare and
Medicaid audits with concurrent potential civil and criminal penalties for
failure to comply
Dialysis Corporation of America is subject to periodic audits by the
Medicare and Medicaid programs, which have various rights and remedies if they
assert that Dialysis Corporation of America has overcharged the programs or
failed to comply with program requirements, none of which it has done. Rights
and remedies available to these programs include repayment of any amounts
alleged to be overpayments or in violation of program requirements, or making
deductions from future amounts due to it. These programs may also impose fines,
criminal penalties or program exclusions.
In the ordinary course of Dialysis Corporation of America's business,
it receives notices of deficiencies for failure to comply with various
regulatory requirements. Dialysis Corporation of America
23
reviews such notices and takes appropriate corrective action. In most cases,
Dialysis Corporation of America and the reviewing agency will agree upon the
measures that will bring the center or services into compliance. In some cases
or upon repeat violations, none of which Dialysis Corporation of America has
experienced, the reviewing agency may take various adverse actions against a
provider, including but not limited to:
o the imposition of fines;
o suspension of payments for new admissions to the center; and
o in extreme circumstances, desertification from participation
in the Medicare or Medicaid programs and revocation of a
center's license.
Any such regulatory actions could adversely affect a provider's ability
to continue to operate, to provide certain services, and/or the eligibility to
participate in Medicare or Medicaid programs or to receive payments from other
payors. Further, actions against one center may subject our other centers deemed
under common control or ownership to adverse remedies.
There has been increased governmental focus and enforcement with respect to
anti-fraud initiatives as they relate to healthcare providers
State and federal governments are devoting increased attention and
resources to anti-fraud initiatives against healthcare providers. Recent
legislation expanded the penalties for heath care fraud, including broader
provisions for the exclusion of providers from the Medicaid program. Dialysis
Corporation of America has established policies and procedures that we believe
are sufficient to ensure that our facilities will operate in substantial
compliance with these anti-fraud and abuse requirements. While we believe that
our business practices are consistent with Medicare and Medicaid criteria, those
criteria are often vague and subject to change and interpretation. Anti-fraud
actions, however, could have an adverse effect on Dialysis Corporation of
America's and our financial position and results of operations.
Dialysis Corporation of America's revenues and financial stability are dependent
on fixed reimbursement rates under Medicare and Medicaid
During 2002, approximately 49% of Dialysis Corporation of America's
patient revenues was derived from Medicare reimbursement and 9% of its patient
revenues was derived from Medicaid and equivalent programs. Decreases in
Medicare and Medicaid and equivalent rates and programs for our dialysis
treatments would adversely affect Dialysis Corporation of America's and our
revenues and profitability. Furthermore, operating costs tend to increase over
the years without comparable increases in the prescribed dialysis treatment
rates.
Decreases in reimbursement payments from third-party, non-government payors
could adversely affect our earnings
Any reduction in the rates paid by private insurers, hospitals and
other non-governmental third-party organizations would adversely affect Dialysis
Corporation of America's and our business. Alternatively, any change in patient
coverage, such as Medicare eligibility as opposed to higher private insurance
coverage, would result in a reduction of revenue. We estimate approximately 42%
of Dialysis
24
Corporation of America's patient revenues for 2002 was obtained from sources
other than Medicare or Medicaid and equivalent programs. Dialysis Corporation of
America generally charges non-governmental organizations for dialysis treatment
rates which exceed the fixed Medicare and Medicaid and equivalent rates. Any
limitation on Dialysis Corporation of America's ability to charge these higher
rates, which may be affected by expanded coverage by Medicare under the fixed
corporate rate, or expanded coverage of dialysis treatments by managed care
organizations, which commonly have lower rates than we charge, could adversely
affect Dialysis Corporation of America's and our business, results of
operations, and financial condition.
