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 56% owned public subsidiary, Dialysis Corporation of America; and
(iii) the investment in technology companies through our interest in Linux Global Partners, Inc. (and in which Dialysis Corporation of America also has an interest), a private speculative company that invests in developing Linux software companies, including its affiliate Xandros, Inc., that has developed and markets a Linux desktop operating system. We sold our 71% interest in our public subsidiary, Techdyne, Inc., in June, 2001, subsequent to which we have had no continuing operations as a contract manufacturer of electronic components. The dialysis operations are the most significant part of our operations, accounting for approximately 98% of our sales revenues. Our investment in technology companies, currently limited to Linux Global Partners and Xandros, has not generated any revenues other than interest income and a gain of approximately $784,000 recorded in August 2003 from our sale of Ximian, Inc. preferred stock that we had acquired on foreclosure of collateral securing our loans to Linux Global Partners. We sold the Ximian stock in connection with the acquisition of Ximian by a third party in August 2003. We also recorded a gain of approximately $402,000 in August 2004 upon the release of half of the escrowed funds due us from that sale, the balance of which is due to be released to us in August 2005 pending fulfillment by the parties to the Ximian acquisition of certain post sale conditions. Our medical products division accounts for approximately 2% 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
Recent Developments
We have agreed to terms with Dialysis Corporation of America for a merger pursuant to which our company will be merged with and into Dialysis Corporation of America in a stock for stock merger transaction. The prospective merger was announced in a joint press release on March 15, 2005. The merger is subject to our receipt of satisfactory tax and fairness opinions, the filing with and declaration of effectiveness of a registration statement, including a proxy statement/prospectus, with the SEC, and shareholder approval by our shareholders and the shareholders of Dialysis Corporation of America. Assuming the merger is completed, holders of our common stock on the effective date of the merger, as currently structured, will have the right to receive .68 shares of Dialysis Corporation of America common stock for each share of Medicore common stock. It is anticipated that Dialysis Corporation of America will issue an aggregate of approximately 5,289,000 shares in the merger, which will result in approximately 9,000,000 of Dialysis Corporation of America shares of common stock to be outstanding upon completion of the merger.
The bases for the merger are essentially to simplify the corporate structure, enable the ownership of our control interest in Dialysis Corporation of America to be in the hands of the public rather than Medicore, and provide Dialysis Corporation of America with the Medicore assets, which include, among other assets, minimum cash of approximately $4,000,000 to $5,000,000, the medical supply operations, and income providing real estate in Hialeah, Florida, with an estimated value of at least $3,000,000. Dialysis Corporation of America's indebtedness to Medicore of approximately $2,435,000 at March 24, 2005, under a financing arrangement provided by us to Dialysis Corporation of America of up to $5,000,000, will be eliminated. This credit facility is for Dialysis Corporation of America's equipment financing, working capital and general corporate purposes. These assets to be obtained in the merger will
enhance Dialysis Corporation of America's liquidity and borrowing power and provide Dialysis Corporation of America with the ability to continue its business strategy of controlled growth, further build its dialysis business, and expand the acquired medical supply operations.
Dialysis Corporation of America is preparing for filing with the SEC in the near future a registration statement on Form S-4 containing a proxy statement/prospectus, as well as an information statement for Dialysis Corporation of America in connection with the merger transaction. Common shareholders are urged to read that filing when it becomes available, since it will contain important information about the merger, our company and Dialysis Corporation of America, including, but not limited to, each company's management, risk factors, stockholder rights, and voting procedures. When the registration statement and the proxy statement/prospectus is available, shareholders may obtain free copies and other documents filed with the SEC at the SEC's website at www.sec.gov. In addition, shareholders and others may obtain free copies of the documents filed with the SEC by contacting Lawrence E. Jaffe, Esq., our corporate Secretary, at 201-288-8282. Medicore and our directors and executive officers may be deemed to be participants in the solicitation of proxies from our shareholders in connection with the merger transaction. Dialysis Corporation of America is providing an information statement with respect to its annual meeting at which shareholder approval for the merger transaction will be sought, but Dialysis Corporation of America does not solicit proxies since a quorum for the shareholder meeting exists by virtue of our controlling interest in Dialysis Corporation of America.
Information regarding the special interests of our directors and executive officers and the directors and executive officers of Dialysis Corporation of America in the merger transaction will be disclosed in the proxy statement/prospectus. Additional information regarding the directors and executive officers of DCA is included in Dialysis Corporation of America's Annual Report on Form 10-K for the year ended December 31, 2004, and as to our directors and executive officers in this Annual Report, Part III, below. These Annual Reports and related documents are available free of charge at the SEC's website at www.sec.gov, and from Lawrence E. Jaffe, corporate Secretary to our company and Dialysis Corporation of America, as described above.
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 23 outpatient dialysis centers in Georgia, Maryland, New Jersey, Ohio, Pennsylvania, South Carolina and Virginia, including its management of an Ohio center in which it has a 40% interest and an unaffiliated Georgia center, in each case 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 that Dialysis Corporation of America distinguishes itself on the basis of quality patient care and a patient-focused, courteous, highly trained professional staff.
General
Dialysis Corporation of America's growth depends primarily on the availability of suitable dialysis centers for development or acquisition in appropriate and acceptable areas, and its ability to develop new dialysis centers at costs within its budget while competing with larger companies, some of which are public companies or divisions of public companies with greater numbers of personnel and amounts of financial resources. Dialysis Corporation of America opened five new dialysis centers during 2004; one in Virginia in January 2004, one in South Carolina in February 2004, one in Pennsylvania in March 2004, one in Maryland in June 2004, and another in Virginia in December 2004. At the end of August 2004, Dialysis Corporation of America acquired a dialysis company which owns and operates two dialysis centers in Pennsylvania. Dialysis Corporation of America is in the process of developing five additional dialysis centers: one in Maryland, one in Ohio and three in South Carolina.
Dialysis Corporation of America's medical service revenues are derived primarily from four sources: (i) outpatient hemodialysis services (46%, 47% and 48% of its medical services revenues for 2004, 2003 and 2002, respectively); (ii) home peritoneal dialysis services (7%, 4% and 3% of its medical services revenues for 2004, 2003 and 2002, respectively); (iii) inpatient hemodialysis services for acute patient care provided through agreements with hospitals and medical centers (5%, 7% and 10% of its medical services revenues for 2004, 2003 and 2002, 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) (42%, 42% and 39% of its medical services revenue for 2004, 2003 and 2002, respectively). Dialysis is an ongoing and necessary therapy to sustain life for kidney dialysis patients, with end stage renal disease, or ESRD. 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 Typically these rates are at least equivalent to or higher than the government fixed rates 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, ESRD, 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 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 at December 31, 2002 was approximately 309,000, and continues to grow at a rate of approximately 7% 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 4,443 dialysis facilities, with the current annual cost for treating ESRD patients in the United States at approximately $25 billion at December, 2002, of which Medicare accounted for approximately $17 billion.
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 with other equipment which 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.
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.
While kidney transplantation, another treatment option for patients with ESRD, is typically the most desirable form of therapeutic intervention, the scarcity of suitable donors and possibility of donee rejection limits the availability of this surgical procedure as a treatment option.
Dialysis Corporation of America's Business Strategy
Dialysis Corporation of America has 28 years' experience in developing and operating dialysis treatment facilities. Its priority is to provide quality patient care. Dialysis Corporation of America intends to continue to establish alliances with physicians and hospitals and attempt to initiate dialysis service arrangements with nursing homes and managed care organizations.
Dialysis Corporation of America continues to actively seek and negotiate with physicians and others to establish new outpatient dialysis facilities. Dialysis Corporation of America is in the process of developing five new dialysis centers and is in different stages of negotiations with physicians for potential new facilities in a variety of states.
In June, 2001 we sold our controlling interest in Techdyne, Inc. for $10,000,000 plus a three year earn-out of between $2,500,000 and $5,000,000. A substantial portion of our after tax proceeds from that sale may be utilized for expansion of Dialysis Corporation of America's dialysis operations.
Development and Acquisition of Facilities
One of the primary elements in developing or acquiring dialysis centers 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.
Dialysis Corporation of America's expansion is accomplished primarily through the development of its 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 Dialysis Corporation of America's 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 the size of Dialysis Corporation of America's dialysis facilities, costs in a range of $750,000 to $1,000,000 including equipment and initial working capital requirements, depending on location, size and related services to be provided by the proposed facility. Acquisition of existing facilities can be 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. We have entered into a financing arrangement with Dialysis Corporation of America which provides Dialysis Corporation of America up to
$5,000,000 for equipment financing and working capital. At March 25, 2005, Dialysis Corporation of America had borrowed $2,435,000 under a demand promissory note issued to us, at an annual interest rate of prime plus 1.25%. Assuming completion of the proposed merger with Dialysis Corporation of America, Dialysis Corporation of America would obtain, among other assets, approximately $4,000,000 to $5,000,000 in cash which it may use for building its dialysis operations. See "Recent Developments" above.
Inpatient Services
Management of Dialysis Corporation of America also seeks to increase acute dialysis treatments through contracts with hospitals for inpatient dialysis services. These contracts are sought with hospitals in areas serviced by its 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.
There is no certainty as to when any additional centers or service contracts will be implemented or, to the extent implemented, the number of dialysis stations or patient treatments these centers or service contracts may involve, or if they will ultimately be profitable. There is no assurance that Dialysis Corporation of America will be able to continue to enter into favorable relationships with physicians who would become medical directors of such proposed dialysis facilities, or that Dialysis Corporation of America 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 their start-up costs and expenses and due to their having a smaller and slower developing patient base. See this Item 1, "Business - Dialysis Corporation of America's Business Strategy - Operations and Competition," 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 23 outpatient dialysis facilities in Georgia, Maryland, New Jersey, Ohio, Pennsylvania, South Carolina and Virginia, 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 it manages. These dialysis facilities have a total designed capacity of 331 licensed stations.
Dialysis Corporation of America owns and operates its centers through subsidiaries a majority of which are 100% owned, with the balance of the centers owned by Dialysis Corporation of America as a majority owner in conjunction with the medical directors of those centers who hold minority interests ranging from 20% to 49%. Dialysis Corporation of America has a minority 40% interest in a center in Toledo, Ohio which it manages, and also manages an unaffiliated dialysis center in Georgia. One of the Pennsylvania and one of the Georgia dialysis facilities are located on properties owned by Dialysis Corporation of America and leased to the subsidiaries operating those centers. Dialysis Corporation of America's Cincinnati, Ohio dialysis center is leased from a corporation owned by the medical director of that facility who, together with his wife, holds a 40% interest in the subsidiary operating that center. See Item 2, "Properties."
The owner of the facility in Georgia that is managed by Dialysis Corporation of America 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 a subsidiary of Dialysis Corporation of America all the assets of that Georgia dialysis facility. The Dialysis Corporation of America subsidiary holds a call option to purchase the assets of the Georgia facility. Each of the put and call options are exercisable through September, 2005. The put option, however, is not exercisable unless that Georgia dialysis facility has recorded $100,000 in pre-tax income. Upon exercise of either the put or call option the owner would receive a 20% interest in Dialysis Corporation of America's subsidiary which will own and operate the Georgia facility, and the remainder of the purchase price will be paid in cash, determined on a formula based upon a multiple of EBITDA.
Additionally, Dialysis Corporation of America provides acute care inpatient dialysis services to nine hospitals in areas serviced by its dialysis facilities, and it is in the process of negotiating additional acute dialysis services contracts in the areas surrounding its facilities as well as in tandem with development of future proposed sites. Each of Dialysis Corporation of America's dialysis facilities has the capacity to provide training, supplies and on-call support services for home peritoneal patients. Dialysis Corporation of America provided approximately 149,000 hemodialysis treatments in 2004, an increase of approximately 31,000 treatments compared to fiscal 2003.
Management of Dialysis Corporation of America estimates that on average its centers were operating at approximately 54% of capacity as of December 31, 2004, 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 significant additional capital expenditures.
Operations of Dialysis Facilities
Dialysis Corporation of America's 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. Dialysis Corporation of America's 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's facilities offer high-efficiency conventional hemodialysis, which, it believes, provides the most viable treatment for most patients, and management considers its dialysis equipment to be both modern and efficient, providing state of the art treatment in a safe and comfortable environment.
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. In addition, there are independent consultants who visit with the dialysis patients at the facilities. These individuals supervise the patient's needs and treatments. See "Employees" below. Dialysis Corporation of America must, in furtherance of its business strategy, strive to attract and retain skilled nurses and other staff, competition for whom is intense.
Dialysis Corporation of America's 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 Dialysis Corporation of America.
Inpatient Dialysis Services
Dialysis Corporation of America presently provides inpatient dialysis services to nine hospitals in Georgia, Ohio and Pennsylvania, 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
Dialysis Corporation of America's dialysis facilities provide certain ancillary services to ESRD patients, including the administration of certain prescription drugs, such as erythropoietin, or 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 manufacturer of EPO in the United States and there are currently no alternative products that perform the functions of EPO available to dialysis treatment providers. Although Dialysis Corporation of America has a good relationship with the manufacturer and has not experienced any problems in receipt of its supply of EPO, any loss or limitation of supply of this product could have a material adverse effect on Dialysis Corporation of America's and our operating revenue and income.
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. Dialysis Corporation of America, therefore, relies on its ability to develop affiliations with area nephrologists.
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. Dialysis Corporation of America retains, by written agreement, qualified physicians or groups of qualified physicians to serve as medical directors for each of its facilities. The medical directors are typically a source of patients treated at the particular center served. Medical directors of eight of Dialysis Corporation of America's centers have acquired a minority ownership interest in the subsidiary operating the center they service, which minority interests range from 20% to 49%. Dialysis Corporation of America's Toledo, Ohio affiliate is owned 60% by the medical director of that facility. Dialysis Corporation of America makes every effort to comply with federal and state regulations concerning its relationship with the physicians and the medical directors treating patients at its facilities, and is not aware of any limitation on physician ownership in its subsidiaries. See Item 1, "Business - Government 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. These agreements, however, do not prohibit physicians providing services at Dialysis Corporation of America's facilities from providing direct patient care services at other locations; and consistent with federal and state law, such agreements do not require a physician to refer patients to Dialysis Corporation of America 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 and operate a dialysis facility in a particular area is substantially dependent upon 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, consequently, on the operations of Dialysis Corporation of America. Compensation of medical directors is separately negotiated for each facility and generally depends on competitive factors, the size of the facility, and the fair market value of the services to be provided.
Quality Assurance
Dialysis Corporation of America implements a quality assurance program to maintain and improve the quality of dialysis treatment and care it provides to 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 the 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. Dialysis Corporation of America's Vice President of Clinical Services, a certified nephrology nurse, oversees this program in addition to ensuring that Dialysis Corporation of America meets federal and state compliance requirements for dialysis centers. See the section below in this Item 1 entitled, "Government Regulation - Dialysis Corporation of America."
Quality Clinical Results
Dialysis Corporation of America's goal is to provide consistent quality clinical care to its patients from caring and qualified doctors, nurses, patient care technicians, social workers and dieticians and has demonstrated an unwavering commitment to quality renal care through its continuous quality improvement initiatives. Dialysis Corporation of America strives to maintain a leadership position as a quality provider in the dialysis industry and often sets its goals higher than the national average standards.
Kt/V is a formula that measures the amount of dialysis delivered to a patient, based on the removal of urea, an end product of protein metabolism. Kt/V provides a means to determine an individual dialysis prescription and to monitor the effectiveness or adequacy of the dialysis treatment as delivered to the patient. It is critical to strive to achieve a Kt/V level of greater than 1.2 for as many patients as possible. The national average for 2003, the most recent data available, indicated 92% of
dialysis patients had a Kt/V level greater than 1.2, while 95% of Dialysis Corporation of America's patients had a Kt/V level greater than 1.2 for 2003 and 2004.
Anemia is a shortage of oxygen-carrying red blood cells. Because red blood cells bring oxygen to all the cells in the body, anemia causes severe fatigue, heart disorders, difficulty concentrating, reduced immune function, and other problems. Anemia is common among renal patients, caused by insufficient erythropoietin, iron deficiency, repeated blood losses, and other factors. Anemia can be detected with a blood test for hemoglobin or hematocrit. It is ideal to have as many patients as possible with hemoglobin levels above 11. The national average for 2003 indicated 79% of dialysis patients had a hemoglobin level greater than 11, while 80% of Dialysis Corporation of America's patients had a hemoglobin level greater than 11 for 2003 and 2004.
One indicator of the overall health of Dialysis Corporation of America's patients is the number of days that are spent in the hospital. The crude hospitalization rate is the total number of hospital days during a given year per total population. Hospitalization of patients can be related or unrelated to chronic kidney disease. The national average for 2001, the most recent data available, was 14.5 hospital days per patient per year, while Dialysis Corporation of America's average was 11 hospital days per patient per year, for 2003 and 2004.
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. The states in which Dialysis Corporation of America operates 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 Dialysis Corporation of America's dialysis services payments and, consequently, its revenues. See "Medicare Reimbursement" below.
Inpatient dialysis services provided by Dialysis Corporation of America are paid for by the hospital or medical center 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 Dialysis Corporation of America's dialysis facilities is certified to participate in the Medicare program. The Medicare reimbursement system fixes the reimbursement rates in advance and limits the allowable charge per treatment, but provides Dialysis Corporation of America with predictable and recurring per treatment revenues and allows it 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.
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 28% of Dialysis Corporation of America's medical services revenues in 2004 was derived from providing dialysis patients with EPO. CMS limits the EPO reimbursement based upon patients' hematocrit levels. Other ancillary services, mostly other drugs, account for approximately an additional 10% of Dialysis Corporation of America's medical services revenues. Dialysis Corporation of America submits claims monthly and is 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. Congress has approved a 1.6% composite rate increase for 2005. Commencing this year, Medicare will reimburse dialysis providers for the ten most utilized ESRD drugs at an amount equal to the cost of such drugs as determined by the OIG. For other ESRD drugs, Medicare will reimburse dialysis providers at an amount equal to the average sale price of the drug plus 6%, and the composite rate will be increased by an amount estimated by HHS to be the dialysis provider's average profit for these drugs. To make this change budget-neutral, a drug add-on composite has been included. Accordingly, it has been determined by CMS that the Medicare ESRD composite rate will increase by approximately 8.7% or $11 per treatment, and that payments for separately billable drugs will be reduced as described above. In addition, it is anticipated that CMS will begin, as of April 1, 2005, to reimburse providers using a case mix formula. CMS plans to adjust reimbursements based on predefined patient parameters such as patient height, weight and age. Congress has mandated a budget neutrality factor adjustment so that aggregate payments under the system for 2005 equal payments that would have been made without the case mix adjustments and the add-on composite for reimbursement of the drugs. Management of Dialysis Corporation of America believes that there will be minimal impact on its average Medicare revenue per treatment as a result of these changes in Medicare reimbursement. This is the first increase in the Medicare ESRD composite rate since 2001. 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 reimbursements 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. Dialysis Corporation of America is a licensed ESRD Medicaid provider in Georgia, Maryland, New Jersey, Ohio, Pennsylvania, South Carolina and Virginia.
Dialysis Corporation of America Sources of Medical Services Revenues
Year Ended December 31, ------------------------------ 2004 2003 2002 ---- ---- ---- Medicare 48% 54% 49% Medicaid and Comparable Programs 8% 8% 9% Hospital inpatient dialysis services 6% 7% 10% Commercial and private payors 38% 31% 32%
Management Services
Dialysis Corporation of America has a management services agreement with each of its wholly- and majority-owned subsidiaries and with its 40% owned affiliate DCA of Toledo, LLC, and with an unaffiliated Georgia dialysis center, providing each of 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 each developed a Corporate Integrity Program to assure that each entity continues to achieve the goals of providing the highest level of care and service in a professional and ethical manner consistent with applicable federal and state laws and regulations. These programs are intended to (i) reinforce Dialysis Corporation of America's as well as our management's, employees' and professional affiliates' awareness of their responsibilities to comply with applicable laws in the increased and complex regulatory environment relating to our operations, (ii) benefit the overall care and services Dialysis Corporation of America provides to its dialysis patients, and that we provide to our medical products customers, and (iii) assure that our operations are in compliance with the law, which in turn should also assist both Dialysis Corporation of America and us 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 its existing policies, including those applicable to claims submission, cost report preparation, internal audit and human resources.
Code of Ethics
As part of our Corporate Integrity Program, we have established a Code of Ethics and Business Conduct covering management and all employees to assure all persons affiliated with us and our
operations act in an ethical and lawful manner. The Code of Ethics and Business Conduct covers relationships among and between affiliated persons, including Dialysis Corporation of America patients and payors, and relates to information processing, compliance, workplace conduct, environmental practices, training, education, development, among other areas. Dialysis Corporation of America has also developed its Code of Ethics and Business Conduct and, in its commitment to delivering quality care to dialysis patients, has mandated rigorous standards of ethics and integrity.
Our Code of Ethics and Business Conduct is designed to provide:
o ethical handling of actual or apparent conflicts of interest between personal and professional relationships
o full, fair, accurate, timely, and understandable disclosure in reports and documents we file with the SEC and in our other public communications
o compliance with applicable governmental laws, rules and regulations
o prompt internal reporting of violations of the Code to an appropriate person identified in the Code
o accountability for adherence to the Code
The portion of our Code of Ethics and Business Conduct as it applies to our principal executive officer, principal financial officer, principal accounting officer, and persons performing similar functions, may be obtained without charge upon request to our corporate Secretary and counsel, Lawrence E. Jaffe, Esq., Jaffe & Falk, LLC, at 777 Terrace Avenue, Hasbrouck Heights, New Jersey 07604.
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 customers 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 28 years, it has never been subject to any suit relating to the providing of dialysis treatments. We currently have general and umbrella liability insurance, in addition to property and workmen's compensation coverage. Dialysis Corporation of America carries similar insurance coverage, as well as professional and products liability insurance. 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 its 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 Dialysis Corporation of America's 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, Inc., a private company which, through its affiliate Xandros, Inc., has developed and markets a Linux desktop operating system. In addition to Xandros, Linux Global Partners has investments in a variety
of other Linux-related software companies, and is attempting to negotiate strategic alliances with certain of those companies in order to employ their systems in conjunction with Linux Global Partner's desktop system. Each of our company and Dialysis Corporation of America holds an interest in Linux Global Partners. 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 the principal amount of this loan and accrued interest to Dialysis Corporation of America. In 2001, Linux Global Partners paid us $215,000 of which $200,000 was applied to the principal amount of the indebtedness. Our loan to Linux Global Partners had been extended on various occasions, and 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 to Linux Global Partners 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 Linux Global Partners' investments include Code Weavers, a software development service and porting company, and Metro Link, which is involved in Linux graphics and the embedded technology sector. All of these companies are private and are in the developmental stages, several with limited revenues, and their success remains speculative.
Under the terms of the loan arrangement with Linux Global Partners, 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 auction sale consisted of 4,115,815 shares of Ximian, Inc. series A convertible preferred stock, which Xandros committed to purchase for $2,992,000. Xandros subsequently failed to meet the conditions of purchase and as a result, in accordance with the negotiated terms of the acquisition of the collateral, forfeited 775,000 shares of its common stock that it had deposited with us as a down payment towards the purchase of the collateral, and we retained the 4,115,815 preferred shares of Ximian. In connection with a third-party's acquisition of Ximian in August, 2003, we sold the Ximian preferred stock for approximately $3,541,000 in cash proceeds resulting in a gain of approximately $784,000 recorded in August 2003. An additional approximately $805,000 of proceeds due us from the sale of the Ximian securities was placed in escrow in accordance with the terms of the acquisition agreement, with one-half of such funds, approximately $402,000, released to us in August 2004 on the first anniversary of the Ximian acquisition. We recorded a gain of approximately $402,000 in August 2004 upon the release of the first half of the escrowed funds. The remaining balance of escrowed funds is scheduled to be released to us on the second anniversary of the Ximian acquisition in August 2005, pending fulfillment by the parties to the Ximian acquisition of certain post-sale conditions. We expect to record an additional gain based on net proceeds received at the time these remaining escrowed funds are disbursed to us from escrow. 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 and 11, 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 investment in research and development of the Linux desktop system, enhanced the system for commercial exploitation, and in October, 2002, initiated the marketing of a 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 that Xandros is subject to all the risks of a startup company, including its ability to continue operations, commercial acceptance of the Linux desktop system, the availability of resources to further develop, market and distribute the system, its ability to generate revenues and whether such revenues will be sufficient to reflect income, and management's oversight of the operations and growth of the company.
We continue to evaluate the technology sector for potential further investments.
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 dialysis center must be certified by CMS, and Dialysis Corporation of America 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. Dialysis Corporation of America's 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 Dialysis Corporation of America is presently operating.
Dialysis Corporation of America's record of compliance with federal, state and local governmental laws and regulations remains excellent. Enforcement of healthcare facility regulations, 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. We are unable to predict the scope and effect of any changes in government regulations on Dialysis Corporation of America's operations, particularly any modifications in the reimbursement rate for medical services or requirements to obtain certification from CMS. Since its inception in 1976, Dialysis Corporation of America has maintained all of its licenses, including its Medicare and Medicaid and equivalent certifications. The loss of any licenses and certifications would have a material adverse effect on Dialysis Corporation of America's operations, revenues and earnings.
Dialysis Corporation of America regularly reviews legislative and regulatory changes and developments and will restructure a business arrangement if it determines such might place its operations in material noncompliance with applicable laws or regulations. See "Fraud and Abuse" and "Stark II" below. To date, none of Dialysis Corporation of America's business arrangements with physicians,
patients or others have been the subject of investigation by any governmental authority. No assurance can be given, however, that Dialysis Corporation of America's 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.
Certification and Reimbursement
Dialysis Corporation of America's dialysis centers must meet certain requirements, including, among others, those relating to patient care, patient rights, medical records, the physical set-up of the center, and personnel, in order to be certified by CMS, to be covered under the Medicare program and to receive Medicare reimbursement. See above under "Operations - Medicare Reimbursement." All of Dialysis Corporation of America's dialysis centers are certified under the Medicare program and applicable state Medicaid programs. Medicare coverage for ESRD services has been revised by CMS for 2005. See above in this section under "Dialysis Operations - Medicare Reimbursement."
Fraud and Abuse
Certain aspects of Dialysis Corporation of America's 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 Dialysis Corporation of America's 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, derived from certain provisions of the Social Securities Act of 1965, 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, as well as 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 Dialysis Corporation of America's dialysis centers is supervised by a medical director, who is a licensed nephrologist or otherwise qualified physician. The compensation of these 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 Dialysis Corporation of America's subsidiaries operating outpatient dialysis centers are owned jointly between Dialysis Corporation of America and physicians who hold a minority position, in most cases, through a professional corporation or association. These physicians also act as the medical directors for those facilities. Dialysis Corporation of America's Toledo, Ohio affiliate is majority-owned by the medical director of that facility. These physicians, except in one instance, also act as the medical directors for those facilities. Dialysis Corporation of America attempts to structure its arrangements with its physicians to comply with the Anti-Kickback Statute. Many of these physicians' patients are treated at Dialysis Corporation of America's facilities. Dialysis Corporation of America believes its arrangements with its medical directors are in material compliance with applicable law. Several states in which Dialysis Corporation of America operates 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 medical directors who hold a percentage ownership in the subsidiary entities owning and operating the dialysis facilities, Dialysis Corporation of America would restructure its relationship with these physicians, but it could still 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 Dialysis Corporation of America 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 being supported by objective documentation, drastically reducing the possibility of over-utilization. Additionally, there are safe harbors for certain arrangements. Nevertheless, while relationships created by medical director ownership of minority interests in Dialysis Corporation of America's facilities satisfy many but not all of the criteria for the safe harbor, 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 its compliance with the law, Dialysis Corporation of America has adopted a Corporate Compliance Program 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, the medical directors who have a minority interest in a particular Dialysis Corporation of America facility may refer patients to hospitals with which Dialysis Corporation of America has an inpatient dialysis services arrangement. We believe Dialysis Corporation of America's acute inpatient hospital services are in compliance with the law. See "Stark II" below.
Dialysis Corporation of America endeavors in good faith to comply with all governmental regulations. However, there can be no assurance that Dialysis Corporation of America will not be required to change its 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 Dialysis Corporation of America's position with respect to the Anti-Kickback Statute, but we will continue to make every effort to ensure that Dialysis Corporation of America will remain in compliance.