Any decrease in the availability of or the reimbursement rate of EPO would
reduce Dialysis Corporation of America's and our revenues and earnings
EPO, the bio-engineered drug used for treating anemia in dialysis
patients, is currently available from a single manufacturer, Amgen, Inc. On
January 1, 2003, Amgen increased the price of EPO, and there is no assurance
there will not be further price increases. There currently is no alternative
drug available to us for dialysis patient treatment of anemia. The available
supply could be delayed or reduced, whether by Amgen, unforeseen circumstances,
or through excessive demand. This would adversely impact Dialysis Corporation of
America's and our revenues and profitability, since approximately 26% of
Dialysis Corporation of America's medical revenues in 2002 were based upon the
administration of EPO to its dialysis patients. Most of Dialysis Corporation of
America's EPO reimbursement is from government programs. We are unsure whether
there will be an EPO reimbursement rate reduction, but if such occurs, it would
adversely affect Dialysis Corporation of America's and our revenues and
earnings.
Dialysis Corporation of America's ability to grow is subject to its resources
and available locations
Other than one center acquisition in 2002, expansion of Dialysis
Corporation of America's operations has been through construction of dialysis
facilities. This is due to the substantial costs involved in an acquisition,
usually valued on a per-patient basis. We seek areas with qualified and
cost-effective nursing and technical personnel, with a sufficient population to
sustain a dialysis facility. These opportunities are limited and we compete with
much larger dialysis companies for appropriate locations. Construction through
commencement of operations generally takes four to six months and sometimes
longer. Once the facility is operable, it generates revenues, but usually does
not operate at full capacity, and may generate losses for approximately 12
months or longer. Our growth strategy based on construction also involves the
risks of our ability to identify suitable locations to develop additional
facilities. Those we do develop may never achieve profitability, and additional
financing may not be available to finance future development.
Our inability to acquire or develop facilities in a cost-effective
manner would adversely affect our ability to expand our dialysis business and
our profitability.
Growth places significant demands on our financial and management
skills. Inability on our behalf to meet the challenges of expansion and to
manage any such growth would have an adverse effect on our management, results
of operations and financial condition.
25
Dialysis Corporation of America's attempts to expand through development or
acquisition of dialysis facilities which are not currently identified entails
risks which shareholders and investors will not have a basis to evaluate
Dialysis Corporation of America expands generally through seeking an
appropriate location considering the patient base, availability of a physician
nephrologist to be medical director of that dialysis facility, and a skilled
work force. Construction and equipment costs for a new dialysis facility with 15
stations typically range from $600,000 to $750,000. The cost of acquiring a
center is usually much greater. Dialysis Corporation of America cannot ensure
that it will be successful in developing or acquiring dialysis facilities, or
otherwise successfully expanding its operations. Dialysis Corporation of America
is negotiating with nephrologists and others to establish new dialysis centers,
but it cannot ensure these negotiations will result in the development of new
centers. Furthermore, there is no basis for shareholders and investors to
evaluate the specific merits or risks of any potential development or
acquisition of dialysis facilities.
Dialysis Corporation of America depends on physician referrals, and the
limitation or cessation of such referrals would adversely impact Dialysis
Corporation of America's and our revenues and earnings
Our dialysis facilities and those centers we seek to develop are
dependent upon referrals of ESRD patients for treatment by physicians
specializing in nephrology. Generally, the nephrologist or medical professional
association of physicians supervising a particular dialysis center's operations,
known as a medical director of that facility, account for most of the patient
base. There is no requirement for these physicians to refer their patients to
us, and they are free to refer patients to any other conveniently located
dialysis facility. We may not be able to renew or otherwise negotiate
compensation under the medical director agreements with our medical director
physicians which could terminate the relationship, and without a suitable
medical director replacement could result in closure of the facility.
Accordingly, the loss of these key referring physicians at a particular center
could have a material adverse effect on the operations of the center and could
adversely affect Dialysis Corporation of America's and our revenues and
earnings.
Some of the referring physicians own minority interests in certain of
the dialysis facilities. If these interests are deemed to violate applicable
federal or state law, these physicians may be forced to dispose of their
ownership interests. We are unable to predict how this would affect Dialysis
Corporation of America's relationship with these referring physicians, or their
patients, who may seek treatment elsewhere, which would have an adverse effect
on Dialysis Corporation of America's and our business.
Industry changes could adversely affect Dialysis Corporation of America's
business
Healthcare organizations, public and private, continue to change the
manner in which they operate and pay for services. Dialysis Corporation of
America's business is designed to function within the current healthcare
financing and reimbursement system. In recent years, the healthcare industry has
been subject to increasing levels of government regulation of reimbursement
rates and capital expenditures, among other things. In addition, proposals to
reform the healthcare system have been considered by Congress, and still remain
a priority issue. Any new legislative initiatives, if enacted, may further
increase government regulation of or other involvement in healthcare, lower
reimbursement rates and otherwise change the operating environment for
healthcare companies. We cannot predict the likelihood of those events or what
impact they may have on Dialysis Corporation of America's or our earnings,
financial condition or business.
26
Dialysis Corporation of America's business is subject to substantial
competition, and it must compete effectively, otherwise its growth could slow
Dialysis Corporation of America is operating in a highly competitive
environment in terms of operations, development and acquisition of existing
dialysis centers. Competition comes from other dialysis centers, many of which
are owned by much larger companies, and from hospitals. The dialysis industry is
rapidly consolidating. There are some very large dialysis companies competing
for the acquisition of existing dialysis centers and the development of
relationships with referring physicians. Most of Dialysis Corporation of
America's competitors have much greater financial resources, more dialysis
facilities and a larger patient base.
We experience competition from physicians who open their own dialysis
facilities. Competition for existing centers has increased the costs of
acquiring such facilities. Competition is also intense for qualified nursing and
technical staff as well as for nephrologists with an adequate patient base.
Management can provide no assurance Dialysis Corporation of America can compete
effectively, and thereby continue its growth.
Medicore, which owns 61% of Dialysis Corporation of America, has some common
officers and directors, which presents the potential for conflicts of interest
We own 61% of Dialysis Corporation of America, and are able to elect
all of Dialysis Corporation of America's directors and otherwise control
Dialysis Corporation of America's management and operations. Such control is
also complemented by the fact that Thomas K. Langbein is Chairman of the Board
and Chief Executive Officer of both our company and Dialysis Corporation of
America, and also the President of our company, and Daniel R. Ouzts is Vice
President and Treasurer of both companies. Neither Mr. Langbein nor Mr. Ouzts
devotes full time to Dialysis Corporation of America. The costs of executive
salaries and other shared corporate overhead for these companies are allocated
on the basis of time spent. The amount of expenses charged by Medicore to
Dialysis Corporation of America for 2002 amounted to approximately $200,000.
Additionally, there have been past and there are current transactions
between our company and Dialysis Corporation of America and their directors,
including loans and insurance coverage. Dialysis Corporation of America advanced
funds to us for working capital requirements until we sold Techdyne, Inc.,
another of our public subsidiaries, in June, 2001. Dialysis Corporation of
America also loaned us $2,200,000 over the last two years for our financing and
investment in Linux Global Partners, Inc., a private company involved in
developing a Linux desktop product and investing in Linux software companies,
and which company is in its developmental stages. We repaid that loan to
Dialysis Corporation of America in June, 2001, with approximately $294,000 of
accrued interest.
Since Medicore holds a majority interest in Dialysis Corporation of
America, there exists the potential for conflicts between Medicore and Dialysis
Corporation of America, and the responsibilities of our management to our
shareholders could conflict with the responsibilities owed by management of
Dialysis Corporation of America to its shareholders.
27
The loss of certain executive personnel without retaining qualified replacements
could adversely affect management of our and Dialysis Corporation of America's
business, and our revenues and earnings could decline
We are dependent upon the services of our executive officer, Thomas K.