Stark II
The Physician Ownership and Referral Act, known as Stark II, bans certain physician referrals, with 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 a facility, that 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, and CMS adopted Phase II of its regulations under Stark II in March, 2004. These regulations exclude from covered designated health services and referral prohibitions, services included in the ESRD composite 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." 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 Dialysis Corporation of America incident to dialysis services within the Stark II prohibitions.
If the provisions of Stark II were found to apply to Dialysis Corporation of America's arrangements however, we believe that Dialysis Corporation of America would be in compliance. Dialysis Corporation of America compensates its nephrologist-physicians, or practice groups with which such nephrologist-physicians are affiliated, as medical directors of its 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 Dialysis Corporation of America's facilities do not receive any compensation from Dialysis Corporation of America.
Medical directors who hold a minority investment interest in certain of the subsidiaries operating Dialysis Corporation of America's dialysis centers may refer patients to hospitals with which Dialysis Corporation of America has an acute inpatient dialysis service arrangement. Although the regulations of Stark II may be interpreted to apply to these types of transactions, 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, Dialysis Corporation of America may be required to restructure certain existing compensation or investment agreements with its medical directors, or, in the alternative, 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 both Dialysis Corporation of America's and our operations and future financial results. We believe that if Stark II is interpreted by CMS or any other governmental entity to apply to Dialysis Corporation of America's dialysis arrangements, it is possible that Dialysis Corporation of America could be permitted to bring its 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 costs and expenses associated with such prospective compliance, if permissible, would not have a material adverse effect on Dialysis Corporation of America and consequently, on us.
Health Insurance Reform Act
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. Under these programs, these governmental entities undertake a variety of monitoring activities, 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 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 Dialysis Corporation of America's submissions and processing of healthcare claims and also applies to many of its payors. We believe that Dialysis Corporation of America is in compliance with the transactions standards rule.
HIPAA also includes provisions relating to the privacy of healthcare information. 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." 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. During 2003 and 2004, Dialysis Corporation of America expended significant resources to develop and implement policies and procedures to address privacy issues, and we believe Dialysis Corporation of America is in compliance with the HIPAA privacy rules.
The final HIPAA security regulations governing the security of health information that is maintained or transmitted electronically were published in February, 2003. Those regulations generally require implementation of safeguards for ensuring the confidentiality of electronic health information. Most covered entitles will have until April 21, 2005 to comply with the security standards established by these HIPAA regulations. Dialysis Corporation of America believes it is currently in compliance with the HIPAA security standards.
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. 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 Dialysis Corporation of America substantially complies with currently applicable state and federal laws and regulations and to date has not had any difficulty in maintaining its 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 Dialysis Corporation of America's operations cannot be predicted. No assurance can be given that Dialysis Corporation of America's dialysis operations will not be reviewed or challenged by regulatory authorities. Dialysis Corporation of America continues to work with its healthcare counsel in reviewing its policies and procedures and making every effort to comply with HIPAA and other applicable federal and state laws and regulations.
Any loss by Dialysis Corporation of America of 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
Dialysis Corporation of America's dialysis centers are subject to various federal, state and local hazardous waste laws and non-hazardous medical waste disposal laws. Most of Dialysis Corporation of America's waste is non-hazardous. Dialysis Corporation of America also follows 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 dialysis 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.
Other Regulation
There are also federal and state laws, such as the federal False Claims Act, prohibiting anyone from presenting false claims or fraudulent information to obtain payments from Medicare, Medicaid and other third-party payors. 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, however, 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 Dialysis Corporation of America is 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." Dialysis Corporation of America's establishment and implementation of its compliance program, coupled with its existing policies and internal controls, could have the effect of mitigating any civil or criminal penalties for potential violations, of which it has had none since its inception 1976. We will continue to use our best efforts to ensure that Dialysis Corporation of America fully complies with federal and state laws, regulations and requirements as applicable to its 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.
Although we hold three patents related to our lancets, 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 industry is extremely competitive and our medical supplies operations are not a significant competitive factor in this area.
The dialysis industry is also highly competitive. There are numerous providers who have dialysis centers in the same areas as Dialysis Corporation of America. Many are owned by larger corporations which operate dialysis centers 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., Gambro Healthcare, Inc., DaVita, Inc., and Renal Care Group, Inc. DaVita recently entered into an agreement to acquire Gambro. These companies have substantially greater financial resources, significantly 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 markets we target. Moreover, competition for acquisitions has increased the cost of acquiring existing dialysis centers. Fresenius and Gambro also manufacture and sell dialysis equipment and supplies, which may provide them with an even greater competitive edge. 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 center 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. We cannot assure you that Dialysis Corporation of America will compete effectively with any of its competitors.
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 in the growth of this modality, renal transplantations could become a more significant competitive aspect to the dialysis treatments provided by Dialysis Corporation of America. Although kidney transplant is a preferred treatment for ESRD, certain patients who have undergone such transplants have subsequently lost the functionality of the transplanted kidney and have returned to dialysis treatments.
Employees
Medicore and its subsidiaries employ 314 full time employees of which nine are administrative, 301 are with the dialysis operations and 4 are engaged in the medical products operations. In addition, Dialysis Corporation of America employs approximately 23 part-time employees and retains 18 independent
contractors and subcontractors, consisting of the social workers and dietitians at certain of its dialysis facilities in addition to medical directors who supervise patient treatment at each facility. Dialysis Corporation of America also uses approximately 78 "per diem" personnel to supplement staffing.
We believe that our relationship with our employees as well as Dialysis Corporation of America's relationship with its employees is excellent and neither we nor Dialysis Corporation of America has suffered any strikes or work stoppages. None of Dialysis Corporation of America's or our employees are represented by a labor union. Both we and Dialysis Corporation of America are an equal opportunity employer.
Risk Factors
We have listed below certain of the risk factors relating to Medicore and our securities. There may be other risks and uncertainties that we 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 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 negatively impact a shareholder's investment in Medicore.
Our dialysis operations are the most significant business segment, and, therefore, most of the risk factors will relate to that business.
Investment in Technology Companies
We have invested in development-stage privately-held Linux software companies, all of which will, most likely, require significant additional financing in order to continue operations for the development and marketing of their products and/or services
In 2000, we initiated a new division for the purpose of investing in technology companies, and our singular investment was the acquisition, in January, 2000, of an 8% ownership interest in Linux Global Partners, a private, development stage company involved in Linux software product development and investment. Both our company and Dialysis Corporation of America hold an interest in Linux Global Partners. As a result of our making a loan to Linux Global Partners, the subsequent default on that loan by Linux Global Partners and our sale of the collateral securing that loan at public auction, we acquired approximately 775,000 shares of common stock of Xandros, Inc., an affiliate of Linux Global Partners that has developed and markets a Linux-based desktop operating system. Both Linux Global Partners and Xandros are recently organized companies in a highly competitive, rapidly evolving market. Neither company has current audited financial statements and both companies have a limited operating history upon which to evaluate future prospects. Moreover, both companies have incurred significant losses since inception and particularly with respect to the initial marketing efforts relating to the desktop operating system. Commercial demand for the operating system has been minimal, and sales of the system have not generated revenues of a level sufficient to meet operating expenses. Neither of the companies has the current resources necessary to pursue the development and marketing of the desktop operating system required to generate commercial interest and recognition. In the absence of a substantial increase in sales revenues from the desktop operating system, both Xandros and Linux Global Partners will require significant equity and/or debt financing in order to continue business operations and to pursue further development and marketing efforts. There can be no assurance that any of such financing will be available or that if available, will be on commercially reasonable terms. To the extent that such additional financing is not obtained, Xandros and Linux Global Partners may be required to curtail certain operations or to ultimately cease operations altogether.
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 23 centers in the states of Georgia, Maryland, New Jersey, Ohio, Pennsylvania, South Carolina and Virginia, with five dialysis centers in development. Some of Dialysis Corporation of America's dialysis centers have generated losses since their commencement of operations. This is due to operational costs and time needed to reach maturity of dialysis treatments. See Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations."
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 center
o government healthcare program participation requirements
o reimbursement for patient services
o patient referral prohibitions
o broad federal and state anti-kickback regulations
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 further judicial and legislative interpretations. If Dialysis Corporation of America is forced to change its method of operations because of these regulations, our earnings, financial condition and business could be adversely affected. The imposition of additional licensing and other regulatory requirements may, among other things, increase Dialysis Corporation of America's and consequently our, cost of doing business. In addition, any violation of these governmental regulations could involve substantial civil and criminal penalties and fines, revocation of licensure, closure of one or more centers, and exclusion from participating in Medicare and Medicaid programs. Any loss by Dialysis Corporation of America of federal or state certifications or licenses would materially adversely impact our business.
Dialysis Corporation of America's arrangements with its physician medical directors do not meet the safe harbor provisions of federal and state laws, and may be subject to greater governmental scrutiny
Neither Dialysis Corporation of America's arrangements with the medical directors of its dialysis facilities, typically retained by Dialysis Corporation of America as independent contractors under a fixed fee medical director agreement, 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. Rights and remedies available under these programs include obtaining repayment from Dialysis Corporation of America of any amounts alleged to be overpayments or in violation of program requirements, or making deductions from future amounts due to Dialysis Corporation of America. 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 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, decertification from participation in the Medicare or Medicaid programs and revocation of a center's license.
Any such regulatory actions could adversely affect a center's ability to continue to operate, to provide certain services, and/or its eligibility to participate in Medicare or Medicaid programs or to receive payments from other payors. Moreover, regulatory actions against one center may subject Dialysis Corporation of America's other centers, which may be deemed under common control or ownership, to similar 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. Legislation has 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 its facilities will operate in substantial compliance with these anti-fraud requirements. While we believe that Dialysis Corporation of America's business practices are consistent with Medicare and Medicaid criteria, those criteria are often vague and subject to change and interpretation. Anti-fraud actions 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, 2003 and 2004, approximately 49%, 54% and 48% of Dialysis Corporation of America's patient revenues was derived from Medicare reimbursement and 9%, 8% and 8% of its patient revenues was derived from Medicaid and equivalent programs. Decreases in Medicare and Medicaid and equivalent rates and programs for dialysis treatments would adversely affect Dialysis Corporation of America's and our revenues and profitability.
Federal and state governments seek to maintain, if not reduce costs, and any such actions in the healthcare industry could adversely affect Dialysis Corporation of America's revenues and earnings, including the following
o reductions in payments to Dialysis Corporation of America or government programs in which Dialysis Corporation of America participates
o increases in labor and supply costs, which Dialysis Corporation of America does experience, without comparable governmental reimbursement rate increases
o inclusion in the flat composite rate for dialysis treatments those ancillary services which Dialysis Corporation of America currently bills separately
This year, the reimbursement rate will change, primarily increasing the composite rate by 8.7% and reducing the reimbursement rate for certain drugs, including EPO. CMS is expanding the drug and ancillary services that are included in the composite rate. Dialysis Corporation of America will be reimbursed for other separately billable ESRD drugs at an average sale price plus 6% The regulations provide for budget-neutrality, case mix and geographic adjustments in the composite rate.
Management of Dialysis Corporation of America does not believe these changes in reimbursement coupled with a 1.6% increase in the Medicare composite rate will have a significant impact on its operations, expenses or earnings.
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%, 38% and 44% of Dialysis Corporation of America's patient revenues for 2002, 2003 and 2004 was obtained from sources other than Medicare or Medicaid and equivalent programs. Dialysis Corporation of America generally charges non-governmental organizations for dialysis treatment at 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 composite rate, or expanded coverage of dialysis treatments by managed care organizations, which commonly have lower rates than Dialysis Corporation of America charges, 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. In 2003, Amgen increased the price of EPO and we cannot assure you that there will not be further price increases. There currently is no alternative drug available to Dialysis Corporation of America for the treatment of anemia of its dialysis patients. The available supply of EPO could be delayed or reduced, whether by Amgen itself, as a result of unforeseen circumstances, or through excessive demand. This would adversely impact Dialysis Corporation of America's and our revenues and profitability, since approximately 26%, 28% and 28% of Dialysis Corporation of America's medical revenues in 2002, 2003 and 2004 were based upon the administration of EPO to its dialysis patients. Most of Dialysis Corporation of America's EPO reimbursement is from government programs.
A new anemia treatment drug could affect Dialysis Corporation of America's use of EPO, adversely impacting our profitability.
Amgen is the sole manufacturer of EPO, which is administered in conjunction with dialysis treatments to address a patient's anemia. Amgen has developed and obtained FDA approval for its new drug Aranesp(R), used to treat anemia, and which is indicated to be effective for a longer period than EPO. Based on its longer lasting capabilities, potential profit margins on Aranesp(R) could be significantly lower than on EPO, and furthermore, Aranesp(R) could be administered by a dialysis patient's physician, further eliminating potential revenues from the treatment of anemia in our dialysis patients. The introduction of Aranesp(R) as an anemia treatment for dialysis patients, therefore, could adversely impact Dialysis Corporation of America's and our revenues and profitability.
The implementation of the case-mix adjustment could adversely affect Dialysis Corporation of America's revenues, profitability and cash flow.
CMS has adopted a case-mix adjustment for the ESRD composite rate, under which the Medicare composite rate will be adjusted based on a patient's age, body mass index and body surface area. These regulations are scheduled to become effective in April, 2005. Management of Dialysis Corporation of
America believes implementing these case-mix adjustments will require significant systems changes for the Medicare fiscal intermediaries that process and pay Medicare claims. If the required systems changes are not made on a timely basis, then the Medicare fiscal intermediaries may delay the payment of claims or may not pay claims correctly, either of which could have an adverse effect on Dialysis Corporation of America's as well as our cash flow and working capital. Dialysis Corporation of America is presently unable to predict the impact of this case-mix adjustment since it is dependant on the patient mix.
Dialysis Corporation of America's ability to grow is subject to its resources and available locations
Other than four center acquisitions over the period 2002 through 2004, expansion of Dialysis Corporation of America's operations has been through construction of dialysis centers. This is due to the substantial costs involved in an acquisition, usually valued on a per-patient basis. Dialysis Corporation of America developed two dialysis centers and acquired one center in 2003 and opened five new centers and acquired a company with two dialysis centers in 2004. Dialysis Corporation of America seeks areas with qualified and cost-effective nursing and technical personnel and a sufficient population to sustain a dialysis center. These opportunities are limited and Dialysis Corporation of America competes with much larger dialysis companies for appropriate locations. The time period from the beginning of construction through commencement of operations of a dialysis center generally takes four to six months and sometimes longer. Once the center is operable, it generates revenues, but usually does not operate at full capacity, and may incur losses for approximately 12 months or longer. Dialysis Corporation of America's growth strategy based on construction also involves the risks associated with its ability to identify suitable locations to develop additional centers. Those centers that are developed may never achieve profitability, and additional financing may not be available to finance future development.
Dialysis Corporation of America's inability to acquire or develop dialysis centers in a cost-effective manner would adversely affect its ability to expand its dialysis business and as a result, both Dialysis Corporation of America's and our profitability.
Growth places significant demands on Dialysis Corporation of America's financial and management skills. Dialysis Corporation of America's inability to meet the challenges of expansion and to manage any such growth would have an adverse effect on its results of operations and financial condition.
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 by seeking an appropriate location for development of a dialysis center and by taking into consideration the potential geographic patient base, the availability of a physician nephrologist to be medical director of that dialysis center, and a skilled work force. Construction, equipment and initial working capital costs for a new dialysis center with 15 stations, typically the size of our dialysis facilities range from $750,000 to $1,000,000. The cost of acquiring a center is usually much greater. There is no assurance that Dialysis Corporation of America will be successful in developing or acquiring dialysis centers, or otherwise expanding its operations. Dialysis Corporation of America is negotiating with nephrologists and others to establish new dialysis centers, but there is no assurance that 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 by Dialysis Corporation of America.
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
Most dialysis facilities, including Dialysis Corporation of America's dialysis facilities, are dependent upon referrals of ESRD patients for treatment by physicians, primarily those 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 Dialysis Corporation of America, and they are free to refer patients to any other conveniently located dialysis facility. Dialysis Corporation of America may not be able to renew or otherwise negotiate compensation under the medical director agreements with its medical director physicians who could terminate the relationship, which, without a suitable medical director replacement, could result in closure of the facility. Accordingly, the loss of these key 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. Although Dialysis Corporation of America's medical director agreements contain non-competition restrictions upon the contracting physician or practice group, we cannot assure you that the courts of the particular jurisdiction in which the agreement is applicable would fully enforce such a provision, if at all, which in turn could potentially increase competition with the dialysis centers and negatively impact Dialysis Corporation of America's revenues and earnings.
Some of the medical directors or medical groups with whom they are associated own minority interests in certain of the subsidiaries which operate Dialysis Corporation of America's dialysis centers. 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 key physicians, their medical groups, or their patients, who may seek dialysis treatment elsewhere. The resulting loss of these patients together with the potential requirement on such jointly owned facilities to repay Medicare reimbursements and pay monetary penalties would have an adverse effect on Dialysis Corporation of America's and our business and financial condition.
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 (i) further increase government regulation of or other involvement in healthcare, (ii) lower reimbursement rates, and (iii) 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.
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, resulting in several very large dialysis companies competing for the acquisition of existing dialysis centers and the development of relationships with referring physicians. Recently, DaVita, Inc. announced the proposed $3 billion acquisition of Gambro Healthcare US, which if consummated could result in one of, if not the largest provider of dialysis services in the United States. Most of Dialysis Corporation of America's competitors have significantly greater financial resources, more dialysis facilities and a significantly larger patient base. In addition, technological advances by Dialysis Corporation of America's competitors may provide more effective dialysis treatments than the services provided by its centers.
Dialysis Corporation of America also experiences 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. Dialysis Corporation of America's failure to compete effectively could significantly impair its continued growth and profitability, and, consequently, our financial condition.
Dialysis Corporation of America could be subject to professional liability claims that may adversely affect us
Operation of dialysis centers and, in particular, the provision of dialysis treatments to ESRD patients, as is the case with most healthcare treatment services, entails significant risks of liability. Accordingly, Dialysis Corporation of America could be subject to various actions and claims of professional liability alleging negligence in the performance of its treatment and related services, as well as for the acts or omissions of its employees. As Dialysis Corporation of America grows and the number of its patients increases, so too does its exposure to potential malpractice, professional negligence, and other related legal theories and causes of action. These potential claims could seek substantial damages, possibly beyond Dialysis Corporation of America's insurance coverage, and could subject it to the incurrence of significant fees and costs related to defending such potential claims. Such potential future claims for malpractice or professional liability, including any judgments, settlements or costs associated with such claims and actions, could have a material adverse effect on Dialysis Corporation of America.
Dialysis Corporation of America's insurance costs and deductibles have been substantially increasing over the last several years, and may not be sufficient to cover claims and losses
Dialysis Corporation of America maintains a program of insurance coverage against a broad range of risks in its business, including, and of primary importance, professional liability insurance, subject to certain deductibles. The premiums and deductibles under its insurance program have been steadily and significantly increasing over the last several years as a result of general business rate increases coupled with its continued growth and development of dialysis centers. Dialysis Corporation of America is unable to predict further increases in premiums and deductibles, but based on experience anticipates further increases in this area, which could adversely impact earnings. The liability exposure of operations in the healthcare services industry has increased, resulting not only in increased premiums, but
in limited liability on behalf of the insurance carriers. Dialysis Corporation of America's ability to obtain the necessary and sufficient insurance coverage for its operations upon expiration of its insurance policies may be limited, and sufficient insurance may not be available on favorable terms, if at all. Such insurance may not be sufficient to cover any judgments, settlements or costs relating to potential future claims, complaints or law suits. To the extent that Dialysis Corporation of America's is unable to obtain sufficient insurance for its operations, significant judgments, settlements and costs relating to future potential actions, suits or claims, could have an adverse effect on Dialysis Corporation of America.
Medicore, which owns 56% of the voting securities of Dialysis Corporation of America, has some common officers and directors, which presents the potential for conflicts of interest
We own 56% of the common stock 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. Thomas K. Langbein is Chairman of the Board of both our company and Dialysis Corporation of America, and also the President and Chief Executive Officer 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. Peter D. Fischbein, a director of our company since 1984, was elected a director of Dialysis Corporation of America in June 2004. Lawrence E. Jaffe, Esq., a member of Jaffe & Falk, LLC, our corporate counsel, is a director and our corporate Secretary, as well as the corporate Secretary of 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 2004 amounted to approximately $200,000.
Additionally, there have been past and there are current transactions between us and Dialysis Corporation of America and their directors, including insurance coverage.
In March, 2004, we agreed to provide Dialysis Corporation of America with up to $1,500,000 in financing under a demand promissory note with annual interest at the prime rate plus 1.25%. The note was subsequently modified to increase the maximum advances to $5,000,000 and its purpose expanded to include working capital. At March 25, 2005, there was $2,435,000 outstanding under this financing. See Note 8 to "Notes to Consolidated Financial Statements."
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.
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 Thomas K. Langbein, Chairman of the Board and our Chief Executive Officer and President, who also holds the position of Chairman of the Board with Dialysis Corporation of America. We are also dependent on the services of Stephen W. Everett, President, Chief Executive Officer and a director of Dialysis Corporation of America. Mr. Langbein has been involved with Medicore 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, President on March 1, 2000, and Chief Executive Officer in May, 2003. Mr. Everett has been involved in the healthcare industry for 25 years. It would be very difficult to replace the services of these individuals, whose services, both individually and combined, if lost would adversely affect our 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
Shares eligible for future sale by restricted shareholders may adversely affect our stock price
Our officers and directors own approximately 2,450,000 shares of our common stock and options exercisable into an additional 212,331 shares of our common stock. Most of the shares of these officers and directors, upon satisfying the conditions of Rule 144 under the Securities Act, may be sold without complying with the registration provisions of the Securities Act. The conditions of Rule 144 include:
o holding the shares for one year from acquisition;
o 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;
o the filing of a Form 144with the SEC;
o Medicore continuing to timely file its reports under the Exchange Act.
Our tradable common stock, known as the float, is approximately 4,536,000 shares, and the approximately 2,450,000 shares of common stock directly owned by the officers and directors represents approximately 54% of the float. Accordingly, the sale by such officers and directors may have an adverse affect on the market price of our common stock, and may inhibit our ability to manage subsequent equity or debt financing.
Over the last several months, our stock price has exhibited volatility, and any investment in our common stock may, therefore, decline for reasons unrelated to our performance
Our common stock trades on the Nasdaq SmallCap Market under the symbol "MDKI." The market price of our common stock has exhibited significant volatility in 2004 and early 2005. The first three quarters of 2004, the stock traded in the $2.05 to $4.43 range on limited volume. The volume and market substantially increased in the last quarter of 2004 approximately as follows:
Common Stock Volume (Weekly Average) ---------------- ----------------------- High Low ---- ---
October, 2004 $ 4.40 $ 2.85 17,317 November, 2004 $ 8.08 $ 3.26 199,251 December, 2004 $10.70 $ 6.50 359,415
The volume of trading of our common stock on December 31, 2004 was approximately 3,039,100 shares. The range of market prices for our common stock and trading volume for the first quarter of 2005
through the announcement on March 15, 2005 of our proposed merger with Dialysis Corporation of America (see "Recent Developments" above) is as reported by Nasdaq:
Common Stock Volume (Weekly Average) ---------------- ----------------------- High Low ---- ---
January, 2005 $13.05 $6.71 608,529 February, 2005 $ 9.88 $7.75 228,980 March 14, 2005 $11.00 $8.32 265,417 (two weeks)
For the period subsequent to the merger announcement our common stock traded in the range of $13.78 to $9.65.
Other than the announcement on March 15, 2005 of the proposed merger and the continued growth of Dialysis Corporation of America, there was no information known to management that would cause the rise or significant fluctuation in the price of our common stock, or the increased trading volume. There has been interest in the renal care industry reflecting continued and rapid consolidation as evidenced by the proposed acquisition involving two of the major dialysis services providers, DaVita, Inc. and Gambro Healthcare U.S., for an estimated $3 billion, which may have generated interest of the marketplace in our common stock as well as the common stock of Dialysis Corporation of America.
Other factors that could continue to cause fluctuation in our common stock include:
o changes in government regulation, whether legislative, enforcement or reimbursement rates
o third party reports relating to the dialysis industry and Dialysis Corporation of America (unsolicited by management)
o announcements by management of Dialysis Corporation of America relating to the company's performance or other material events
o actions and announcements by competitors of Dialysis Corporation of America
o the outlook for the healthcare industry generally
Investors should understand that in general, stock prices fluctuate for reasons unrelated to operating results, which management surmises was the case for our common stock over the last quarter of 2004. Any changes in the above discussed factors, the Medicare and Medicaid reimbursement rates in particular, or general economic, political, global and market conditions, could result in a decline in the market price and volume of trading in our common stock.
Item 2.
Item 2. Properties
Medicore leases 2,800 square feet for its executive offices in Hialeah, Florida pursuant to a lease expiring December 31, 2007. In addition, we lease a 5,000 square foot facility at a different location in Hialeah, Florida, for our medical product operations pursuant to a five year lease expiring June 30, 2008, with one five year renewal option. Our previously existing lease for 1,500 square feet also in Hialeah, Florida was not renewed, and expired on January 31, 2004. Medicore also leases 3,900 square feet of space for 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. Dialysis Corporation of America uses approximately 600 square feet at that property for an administrative office.
The Lemoyne property consists of approximately 15,000 square feet and houses one of Dialysis Corporation of America's dialysis centers which accounts for approximately 5,400 square feet under a five year lease through December 22, 2008, with one additional renewal period of five years. The center is approved for 17 dialysis stations with space available for expansion. Dialysis Corporation of America uses approximately 4,000 square feet of the Lemoyne property for administrative offices.
The Easton, Maryland property has a mortgage securing a $700,000 development loan made by a third party to Dialysis Corporation of America's 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 $610,000 at December 31, 2004. 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, which property is subject to a five year $788,000 mortgage obtained in April, 2001 accruing interest at the prime rate plus 1/2% with a minimum rate of 6%, maturing in April, 2006. This mortgage had a remaining principal balance of approximately $675,000 at December 31, 2004. Dialysis Corporation of America constructed a dialysis center at this property comprising approximately 6,000 square feet which it has leased to one of its subsidiaries for $90,600 per year under a 10-year lease, with two additional renewal periods of five years each.
With respect to its Cincinnati, Ohio facility, Dialysis Corporation of America purchased the property and completed the construction of an approximately 5,000 square foot dialysis facility at a cost of approximately $740,000. In February, 2003, Dialysis Corporation of America sold the property to a corporation owned by the medical director of that facility which, in turn, leased the facility to Dialysis Corporation of America's Cincinnati subsidiary for an initial term of 10 years from the commencement date of February 6, 2003, with two additional five-year renewal periods. Annual rental fees remain the same for the first four years of the lease, and thereafter increase based upon a percentage increase in the CPI for the Cincinnati, Ohio area. Tenant improvements at the Cincinnati facility aggregated $75,000 and were funded by a loan from DCA to its Cincinnati subsidiary operating this dialysis center, for which the Cincinnati subsidiary issued to Dialysis Corporation of America a five-year promissory note. The loan must be paid prior to that subsidiary paying any other indebtedness, and earlier if the subsidiary has cash flow or other proceeds available for distribution to its members under its operating agreement, subject to tax payment distributions which have a priority. Should the Cincinnati subsidiary sell additional limited liability interests, the proceeds will first be used to repay the loan.
In addition to its Lemoyne, Pennsylvania; Valdosta, Georgia; and Cincinnati, Ohio facilities, Dialysis Corporation of America presently has 19 other dialysis centers, including the facility in Toledo, Ohio in which it has a 40% interest, that lease their respective facilities from unaffiliated third parties. Most of the leases are for five to ten year initial terms, usually with two additional renewal periods of five years each, for space ranging from approximately 3,000 to 7,000 square feet. Dialysis Corporation of America sublets a minimal amount of space at four of its dialysis centers to the physicians who are its
medical directors at those centers, for their medical offices. The subleases are on a commercially reasonable basis and are structured to comply with the safe harbor provisions of the "Anti-Kickback Statute." See Item 1, "Business - Government Regulation - Fraud and Abuse."
In June, 2004, Dialysis Corporation of America moved its executive offices from the approximately 2,300 square foot premises it had been leasing in Hanover, Maryland to approximately 4,600 square feet of space in Linthicum, Maryland pursuant to a five year lease.