Langbein, Chairman of the Board and Chief Executive Officer, who also holds
those positions with Dialysis Corporation of America. He is also President of
our company. We are also dependent on the services of Stephen W. Everett,
director and President of Dialysis Corporation of America. Mr. Langbein has been
involved with our company since 1971, when his investment banking firm, Todd &
Company, Inc., took us public, and with Dialysis Corporation of America since it
became a public company in 1977 (originally our wholly-owned subsidiary
organized in 1976). Mr. Everett joined Dialysis Corporation of America in
November, 1998 as Vice President, became Executive Vice President in June, 1999,
and President on March 1, 2000. Mr. Everett has been involved in the healthcare
industry for 23 years. Mr. Langbein has an employment agreement with our company
through August 21, 2003, which provides for non-competition within 20 miles of
our primary operations, with an option for the company to pay $4,000 per month
for 12 months for additional non-competition provisions. Mr. Everett has an
employment agreement with Dialysis Corporation of America through December 31,
2005 with a one-year non-competition provision within the United States. It
would be very difficult to replace the services of these individuals, whose
services, individually and certainly combined, if lost would adversely affect
our company, its operations and earnings, and most likely as a result, the
trading price of our common stock. There is no key-man life insurance on any of
our officers.
General
There is a possibility of continued volatility in our security price
Our common stock trades on the Nasdaq SmallCap Market. Over the years
the market price of the common stock has significantly fluctuated. During the
last two years, the common stock has been as high as $2.77 in the second quarter
of 2002 and as low as $.63 in the first quarter of 2001. On March 13, 2003, the
closing price of the common stock was $1.37. The market price of our common
stock could fluctuate substantially based upon announcements concerning our
company, such as operating results, government regulatory changes, technological
innovations, or information concerning our competitors. In addition, security
prices fluctuate widely for reasons unrelated to operations, usually general
political, and worldwide and domestic economic conditions, and the stock
market's reaction. These fluctuations and events could adversely affect the
market price of our common stock.
Possible delisting and risks of low priced stocks
Our common stock trades on the Nasdaq SmallCap Market. There are
certain criteria for continued listing on the Nasdaq SmallCap Market, known as
maintenance requirements. Failure to satisfy any one of these maintenance
listing requirements could result in our securities being delisted from the
Nasdaq SmallCap Market. These criteria include two active market makers,
maintenance of $2,500,000 of stockholders' equity (or a market capitalization of
$35,000,000 or a net income of $500,000 for our most recently completed fiscal
year or in two of the last three most recently completed fiscal years), a
minimum bid price for our common stock of $1.00, and at least 500,000 publicly
held shares with a market value of at least $1,000,000, among other criteria.
For SmallCap companies, as is our company, if a deficiency occurs for a period
of 30 consecutive business days, the particular company is notified by Nasdaq
and has 180 days to achieve compliance. Following this grace period, issuers
that
28
demonstrate compliance with the core initial listing standards of the SmallCap
Market, which is either net income of $750,000 (determined from the most
recently completed fiscal year or two of the most recently completed fiscal
years), stockholders' equity of $5,000,000, or market capitalization of
$50,000,000, will be afforded an additional 180-day grace period within which to
regain compliance. If the company is unable to demonstrate compliance, the
security is subject to delisting. The security might be able to trade on the OTC
Bulletin Board, a less transparent trading market which may not provide the same
visibility for the company or liquidity for its securities, as does the Nasdaq
SmallCap Market. As a consequence, an investor may find it more difficult to
dispose of or obtain prompt quotations as to the price of our securities, and
may be exposed to a risk of decline in the market price of the common stock.
In December, 2000 and again in April, 2001, we received notification
from the Nasdaq Listing Qualifications Department of the Nasdaq Stock Market
that our common stock failed to maintain a closing bid price greater than or
equal to $1.00 per share for 30 consecutive days, as required by Marketplace
Rule 4310(c)(4). In each instance, we maintained our Nasdaq SmallCap Market
listing. These situations dealing with the trading market are beyond our
control. There can be no assurance that some other listing maintenance criteria
will not become deficient, whether within or beyond our control, and without a
timely cure, could cause our common stock to be delisted from the Nasdaq
SmallCap Market.
Shares eligible for future sale by our current shareholders may adversely affect
our stock price
Officers and directors of our company own approximately 2,114,000
shares of common stock and 610,000 options exercisable into an additional
610,000 shares of common stock. A registration statement covering the sale of
shares held by officers and directors may be effected, since these are
controlling persons of our company, and all their shares, including those
issuable upon exercise of their options, would be eligible for sale into the
public market without restriction, if so registered. Also, the officers' and
directors' common stock upon satisfying the conditions of Rule 144 under the
Securities Act, may be sold without complying with the registration provisions
of the Securities Act. These conditions include holding the shares for one year
from acquisition, volume limits of selling every three months an amount of
shares which does not exceed the greater of 1% of the outstanding common stock,
or the average weekly volume of trading as reported by Nasdaq during the four
calendar weeks prior to the sale, the filing of a Form 144, our company
continuing to timely file its reports under the Exchange Act, and the sales are
made directly to a market maker or otherwise sold through a typical broker's
transaction, with normal commissions and no prearranged solicitations of the
purchase order. Our tradable common stock, known as the float, is approximately
4,410,000 shares, and the approximately 2,114,000 shares of common stock
directly owned by the officers and directors represents approximately 48% of the
float, and with the options for 610,000 additional shares, would represent
approximately 54% of the float. Accordingly, the sale by such officers and
directors, whether through a registration statement or under Rule 144, may have
an adverse affect on the market price of our common stock, and may hamper our
ability to manage subsequent equity or debt financing. If these shareholders
sell substantial amounts of their common stock of our company, including shares
issued upon the exercise of their options into the public market, the market
price of our common stock could fall.
Item 2. Properties
Medicore leases 2,800 square feet for its executive offices in Hialeah,
Florida pursuant to a lease expiring December 31, 2007. We also lease a 5,000
square foot facility pursuant to a month-to-month lease for which we are
negotiating a long-term lease at a different location in Hialeah, Florida, for
our medical
29
product operations. We also lease 1,500 square feet of warehouse space in
Hialeah, Florida for our medical product operations under a lease through
January 31, 2004. Medicore also leases 3,900 square feet of space for other
executive offices in Hasbrouck Heights, New Jersey through March 31, 2006.
Dialysis Corporation of America owns three properties, one located in
Lemoyne, Pennsylvania, a second in Easton, Maryland, and a third in Valdosta,
Georgia. The Maryland property consists of approximately 7,500 square feet, most
of which is leased to a competitor under a 10-year lease through June 30, 2009
with two renewals of five years each. The lease is guaranteed by the tenant's
parent company. We use approximately 600 square feet at that property for an
administrative office.
The Lemoyne property of approximately 15,000 square feet houses one of
our dialysis centers of approximately 5,400 square feet, approved for 16
dialysis stations with space available for expansion under a five year lease
through December 22, 2003, with two renewals of five years each. We use
approximately 4,000 square feet for administrative offices.
Dialysis Corporation of America paid off the remaining balance on first
mortgages on its Easton, Maryland and Lemoyne, Pennsylvania properties in
December 2002. The Easton, Maryland property has a mortgage to secure a $700,000
development loan to our Vineland, New Jersey subsidiary at an annual interest
rate of 1% over the prime rate, maturing in December 2007, which loan Dialysis
Corporation of America guarantees. This loan had a remaining principal balance
of approximately $662,000 at December 31, 2002. See Item 7, "Management's
Discussions and Analysis of Financial Condition and Results of Operations" and
Note 3 to "Notes to Consolidated Financial Statements."
Dialysis Corporation of America acquired property in Valdosta, Georgia
in 2000, and constructed a dialysis facility there. This property is subject to
a five year $788,000 mortgage obtained in April, 2001 with inter