Dialysis Corporation of America is constructing or renovating facilities for three new centers in Maryland, Ohio and South Carolina under recently signed leases for those premises, and has acquired, or is in contract to acquire, two additional properties in South Carolina for development of new facilities. Neither of the South Carolina properties being acquired are expected to be subject to a mortgage. Dialysis Corporation of America continues to actively pursue the additional development and acquisition of dialysis facilities in other areas which would entail the acquisition or lease of additional property.
Dialysis Corporation of America constructs most of its dialysis centers, which have state-of-the-art equipment and facilities. Dialysis stations are equipped with modern dialysis machines under a 1996 master lease/purchase agreement. Dialysis Corporation of America now acquires its equipment with advances from us under a demand promissory note for up to $5,000,000 with annual interest on advances at 1.25% over the prime rate. See Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations," Item 13, "Certain Relationships and Related Transactions," and Note 8 to "Notes to Consolidated Financial Statements."
None of the dialysis facilities are operating at full capacity. See "Business - Dialysis Operations - Location, Capacity and Use of Facilities" above. The existing dialysis facilities could accommodate greater patient volume, particularly if Dialysis Corporation of America were to increase hours and/or days of operation without adding additional dialysis stations or any additional capital expenditures. Dialysis Corporation of America also has the ability and space at most of its facilities to expand to increase patient volume subject to obtaining appropriate governmental approval.
We own two adjacent buildings and land near these buildings in Hialeah, Florida which we lease to our former subsidiary, Simclar (formerly Techdyne), under a ten year lease expiring August 31, 2010.
Item 3.
Item 3. Legal Proceedings
None.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders
No matter was submitted during the fourth quarter of our fiscal year to a vote of security holders through the solicitation of proxies or otherwise.
PART II
Item 5.
Item 5. Market for the Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Price Range
Our shares trade on the Nasdaq SmallCap Market under the symbol "MDKI." The table below indicates the high and low bid prices for our common stock as reported by Nasdaq for the four quarters for the years ended December 31, 2003 and 2004.
Bid Price ---------
High Low ---- ---
1st Quarter................ $1.54 $1.15 2nd Quarter................ $1.71 $1.19 3rd Quarter................ $2.39 $1.16 4th Quarter................ $2.70 $1.82
Bid Price ---------
High Low ---- ---
1st Quarter................ $4.05 $2.00 2nd Quarter................ $3.54 $2.65 3rd Quarter................ $3.25 $2.62 4th Quarter................ $10.61 $2.67
At March 24, 2005, the high and low sales prices of Medicore common stock was $11.09and $10.41 per share.
Bid prices represent prices between bidders, and do not include retail mark-ups, mark-downs, or any commission, and may not necessarily represent actual transactions.
Stockholders
As of March 24, 2005, there were approximately 1,014 shareholders of record, as reported by our transfer agent. We have been advised by ADP, which organization holds securities for brokers and depositories, that our common stock is beneficially held by in excess of approximately 2,400 shareholders.
Dividend Policy
Medicore has not paid dividends in the last two years and does not anticipate that it will pay dividends in the foreseeable future. Dividends are paid at the discretion of the board of directors, and depend
on our earnings, capital requirements, financial condition, and other similar relevant factors. The board of directors intends that any earnings be retained for use in our business.
Equity Compensation Plan
The following table provides certain information with respect to securities issuable in connection with our equity compensation plans outstanding that were approved by shareholders and equity compensation plans outstanding that were not approved by shareholders, in each case in effect as of December 31, 2004.
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(1) The options, all of which were granted under our 1989 Stock Option Plan, are five years in duration, expiring in July, 2005 (except for 35,000 options which are exercisable for three years through September, 2006), of which 245,661 options have vested and 14,000 are non-vested. The options contain anti-dilution provisions providing for adjustments of the exercise price under certain circumstances and have termination provisions.
(2) Represents non-qualified options issued as partial consideration in connection with a third party non-exclusive consulting agreement, which options are exercisable through May, 2005. We terminated the consulting agreement in December 2004 and, pursuant to the terms of the option, subsequent to December 31, 2004, the holder thereof exercised the options via a "cashless" exercise at a price per share of $7.14, resulting in an aggregate of 130,000 shares being issued to the holder.
Sale of Securities Not Registered Under the Securities Act
There were no sales of our securities, registered or unregistered, under the Securities Act of 1933, as amended (the "Securities Act"), except under option exercises which were exempt from the registration requirements of Section 5 of the Securities Act under the private placement exemption of Section 4(2) and/or Regulation D of the Securities Act, based on the limited number of optionees who are our officers, directors and key employees, as well as officers and directors of our public subsidiary, Dialysis Corporation of America. See Item 11, "Executive Compensation," Item 12, "Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters," and Note 6 to "Notes to Consolidated Financial Statements." These sales and issuances of shares of our common stock pursuant to option exercises were reported in our quarterly reports on From 10-Q for the periods ended March 31, 2004, June 30, 2004 and September 30, 2004. We did not grant any options during fiscal 2004.
Stock Repurchases
In December, 2002, the board of directors authorized us to buy back up to 1,000,000 shares of our common stock based upon the current market price. We did not make any repurchases of our common stock in fiscal 2002. During the first six months of fiscal 2003, we repurchased an aggregate of 48,500 shares for approximately $70,000. We did not make any repurchases of our common stock during 2004. See Note 13 to "Notes to Consolidated Financial Statements."
Item 6.
Item 6. Selected Financial Data
The following selected financial data for the five years ended December 31, 2004 is derived from the audited consolidated financial statements of the company and its subsidiaries. The consolidated financial statements and related notes for the three years ended December 31, 2004, together with the related Reports of Independent Registered Public Accounting Firms, are included elsewhere in this Annual Report on Form 10-K. The data should be read in conjunction with the consolidated financial statements, related notes and other financial information included herein, and Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations."
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(1) Prior year amounts have been reclassified to conform to current year presentations.
(2) Reflects reclassification as discontinued operations of amounts related to Techdyne, of which subsidiary we sold our 71.3% interest in June, 2001.
(3) Includes Techdyne in 2001 and 2000. See Note (2) above.
Item 7.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
Management's Discussion and Analysis of Financial Condition and Results of Operations, commonly known as MD&A, is our attempt to provide a narrative explanation of our financial statements, and to provide our shareholders and investors with the dynamics of our business as seen through our eyes as management. Generally, MD&A is intended to cover expected effects of known or reasonably expected uncertainties, expected effects of known trends on future operations, and prospective effects of events that have had a material effect on past operating results. Our discussion of MD&A should be read in conjunction with our consolidated financial statements, including the notes, included elsewhere in this Annual Report on Form 10-K. Please also review the Cautionary Notice Regarding Forward-Looking Information on page one of this Annual Report.
Overview
Although we have a medical products division and investment in two affiliated technology companies, our primary operations, revenues and income are derived from our dialysis operations through our 56% owned public subsidiary, Dialysis Corporation of America. That subsidiary provides dialysis services, primarily kidney dialysis treatments through its 23 outpatient dialysis centers, including the management of each of a center in which it holds a 40% minority interest and one unaffiliated dialysis center. In addition, Dialysis Corporation of America provides dialysis treatments to patients at nine hospitals and medical centers through its acute inpatient dialysis services agreements with these entities. Dialysis Corporation of America also provides homecare services, including home peritoneal dialysis and method II services, the latter relating to providing patients with supplies and equipment.
The following table shows the number of in-center, home peritoneal and acute inpatient treatments performed by Dialysis Corporation of America through the dialysis centers it operates, including the two centers it manages, one in which it has a 40% ownership interest, and those hospitals and medical centers with which it has inpatient acute service agreements for the periods presented:
Year Ended December 31, ---------------------------------------------- 2004 2003 2002 ------- ------- ------- In center 127,293 103,025 86,475 Home peritoneal 13,311 7,193 4,504 Acute 8,387 8,010 9,116 ------- ------- ------- 148,991(1) 118,228(1) 100,095(1) ======= ======= =======
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(1) Treatments by the two managed centers included: in-center treatments of 13,196, 11,081 and 6,563 respectively, for 2004, 2003 and 2002; no home peritoneal treatments; and acute treatments of 128, 156 and 87, respectively, for 2004, 2003 and 2002.
Dialysis Corporation of America also provides ancillary services associated with dialysis treatments, including the administration of EPO for the treatment of anemia in its dialysis patients. EPO is currently available from only one manufacturer, and no alternative drug has been available to Dialysis Corporation of America for the treatment of anemia in its dialysis patients. If the available supply of EPO were reduced either by the manufacturer or due to excessive demand, Dialysis Corporation of America's and our revenues
and net income would be adversely affected. The manufacturer of EPO increased its price in early 2003, and could implement further price increases which would adversely affect Dialysis Corporation of America's and our net income. This manufacturer has also developed another anemia drug that could possibly substantially reduce Dialysis Corporation of America's and our revenues and profit margins from the treatment of anemia in dialysis patients.
ESRD patients must either obtain a kidney transplant or obtain regular dialysis treatments for the rest of their lives. Due to a lack of suitable donors and the possibility of transplanted organ rejection, the most prevalent form of treatment for ESRD patients is hemodialysis through a kidney dialysis machine. Hemodialysis patients usually receive three treatments each week with each treatment lasting between three and five hours on an outpatient basis. Although not as common as hemodialysis in an outpatient facility, home peritoneal dialysis is an available treatment option, representing the third most common type of ESRD treatment after outpatient hemodialysis and kidney transplantation.
Approximately 56% of medical service revenues from our dialysis operations are derived from Medicare and Medicaid reimbursement with rates established by CMS, and which rates are subject to legislative changes. Over the last two years, Medicare reimbursement rates have not increased. Congress has approved a 1.6% composite rate increase for 2005. Also for 2005, Medicare is implementing changes in the way it reimburses dialysis providers, which includes revision of pricing for separately billable drugs and biologics, with an add-on component to make the change budget-neutral. Medicare also is to implement a case mix payment system as an adjustment to the composite rate. See Item 1, "Business - Dialysis Operations - Medicare Reimbursement." Dialysis is typically reimbursed at higher rates from private payors, such as a patient's insurance carrier, as well as higher payments received under negotiated contracts with hospitals for acute inpatient dialysis services.
The following table shows the breakdown of medical services revenues by type of payor for the periods presented:
The medical service revenues from our dialysis operations are derived primarily from four sources: outpatient hemodialysis services, home peritoneal dialysis services, inpatient hemodialysis services and ancillary services. The following table shows the breakdown of medical service revenues from our dialysis
operations (in thousands) derived from primary revenue sources and the percentage of total medical service revenue represented by each source for the periods presented:
Essential to profitability of our dialysis operations is Medicare reimbursement, which is at a fixed rate determined by CMS. The level of Dialysis Corporation of America's, and therefore, our revenues and profitability may be adversely affected by any potential legislation resulting in Medicare reimbursement rate cuts. Increased operating costs with respect to dialysis treatment as well as reductions in commercial third-party reimbursement rates could also adversely affect Dialysis Corporation of America's, and therefore, our margins and profitability.
The healthcare industry is subject to extensive regulation of federal and state authorities. There are a variety of fraud and abuse measures to combat waste, which include anti-kickback regulations and extensive prohibitions relating to self-referrals, violations of which are punishable by criminal or civil penalties, including exclusion from Medicare and other governmental programs. Unanticipated changes in healthcare programs or laws would require Dialysis Corporation of America to restructure its business practices which, in turn, could materially adversely affect its operations and financial condition. See Item 1, "Business - Regulation - Dialysis Corporation of America." Dialysis Corporation of America has developed a Corporate Integrity Program to assure that it provides the highest level of patient care and services in a professional and ethical manner consistent with applicable federal and state laws and regulations. See Item 1, "Business - Corporate Integrity Program."
Dialysis Corporation of America's future growth depends primarily on the availability of suitable dialysis centers for development or acquisition in appropriate and acceptable areas, and Dialysis Corporation of America's ability to manage the development costs for these potential dialysis centers while competing with larger companies, some of which are public companies or divisions of public companies with greater numbers of personnel and amounts of financial resources available for acquiring and/or developing dialysis facilities in areas targeted by Dialysis Corporation of America. Additionally, there is intense competition for retaining qualified nephrologists who would serve as medical directors of and be responsible for the supervision of these dialysis centers. There is no assurance as to when any new dialysis center or inpatient service contract with hospitals will be implemented, or the number of stations, or patient treatments such center or service contract may involve, or if such center or service contract will ultimately be profitable. It has been our experience that newly established dialysis centers, although contributing to increased revenues, have adversely affected Dialysis Corporation of America's results of operations in the short term due to start-up costs and expenses and a smaller patient base.
Results of Operations
The following table shows our results of operations (in thousands) for the periods presented:
2004 Compared to 2003
Operating income increased approximately $1,687,000 for the year ended December 31, 2004 compared to the preceding year. For this same period, income before income taxes, minority interest and equity in affiliate earnings increased approximately $1,914,000, and net income increased approximately $241,000.
Consolidated operating revenues, increased by approximately $10,961,000 (36%) for the year ended December 31, 2004 compared to the preceding year. Sales revenues increased by approximately $10,745,000 (35%) for the year ended December 31, 2004 compared to the preceding year. Other operating income increased by approximately $216,000 for the year ended December 31, 2004, compared
to the preceding year. This includes a litigation settlement of $134,000 during 2004 and an increase in management fee income of $82,000 for the year ended December 31, 2004 pursuant to a management services agreement between Dialysis Corporation of America and its 40% owned Toledo, Ohio affiliate and a management services agreement with an unaffiliated dialysis center. See Notes 1 and 18 to "Notes to Consolidated Financial Statements."
In April, 2004, we received payment of approximately $930,000 representing the third installment of an earn-out payment from our sale of Techdyne to Simclar International in 2001. This resulted in our having received approximately $546,000 in excess of the minimum earn-out of $2,500,000 that we had previously recorded. This excess amount has been recorded as a non-operating gain in our consolidated statement of operations. On May 10, 2004, we filed an action against Simclar International in Florida state court, alleging breach of contract by Simclar International, seeking collection of an additional approximately $155,000 which should have been included in the April, 2004 earn-out payment based on Techdyne's consolidated sales for 2003. Simclar International has filed a counterclaim alleging that due to its certification of erroneous sale amounts for 2001, 2002 and 2003 it had overpaid Medicore by approximately $316,000. We believe the counterclaim is without merit. See Note 12 to "Notes to Consolidated Financial Statements."
Other non-operating income increased approximately $86,000 for the year ended December 31, 2004 compared to the preceding year. Interest income from unrelated parties increased $24,000 for the year ended December 31, 2004 compared to the preceding year. Rental income increased approximately $33,000, miscellaneous other income decreased by approximately $11,000, and interest expense decreased approximately $39,000, with the effect of reduced average borrowings more than offsetting an increase in average interest rates for the year ended December 31, 2004, in each case compared to the preceding year. The prime rate was 5.25% at December 31, 2004 and 4.00% at December 31, 2003. See Note 1 and 3 to "Notes to Consolidated Financial Statements."
In conjunction with a sale of third-party securities that we had acquired through foreclosure proceedings on an outstanding debt obligation to us, we recorded gains of approximately $402,000 during 2004 and $784,000 during 2003.
Medical product sales revenues decreased approximately $28,000 for the year ended December 31, 2004 compared to the preceding year. Although our medical products division has expanded its product line with several diabetic disposable products, demand to date for these products continues to be less than anticipated. Management is attempting to be more competitive in lancet sales through overseas purchases and expansion of its customer base.
Medical services revenues, representing the sales revenues of our dialysis division, Dialysis Corporation of America, increased approximately $10,773,000 (36%) for the year ended December 31, 2004 compared to the preceding year, with the increase largely attributable to a 27% increase in total dialysis treatments performed by our dialysis division from 106,991 during 2003 to 135,667 during 2004. This increase reflects: (i) increased revenues from Dialysis Corporation of America's Pennsylvania dialysis centers of approximately $2,500,000, including revenues of $782,000 from its new Pottstown center; and revenues of $750,000 for the two centers operated through its Keystone Kidney Care, Inc. subsidiary, which was acquired by Dialysis Corporation of America effective August 31, 2004; (ii) increased revenues of approximately $1,064,000 from its New Jersey centers; (iii) increased revenues of approximately $1,548,000 from its Georgia centers; (iv) increased revenues of approximately $1,109,000 from its Maryland centers, including revenues of $305,000 from its new Rockville center; (v) increased
revenues of approximately $1,361,000 from its Ohio center; (vi) revenues of approximately $1,089,000 for its two new Virginia centers; and (vii) revenues of approximately $2,101,000 from its new South Carolina center. Some patients of Dialysis Corporation of America carry commercial insurance which may require an out of pocket co-pay by the patient, which is often uncollectible by Dialysis Corporation of America. This co-pay is typically limited, and therefore may lead to an under-recognition of revenue by Dialysis Corporation of America at the time of service. Dialysis Corporation of America routinely recognizes these revenues as it becomes aware that these limits have been met.
Cost of sales as a percentage of consolidated sales amounted to 58% for the year ended 2004 compared to 61% for the preceding year.
Cost of goods sold for the medical products division as a percentage of medical product sales was 63% for year ended December 31, 2004 and for the preceding year. Changes in the cost of goods sold percentage for this division result largely from a change in product mix.
Cost of medical services sales as a percentage of medical services revenues decreased to 58% for the year ended December 31, 2004, compared to 61% for the preceding year, including decreases in payroll costs and supply costs as a percentage of medical services sales.
Approximately 28% of Dialysis Corporation of America's medical services revenues for the year ended December 31, 2004 and for the preceding year were derived from the administration of EPO to its patients. EPO is only available from one manufacturer in the United States. Price increases for this product without Dialysis Corporation of America's ability to increase its charges would increase its costs and thereby adversely impact its earnings. We cannot predict the timing or extent of any future price increases by the manufacturer, or Dialysis Corporation of America's ability to offset any such increases. Beginning this year, Medicare will reimburse dialysis providers for the ten most utilized ESRD drugs at an amount equal to the cost of such drugs as determined by the OIG, with complimentary increases in the composite rate. Dialysis Corporation of America believes this will have little impact on its average Medicare revenue per treatment. See Item 1, "Business - Dialysis Operations - Medicare Reimbursement."
Selling, general and administrative expenses, increased approximately $2,992,000 (27%) for the year ended December 2004, compared to the preceding year. This increase reflects operations of Dialysis Corporation of America's new dialysis centers in Pennsylvania, South Carolina, Virginia and Maryland, the cost of additional support activities from expanded dialysis operations and approximately $1,231,000 of compensation expense attributable to officer, director, employee and legal counsel bonuses recorded in 2004 compared to $760,000 of compensation expense attributable to such bonuses recorded in 2003. As a percentage of sales revenues selling, general and administrative expenses amounted to 34% for the year ended December 31, 2004 compared to 36% for the preceding year. These expenses include expenses of new dialysis centers incurred prior to Medicare approval for which there were no corresponding medical service revenues.
Provision for doubtful accounts increased by approximately $908,000, for the year ended December 31, 2004, compared to the preceding year. Medicare bad debt recoveries of $213,000 were recorded during the year ended December 31, 2004, compared to approximately $326,000 for the preceding year. Without the effect of the Medicare bad debt recoveries, provision for doubtful accounts receivable would have amounted to 3% of sales for the year ended December 31, 2004 compared to 2% for the preceding year. The provision for doubtful accounts reflects our collection experience with the impact of that experience included in accounts receivable presently reserved, plus recovery of accounts previously considered uncollectible from our Medicare cost report filings. The provision for doubtful
accounts of our medical services operation, which is the primary component of this provision, is determined under a variety of criteria, primarily aging of the receivables and payor mix. Accounts receivable are estimated to be uncollectible based upon various criteria including the age of the receivables, historical collection trends and our understanding of the nature and collectibility of the receivables, and are reserved for in the allowance for doubtful accounts until they are written off.
Although Dialysis Corporation of America's operation of additional dialysis centers has resulted in additional revenues, certain of these centers are still in the developmental stage and, accordingly, their operating results will adversely impact Dialysis Corporation of America's and our results of operations until they achieve a patient count sufficient to sustain profitable operations.
Dialysis Corporation of America experienced same-center growth in total treatments of approximately 9% for the year ended December 31, 2004, compared to the preceding year, and same-center revenues grew by approximately 20%. Dialysis Corporation of America continues to search for ways to operate more efficiently and reduce costs through process improvements. In addition, it is reviewing technological improvements and intends to make capital investments to the extent it is confident such investments will improve patient care and operating performance.
Minority interest represents the proportionate equity interests of minority owners of subsidiaries whose financial results are included in our consolidated results. Equity in affiliate earnings represents Dialysis Corporations of America's equity in the earnings incurred by its Ohio affiliate, in which Dialysis Corporation of America has a 40% ownership interest. This dialysis center commenced operations in February, 2001. See Notes 1 and 18 to "Notes to Consolidated Financial Statements."
2003 Compared to 2002
Consolidated operating revenues, increased by approximately $4,564,000 (17%) in 2003 compared to the preceding year. Sales revenues increased by approximately $4,435,000 (17%) compared to the preceding year. Other operating income increased by approximately $129,000 for the year ended December 31, 2003 pursuant to a management services agreement between Dialysis Corporation of America and its 40% owned Toledo, Ohio affiliate and management services agreement with an unaffiliated dialysis center. See Note 1 to "Notes to Consolidated Financial Statements."
Medical service revenues, representing the revenues of our dialysis division, Dialysis Corporation of America, increased approximately $4,514,000 (18%) for 2003 compared to the preceding year, which increase was primarily attributable to a 14% increase in total dialysis treatments performed by DCA from 93,443 in 2002 to 106,991 in 2003. This increase reflects (i) increased revenues of Dialysis Corporation of America's Pennsylvania dialysis centers of approximately $1,998,000; (ii) increased revenues of approximately $674,000 for its Georgia centers; (iii) revenues of approximately $1,255,000 for its new Maryland center; and (iv) revenues of approximately $709,000 for its new Ohio center; partially offset by decreased revenues of approximately $95,000 for its New Jersey centers reflecting termination of two New Jersey acute care contracts and a decrease of $27,000 in consulting and license income.
Medical product sales revenues decreased approximately $79,000 (9%) for 2003 compared to the preceding year which is attributable to decreased sales to a major customer that has indicated it is changing suppliers and has commenced phasing out purchases from us. Although management is attempting to be more competitive in lancet sales through overseas purchases and expansion of its customer base, we cannot assure you that we will be able to replace lost sales or increase other sales. Although our medical products division has expanded its product line with several diabetic disposable products, demand to date for these products has been less than anticipated.
Other non-operating income decreased approximately $128,000 for the year ended December 31, 2003 compared to the preceding year. Interest income from unrelated parties decreased $228,000 for the year ended December 31, 2003 compared to the preceding year large due to our foreclosure and sale of collateral in payment of loans due from Linux Global Partners. See Note 11 to "Notes to Consolidated Financial Statements." Rental income increased approximately $19,000, miscellaneous other income decreased by approximately $40,000, and interest expense decreased approximately $41,000, reflecting reduced average borrowings and lower interest rates on variable rate debt. The prime rate was 4.00% at December 31, 2003 and 4.25% at December 31, 2002. See Notes 1 and 3 to "Notes to Consolidated Financial Statements."
In conjunction with a sale of third-party securities that we acquired through foreclosure proceedings on an outstanding debt obligation to us, we recorded a gain of approximately $784,000 during 2003. See Note 11 to "Notes to Consolidated Financial Statements."
Cost of sales as a percentage of consolidated sales amounted to 61% for 2003 compared to 60% for the preceding year.
Cost of goods sold for the medical products division as a percentage of medical product sales was 63%, for 2003 compared to 56% for the preceding year. Changes in cost of goods sold for this division resulted largely from a change in product mix.
Cost of medical services sales as a percentage of medical services revenues increased to 61% for the year ended December 31, 2003, compared to 60% for the preceding year, which increase is primarily attributable to (i) costs for treatments at new dialysis centers prior to Medicare approval of these centers resulting in no corresponding medical service revenues for such treatments, (ii) increases in the cost of EPO as a percentage of EPO sales revenues, and (iii) increases in the cost of professional liability insurance. The cost of professional liability insurance coverage for our medical services division increased by $43,000 or 62% for the year ended December 31, 2003, compared to the preceding year. While a portion of this increase is attributable to Dialysis Corporation of America's new centers and overall increase in treatments, a substantial portion of the cost increase relates to the general market conditions for professional liability coverage including reduced availability and higher costs for this coverage. Continued cost increases for professional liability coverage at Dialysis Corporation of America could adversely impact both Dialysis Corporation of America's and our earnings.
Approximately 28% of Dialysis Corporation of America's 2003 medical services revenues were derived from the administration of EPO to its patients compared to 26% for the preceding year. EPO is only available from one manufacturer in the United States which raised its price for the product in January, 2003. Continued price increases for this product without Dialysis Corporation of America's ability to increase its charges would increase its costs and thereby adversely impact its earnings. We cannot predict the timing or extent of any future price increases by the manufacturer, or Dialysis Corporation of America's ability to offset any such increases.
Selling, general and administrative expenses, increased $2,579,000 for 2003 compared to the preceding year. This increase reflects operations of Dialysis Corporation of America's new dialysis centers in Maryland and Ohio, the cost of additional support activities from expanded dialysis operations and an aggregate of approximately $598,000 of stock option exercise bonuses to officers, directors and employees and officer bonuses compared to approximately $100,000 in the preceding year.
Provision for doubtful accounts decreased by approximately $416,000, primarily through Medicare bad debt recoveries of approximately $341,000 during 2003. Without the effect of Medicare bad debt recoveries, the provision for doubtful accounts receivable would have amounted to 2% of sales for the year ended December 31, 2003 compared to 3% for the preceding year. This change reflects our collection experience with the impact of that experience included in accounts receivable presently resolved, plus recovery of amounts previously considered uncollectible from our Medicare cost report filing. The provision for doubtful accounts of our medical services operation, which is the primary component of this provision, is determined under a variety of criteria, primarily aging of the receivables and payor mix. Accounts receivable are estimated to be uncollectible based upon various criteria including the age of the receivable, historical collection trends and our understanding of the nature and collectibility of the receivables, and are reserved for in the allowance for doubtful accounts until they are written off.
Although operations of additional dialysis centers have resulted in additional revenues, certain of these centers are still in the developmental stage and, accordingly, their operating results will adversely impact Dialysis Corporation of America's and our results of operations until they achieve a patient count sufficient to sustain profitable operations.
Dialysis Corporation of America experienced same-center growth in total treatments of approximately 7% in 2003, and same-center revenues grew approximately 9% in fiscal 2003. Dialysis Corporation of America continues to search for ways to operate more efficiently and reduce costs through process improvements. In addition, it is reviewing technological improvements and intends to make capital investment to the extent it is confident such improvements will improve patient care and operating performance.
Equity in affiliate earnings represents equity in the earnings incurred by Dialysis Corporations of America's Ohio affiliate, in which Dialysis Corporation of America has a 40% ownership interest. This dialysis center commenced operations in February, 2001.
Liquidity and Capital Resources
Working capital totaled approximately $12,604,000 at December 31, 2004, which reflects a decrease of $828,000 (6%) during the year ended December 31, 2004. The change in working capital included a decrease in cash of $2,284,000 including net cash provided by operating activities of $1,959,000, net cash used in investing activities of $3,322,000 (including additions to property, plant and equipment of $3,182,000, payment of $670,000 by Dialysis Corporation of America to a minority member in two of its subsidiary dialysis centers for the remaining balance due to acquire an aggregate of 30% of such member's interest in each of such subsidiaries, a net cash expenditure of $758,000 by Dialysis Corporation of America for the acquisition of Keystone Kidney Care, an earn-out payment of $930,000 received from the sale of a former subsidiary, receipt of $402,000 from escrowed funds released on the August 2003 sale of Ximian shares, $97,000 of distributions received from Dialysis Corporation of America's 40% owned Ohio affiliate and $125,000 of loans to physician affiliates), and net cash used in financing activities of $921,000 (including payments on long-term debt of $715,000, $436,000 of distributions to the minority members of Dialysis Corporation of America's subsidiaries, $53,000 from a share payment on prior year stock grants, $172,000 of capital contributions from a subsidiary minority member and $5,000 of receipts from the exercise of subsidiary stock options).
In January, 2003, we executed on certain of the collateral securing Linux Global Partners' indebtedness to us, resulting in our acquiring 4,115,815 shares of series A convertible preferred stock of Ximian, Inc. These shares were sold in August, 2003, in connection with a third party's acquisition of Ximian, for which we received $3,541,000 with an additional $805,000 placed in escrow, approximately half ($402,000) of which was released in August, 2004, and the balance of which is to be released in August, 2005, subject to the parties to the Ximian acquisition fulfilling certain conditions. See Note 11 to "Notes to Consolidated Financial Statements."
In May, 2003, we entered into a one-year, non-exclusive consulting agreement with an investment relations firm, which agreement expired by its terms in May, 2004. The agreement provided for a $4,000 monthly fee and issuance of an option for 200,000 shares of our common stock exercisable through May, 2005, at an exercise price of $2.50 per share. The parties to the agreement agreed to continue the consulting arrangement on a month-to-month basis through December 2004. The month-to-month arrangement was terminated effective December 2004, and in March 2005, in accordance with the terms of the option, the investment relations firm exercised the option in full, via a "cashless" exercise, for which it received an aggregate of 130,000 shares. See Notes 5 and 7 to "Notes to Consolidated Financial Statements."
In July, 2003, pursuant to a mediation proceeding following a partial summary judgment, we obtained against Viragen, Inc., our former subsidiary, Viragen agreed to abide by the terms of our royalty agreement and remitted $30,000 to us in August, 2003 and an additional $30,000 plus $3,000 of interest in August, 2004, with a remaining payment of $30,000 plus interest at 5% per annum due in August, 2005. Viragen also agreed to commence remitting royalty payments on a quarterly basis pursuant to the royalty agreement and has remitted quarterly payments of $2,580 in October 2003, $2,905 in January 2004, $3,735 in April 2004, $3,426 in July 2004, $1,521 in November 2004 and $2,543 in January 2005. See Note 2 to "Notes to Consolidated Financial Statements."
In April, 2004, we received a third earn-out payment of $930,248 on the June, 2001 sale of our interest in Techdyne. Including the April, 2004 payment, we have received approximately $3,046,000 of earn-out payments, which exceeded the $2,500,000 minimum earn-out we originally recorded resulting in a non-operating gain of approximately $546,000 which was recorded during the first quarter of 2004. Earn-out payments were specified as 3% of Techdyne's consolidated sales, which were $36,187,105 for 2003, and as a result, we believe that the April, 2004 earn-out payment should have been $1,085,613. We have demanded payment from and initiated legal action in Florida state court against Simclar International, the purchaser of Techdyne, for the $155,365 balance due. Simclar has filed a counterclaim in the amount of $316,464 alleging prior overpayments resulting from Simclar's certification of erroneous sales amounts for 2003, 2002 and 2001. We believe the counterclaim is without merit. See Note 12 to "Notes to Consolidated Financial Statements."
In December, 2002, we announced our intent to purchase up to 1,000,000 shares of our outstanding common stock based on then current market prices. We repurchased and cancelled 48,500 shares of our outstanding common stock at a cost of approximately $70,000 during the first half of 2003. We did not make any repurchases during 2004. See Note 13 to "Notes to Consolidated Financial Statements," and Part II, "Other Information," Item 2, "Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities."
Dialysis Corporation of America, has a mortgage on its real property in Easton, Maryland securing a development loan made by a third party to one of Dialysis Corporation of America's New Jersey dialysis centers. The outstanding balance of the loan was $610,000 at December 31, 2004, and $636,000 at December 31, 2003. In April, 2001, Dialysis Corporation of America obtained a $788,000 five-year mortgage on its building in Valdosta, Georgia which had an outstanding principal balance of $675,000 at
December 31, 2004, and $715,000 at December 31, 2003. Dialysis Corporation of America has an equipment financing agreement with a third party for the purchase of kidney dialysis machines for its facilities. Dialysis Corporation of America had outstanding balances under this agreement of $814,000 at December 31, 2004, and $1,321,000 at December 31, 2003. Dialysis Corporation of America has not engaged in any additional equipment financing under this agreement during 2004. See Note 3 to "Notes to Consolidated Financial Statements."
In March, 2004, we agreed to advance Dialysis Corporation of America up to $1,500,000 for the purpose of equipment financing by Dialysis Corporation of America, which loan arrangement was evidenced by a demand promissory note from Dialysis Corporation of America. Subsequently, the loan arrangement was modified to increase the maximum amount of advances that can be made to $5,000,000 and by adding working capital and other corporate needs to the purposes of the financing. Advances under this loan arrangement, were approximately $1,435,000 for 2004. See Note 8 to "Notes to Consolidated Financial Statements."
Dialysis Corporation of America opened centers in Pottstown, Pennsylvania; Aiken South Carolina; Warsaw, Virginia, Ashland, Virginia; and Rockville, Maryland during 2004, and acquired Keystone Kidney Care, which operates two dialysis facilities in central Pennsylvania, effective as of the close of business on August 31, 2004. Dialysis Corporation of America is in the process of developing a new dialysis center in each of Maryland and Ohio and three new centers in South Carolina. Payment of the balance due of $670,000 on the purchase of minority interests in two of Dialysis Corporation of America's dialysis centers was made during the second quarter of 2004. Payment of $761,000 was made September 1, 2004 on the acquisition of Keystone Kidney Care. See Note 9 to "Notes to Consolidated Financial Statements."
On March 15, 2005, together with Dialysis Corporation of America, we issued a joint press release announcing the agreement to terms for a merger of Medicore into Dialysis Corporation of America. The proposed merger is subject to finalizing an Agreement and Plan of Merger, our receipt of satisfactory tax and fairness opinions, the filing with and declaration of effectiveness of a registration statement containing a proxy statement/prospectus by the SEC, and the approval of our shareholders and the shareholders of Dialysis Corporation of America. This transaction will enable the control interest in Dialysis Corporation of America to be in the hands of the public stockholders and provide Dialysis Corporation of America with additional capital resources to expand. See Item 1, "Business - Recent Developments," and Note 9 to "Notes to Consolidated Financial Statements."
Capital is needed by Dialysis Corporation of America primarily for the development of outpatient dialysis centers. The construction of a 15 station facility, typically the size of Dialysis Corporation of America's dialysis facilities, costs in the range of $750,000 to $1,000,000, depending on location, size and related services to be provided, which includes equipment and initial working capital requirements. Acquisition of an existing dialysis facility is more expensive than construction, although acquisition would provide Dialysis Corporation of America with an immediate ongoing operation, which most likely would be generating income. Although Dialysis Corporation of America's expansion strategy focuses primarily on development and construction of new centers, it has expanded through acquisitions of dialysis facilities and continues to review potential further acquisitions. Development of a dialysis facility to initiate operations takes four to six months and usually up to 12 months or longer to generate income. Dialysis Corporation of America considers some of its centers to be in the developmental stage, since they have not developed a patient base sufficient to generate and sustain earnings.
Dialysis Corporation of America is seeking to expand its outpatient dialysis treatment facilities and inpatient dialysis care and is presently in different phases of negotiations with physicians for additional outpatient centers. Such expansion requires capital. Dialysis Corporation of America has been funding its expansion primarily through internally generated cash flow and financing from us. See Note 9 to "Notes to Consolidated Financial Statements." While we anticipate that financing will be available to Dialysis Corporation of America either from a financial institution or us, including the proposed merger into Dialysis Corporation of America, providing it with cash of approximately $4 to $5 million (see Item 1, "Business - Recent Developments"), no assurance can be given that Dialysis Corporation of America will be successful in implementing its growth strategy or that adequate financing, to the extent needed, will be available to support such expansion.
The bulk of our cash balances are carried in interest-yielding vehicles at various rates and mature at different intervals depending on our anticipated cash requirements.
We anticipate that current levels of working capital and working capital from operations will be adequate to successfully meet liquidity demands for at least the next twelve months.
Aggregate Contractual Obligations
As of December 31, 2004, our contractual obligations (in thousands), including payments due by period, are as follows:
New Accounting Pronouncements
In November, 2004, the Financial Accounting Standards Board, or FASB, issued Statement of Financial Accounting Standards No. 151, "Inventory Costs", an amendment of ARB No. 43, Chapter 4 ("FAS 151"). FAS 151 requires companies to recognize as current-period charges abnormal amounts of idle facility expense, freight, handling costs, and wasted materials (spoilage). FAS 151 is effective for inventory costs incurred during fiscal years beginning after June 15, 2005. The Company does not expect FAS 151 to have a significant effect on its consolidated financial statements. See Note 1 to "Notes to Consolidated Financial Statements."
In December, 2004, the FASB issued Statement of Financial Accounting Standards No. 153, "Exchanges of Non-monetary Assets", an amendment of APB Opinion No. 29 ("FAS 153"). The amendments made by FAS 153 are intended to assure that non-monetary exchanges of assets that are commercially substantive are based on the fair value of the assets exchanged. FAS 153 is effective for non-monetary assets exchanges occurring in fiscal periods beginning after June 15, 2004. The Company does no expect FAS 153 to have a significant effect on its financial statements.
In December 16, 2004, the FASB issued Statement of Financial Accounting Standards No. 123 (revised), "Share-Based Payment" (FAS 123(R)"). FAS 123(R) requires companies to recognize the fair value of stock option grants as compensation costs in their financial statements. Public entities, other than small business issuers, will be required to apply FAS 123(R) in the first interim or annual reporting period that begins after June 15, 2005. The Company will be subjects to the provisions of FAS 123(R) effective July 1, 2005. In addition to stock options granted after the effective date, companies will be required to recognize a compensation cost with respect to any unvested stock options outstanding as of the effective date equal to the grant date fair value of those options (as previously disclosed in the notes to the financial statements) with the cost of vested options later recognized over the vesting period of the options. The Company is in the process of determining the impact that FAS 123(R) will have on its consolidated financial statements.
Critical Accounting Policies and Estimates
The Securities and Exchange Commission has issued cautionary advice to elicit more precise disclosure in this Item 7, MD&A, about accounting policies management believes are most critical in portraying our financial results and in requiring management's most difficult subjective or complex judgments.
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make judgments and estimates. On an on-going basis, we evaluate our estimates, the most significant of which include establishing allowances for doubtful accounts, a valuation allowance for our deferred tax assets and determining the recoverability of our long-lived assets. The basis for our estimates are historical experience and various assumptions that are believed to be reasonable under the circumstances, given the available information at the time of the estimate, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily available from other sources. Actual results may differ from the amounts estimated and recorded in our financial statements.
We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements.
Revenue Recognition: Revenues are recognized as services are rendered. Dialysis Corporation of America receives payments through reimbursement from Medicare and Medicaid for its outpatient dialysis treatments coupled with patients' private payments, individually and through private third-party insurers. A substantial portion of Dialysis Corporation of America's revenues are derived from the Medicare End Stage Renal Disease program, which outpatient reimbursement rates are fixed under a composite rate structure, which includes the dialysis services and certain supplies, drugs and laboratory tests. Certain of these ancillary services are reimbursable outside of the composite rate. Medicaid reimbursement is similar and supplemental to the Medicare program. Dialysis Corporation of America's acute inpatient dialysis operations are paid under contractual arrangements, usually at higher contractually established rates, as are certain of the private pay insurers for outpatient dialysis. Dialysis Corporation of America has developed a sophisticated information and computerized coding system, but due to the complexity of the payor mix and regulations, it sometimes receives more or less than the amount expected at the time the services are provided. Dialysis Corporation of America reconciles any such differences quarterly. Product sales are recognized pursuant to stated shipping terms.
Allowance for Doubtful Accounts: We maintain an allowance for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments and Dialysis Corporation of America's patients or their insurance carriers to make required payments. Based on historical information, we believe that our allowance is adequate. Changes in general economic, business and market conditions could result in an impairment in the ability of our customers and Dialysis Corporation of America's patients and their insurance carriers to make their required payments, which would have an adverse effect on cash flows and our results of operations. Therefore, the allowance for doubtful accounts is reviewed monthly and changes to the allowance are updated based on actual collection experience. We use a combination of percentage of sales and specific account identification and the aging of accounts receivable to establish an allowance for losses on accounts receivable.
Allowance for Inventory Obsolescence: We maintain an allowance for inventory obsolescence for losses resulting from inventory items becoming unsaleable due to loss of specific customers or changes in customers' requirements. Based on historical and projected sales information, we believe our allowance is adequate. However, changes in general economic, business and market conditions could cause our customers' purchasing requirements to change. These changes could affect our inventory saleability. Therefore, the allowance for inventory obsolescence is reviewed regularly and changes to the allowance are updated as new information is received.
Valuation Allowance for Deferred Tax Assets: The carrying value of deferred tax assets assumes that we will be able to generate sufficient future taxable income to realize the deferred tax assets based on estimates and assumptions. If these estimates and assumptions change in the future, we may be required to adjust our valuation allowance against deferred tax assets which could result in additional income tax expense.
Long-Lived Assets: We state our property and equipment at acquisition cost and compute depreciation for book purposes by the straight-line method over estimated useful lives of the assets. In accordance with SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate the carrying amount of the asset may not be recoverable. Recoverability of assets to be held and used is measured by comparison of the carrying amount of an asset to the future cash flows expected to be generated by the asset. If the carrying amount of the asset exceeds its estimated future cash flows, an impairment charge is recognized to the extent the carrying amount of the asset exceeds the fair value of the asset. These computations are complex and subjective.
Goodwill and Intangible Asset Impairment: In assessing the recoverability of our goodwill and other intangibles we must make assumptions regarding estimated future cash flows and other factors to determine the fair value of the respective assets. This impairment test requires the determination of the fair value of the intangible asset. If the fair value of the intangible assets is less than its carrying value, an impairment loss will be recognized in an amount equal to the difference. If these estimates or their related assumptions change in the future, we may be required to record impairment charges for these assets. We adopted Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets," (FAS 142) effective January 1, 2002 and are required to analyze goodwill and indefinite lived intangible assets for impairment on at least an annual basis.
Impact of Inflation
Inflationary factors have not had a significant effect on our operations. We attempt to pass on increased costs and expenses incurred in our medical products division by increasing selling prices when and where possible. In our dialysis division, revenue per dialysis treatment is subject to reimbursement rates established and regulated by the federal government. These rates do not automatically adjust for inflation. Any rate adjustments relate to legislation and executive and Congressional budget demands, and have little to do with the actual cost of doing business. Therefore, dialysis medical service revenues cannot be voluntarily increased to keep pace with increases in supply costs or nursing and other patient care costs. Increased operating costs without a corresponding increase in reimbursement rates may adversely affect Dialysis Corporation of America's and, accordingly, our future earnings.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
We are exposed to market risks from changes in interest rates. We have exposure to both rising and falling interest rates.
Sensitivity of results of operations to interest rate risks on our investments is managed by conservatively investing liquid funds in short-term government securities and interest bearing accounts at financial institutions in which we had approximately $7,186,000 invested as of December 31, 2004. A 15% relative decrease in rates on our period-end investments would have resulted in a negative impact of approximately $13,000 on our results of operations for 2004.
We have interest rate exposure on debt agreements with variable interest rates of which we had approximately $ 1,285,000 of such debt outstanding as of December 31, 2004. A 15% relative increase in interest rates on our period-end variable rate debt would have resulted in a negative impact of approximately $ 4,000 on our results of operations for 2004.
We do not utilize financial instruments for trading or speculative purposes, and do not currently use interest rate derivatives.
Item 8.
Item 8. Financial Statements and Supplementary Data
The response to this item is submitted as a separate section to this report, specifically, Part IV, Item 15, "Exhibits, Financial Statement Schedules and Reports on Form 8-K," subpart (a)1, "All Financial Statements - See Index to Consolidated Financial Statements," and subpart (a)2, "Financial Statement Schedules - See Index to Consolidated Financial Statements."
Item 9.
Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure
None
Item 9A.
Item 9A. Controls and Procedures
(a) Evaluation of Disclosure Controls and Procedures.
As of the end of the period covered by this Annual Report on Form 10-K for the year ended December 31, 2004, we carried out an evaluation, under the supervision and with the participation of our management, including our President and Chief Executive Officer, and the Principal Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Rule 13a-14 of the Securities Exchange Act of 1934 (the "Exchange Act"), which disclosure controls and procedures are designed to provide reasonable assurance that information required to be disclosed by a company in the reports that it files under the Exchange Act is recorded, processed, summarized and reported within required time periods specified by the SEC's rules and forms, and that such information is accumulated and communicated to our management, including our President and Chief Executive Officer, and our Principal Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.
(b) Changes in Internal Control.
There were no changes in our internal controls over financial reporting that occurred during fiscal 2004 or subsequent to the evaluation as described in subparagraph (a) above that materially affected or that are reasonably likely to materially affect our control over financial reporting.
Item 9B.
Item 9B. Other Information
We have reported all information required to be disclosed in our current reports on Form 8-K during the fourth quarter of our 2004 fiscal year.
PART III
Item 10.
Item 10. Directors and Executive Officers of the Registrant
Below are the names, ages, positions held with Medicore, business experience and related information for our directors and executive officers. Our executive officers are appointed each year by the board of directors at its first meeting following the annual meeting of shareholders to serve during the ensuing year. There are no family relationships between any of our executive officers and directors.
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(1) Member of the Audit Committee of the Board of Directors.
(2) Member of the Compensation Committee of the Board of Directors.
(3) Member of the Nominating Committee of the Board of Directors.
Thomas K. Langbein has been affiliated with Medicore since 1980. He has been Chairman of the Board of our 56%-owned public subsidiary, Dialysis Corporation of America, since 1980, and served as its Chief Executive Officer through May, 2003. He is also an officer and director of most of Dialysis Corporation of America's subsidiaries. He is President, sole shareholder and director of Todd & Company, Inc., a securities brokerage firm, currently not active, registered with the SEC and a member of the NASD. Mr. Langbein in 2000 was appointed as a director of Linux Global Partners, Inc., a private company that invests in developing Linux software companies in which Medicore invested and also loaned money at various times between 2000 and 2002, which amounts have been satisfied. Mr. Langbein resigned as a Linux Global Partner director in November, 2002. Mr. Langbein devotes most of his time and efforts to the affairs of Medicore and DCA, and maintains contact with Linux Global Partners and Xandros, Inc. for the purpose of monitoring their development and overseeing Medicore's remaining investment in those entities.
Daniel R. Ouzts is a certified public accountant. He joined Medicore in 1980 as Controller of its plasma division. In 1983 he became Controller of Medicore and Dialysis Corporation of America, and in 1986 became Vice-President of Finance and Treasurer of Medicore. In June, 1996, Mr. Ouzts was appointed Vice President and Treasurer of Dialysis Corporation of America, where he served in the capacity of principal financial officer through January 2002 and from July 2003 through August 16, 2004, when he ceased serving as principal financial officer. Mr. Ouzts continues to serve as Vice President and Treasurer of Dialysis Corporation of America.. See Item 13, "Certain Relationships and Related Transactions."
Charles B. Waddell was previously employed as Secretary and served as a director of our former subsidiary, Techdyne (Europe) from 1988 to 1997, responsible for preparing budgets and government financial and management reports. Mr. Waddell is qualified in the United Kingdom as a certified and corporate accountant, and as a member of the British Institute of Management.
Seymour Friend has been a director of Medicore since 1975. Mr. Friend is a real estate investor and devotes a portion of his time to the affairs of Medicore.
Peter D. Fischbein has been a director of Medicore since 1984. He also serves as a director of Dialysis Corporation of America. He was a director of Viragen, Inc., a former public subsidiary of Medicore, until his resignation in 2002. Mr. Fischbein is a practicing attorney.
Robert P. Magrann has been a director of our company since 1997. Mr. Magrann was affiliated with Tetley USA, Inc., with whom he held the position of Senior Vice President, Sales for its North American Food Group until July, 1999. He then became Vice President of Worldwide Sales for Kenosia Corporation, which creates software applications for manufacturers and retailers. In July, 2000, he became President and CEO of a premiere start-up website consumer value company, Couponbasket.com, which closed in November, 2000, and effected an arrangement for the benefit of creditors. Mr. Magrann served as Senior Vice President of Sales at DelMonte Foods, Inc., from April, 2001 through November, 2002, and has served as Executive Vice President from December, 2002 through the present date.
Anthony C. D'Amore has been a director of Medicore since 1979. Mr. D'Amore is an insurance broker and has been in the insurance business since the early 1960's.
Lawrence E. Jaffe has been a director of Medicore since 2000 and is an attorney and member of the law firm of Jaffe & Falk, LLC, which serves as corporate counsel to Medicore and Dialysis Corporation of America. Mr. Jaffe is corporate Secretary to each of our company and Dialysis Corporation of America, and he receives a substantial portion of his professional fees from these companies. See Item 13, "Certain Relationships and Related Transactions."
Stephen W. Everett has been involved in the healthcare industry for over 25 years, primarily responsible for oversight, deal structuring, physician recruitment and practice management in the renal healthcare field. He joined Dialysis Corporation of America in November, 1998 as Vice President, became Executive Vice President in June, 1999, President in March, 2000, and Chief Executive Officer in May, 2003.
There are no family relationships among any of our officers or directors.
Corporate Governance
Our board of directors oversees the business and affairs of Medicore and monitors the performance of management. In accordance with corporate governance principles, the board does not involve itself in day-to-day operations. The board is kept apprised through discussions with the Chairman, other directors, executives, the Audit, Nominating and Compensation Committees, division heads, advisors, including counsel, outside auditors, investment bankers and other consultants, by reading reports, contracts and other materials sent to them and by participating in board and committee meetings.
Our board and management have a commitment to sound and effective corporate governance practices. In 2002, our subsidiary, Dialysis Corporation of America adopted a Compliance Program to prevent and detect violations commonly known in the healthcare industry as "fraud and abuse" laws.
Medicore and Dialysis Corporation of America have each developed a Corporate Integrity Program to assure that each entity continues to achieve the goals of providing the highest level of care and service in a professional and ethical manner consistent with applicable federal and state laws and regulations. These programs are intended to reinforce Dialysis Corporation of America's as well as our management's, employees' and professional affiliates' awareness of their responsibilities to comply with applicable laws in the increased and complex regulatory environment relating to our operations.
As part of our Corporate Integrity Program, we have developed a Code of Ethics and Business Conduct covering management and all employees to assure all persons affiliated with us and our operations act in an ethical and lawful manner. The Code of Ethics and Business Conduct covers relationships among and between affiliated persons, including Dialysis Corporation of America patients and payors, and relates to information processing, compliance, workplace conduct, environmental practices, training, education, development, among other areas. Dialysis Corporation of America has also developed its Code of Ethics and Business Conduct and, in its commitment to delivering quality care to dialysis patients, has mandated rigorous standards of ethics and integrity. Our Code of Ethics, as well as that of Dialysis Corporation of America, is reviewed and updated as necessary. We will provide to any person, without charge, upon request, a copy of our Code of Ethics upon submission of a request for the same to our corporate Secretary, Lawrence E. Jaffe, Esq., at Jaffe & Falk, LLC, 777 Terrace Avenue, Hasbrouck Heights, New Jersey 07604, telephone number (201) 288-8282, or email, lej@jaffefalkllc.com.
Board Committees
Our board of directors which is comprised of a majority of independent directors, has an Audit Committee, and Nominating and Compensation Committees, each of which consist solely of independent directors. Our board has two employee members.
Audit Committee
In accordance with Nasdaq Stock Market Rule 4350(d), our Audit Committee is comprised of at least three members, all of whom (i) are independent as defined in Rule 4200(a)(15), (ii) meet the criteria of independence set forth in Rule 10A-3(b)(1) under the Exchange Act, (iii) have not participated in the preparation of our financial statements at any time during the past three years, and (iv) are able to read and understand fundamental financial statements, including our balance sheet, income statement and cash flow statement. Charles B. Waddell, Chairman of our Audit Committee, has past employment experience in finance and accounting, forming the background which results in his financial sophistication and his designation as the "financial expert" of the Audit Committee pursuant to Item 401(h) of Regulation S-K promulgated under the Exchange Act. For Mr. Waddell's credentials, reference is made to "Information About Directors and Executive Officers." The designation of Mr. Waddell as the Audit Committee financial expert does not impose on him any duty, obligation or liability that is greater than any duty, obligation or liability imposed on any member of the Audit Committee and board of directors. The other members of our Audit Committee are Peter D. Fischbein and Robert P. Magrann. Mr. Fischbein is an independent member of the board of Dialysis Corporation of America and its Audit, Nominating and Compensation Committees.
The Audit Committee, a very essential oversight committee, pursuant to its charter provides assistance to the board in fulfilling its responsibilities to our shareholders and the investment community relating to accounting, reporting practices, the quality and integrity of our financial reports, and surveillance of internal controls and accounting and auditing services. The Audit Committee charter specifies:
o the scope of the Audit Committee's responsibilities
o how the Audit Committee carries out those responsibilities
o the structure, processes and membership requirements
The Audit Committee does not prepare financial statements or perform audits, and its members are not auditors or certifiers of our financial statements. A more complete description of the Audit Committee's responsibilities is provided in its charter, a copy of which is attached as Appendix A to our definitive proxy statement for our 2004 annual meeting of shareholders which was filed with the SEC on Schedule 14A on April 29, 2004.
Shareholder Nominee Procedures
There have been no material changes to the procedures by which security holders may recommend nominees to our board of directors as described in our definitive proxy statement for our 2004 annual shareholders' meeting filed with the SEC on Schedule 14A on April 29, 2004, under the caption "Information about Directors and Executive Officers - Other Nominees."
Section 16(a) Beneficial Ownership Reporting Compliance
Section 16(a) of the Exchange Act requires our directors, executive officers and 10% shareholders to file reports with the SEC, the Nasdaq Stock Market and our company, indicating their beneficial ownership of common stock of the company and any changes in their beneficial ownership. The rules of the SEC require that we disclose failed or late filings of reports of company stock ownership by our directors and
executive officers. To the best of our knowledge, and based solely on our review of such forms filed with us, all beneficial ownership reports by these reporting persons for the year 2004 were filed on a timely basis, except that Mr. Langbein filed two late reports on Form 4, relating to gift transfers of common shares of Medicore to family members in January and November 2004.
Item 11.
Item 11. Executive Compensation
The Summary Compensation Table below sets forth compensation paid by us and our dialysis operations subsidiary for each of the last three fiscal years ended December 31, 2004 for services in all capacities to each of our respective Chief Executive Officer and each of Medicore's executive officers whose total annual salary, bonus or other compensation exceeded $100,000.
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(1) Mr. Langbein is the President and Chief Executive Officer of Medicore and served as the Chief Executive Officer of Dialysis Corporation of America until May, 2003, at which time Mr. Everett was appointed Chief Executive Officer. Mr. Langbein continues to serve as the Chairman of the Board of Dialysis Corporation of America.
(2) Includes (i) a $69,000 cash bonus paid February, 2004, (ii) a $150,000 bonus accrued in 2004 and paid February 2005 and (iii) a $215,000 stock option exercise bonus.
(3) Includes automobile allowance and related expenses, life and disability insurance premiums.
(4) Vests in equal annual increments of 12,500 shares every June 7 from 2005 through 2008.
(5) Includes (i) a cash bonus of $100,000 accrued in fiscal 2003 and paid in 2004, and (ii) a bonus relating to the exercise of stock options for officers, directors and employees which included the payment of the exercise price of $1.38 for 100,000 shares exercised under Mr. Langbein's options (valued at $138,000) and a related cash distribution to Mr. Langbein of $41,400.
(6) Bonus accrued in 2002 and paid in January, 2003; does not include $46,429 accrued in 2002 by Dialysis Corporation of America and paid in March, 2003 for a partial exercise of Mr. Langbein's Dialysis options.
(7) Includes (i) a $10,350 cash bonus paid February, 2004, (ii) a $15,000 bonus accrued in 2004 and paid February, 2005, and (iii) a $32,250 stock option exercise bonus.
(8) Life insurance premium.
(9) Includes (i) a cash bonus of $2,500 accrued in fiscal 2003 and paid in 2004, and (ii) a bonus relating to the exercise of stock options for officers, directors and employees which included the payment of the exercise price of $1.38 for 15,000 shares exercised under Mr. Ouzts' options (valued at $20,700) and a related cash distribution to Mr. Ouzts of $6,210.
(10) Bonus accrued in 2002 and paid in January, 2003.
(11) Dialysis Corporation of America effected a 2-for-1 stock split of its common shares on January 28, 2004. All share amounts and per share exercise prices with respect to Dialysis Corporation of America common stock set forth in this table have been adjusted to give effect to such stock split.
(12) Chief Executive Officer (since May, 2003), President and director of Dialysis Corporation of America. All compensation to Mr. Everett set forth in this table, including option grants under Long Term Compensation Award were paid or granted solely by Dialysis Corporation of America.
(13) Accrued in 2004 and paid in 2005 by Dialysis Corporation of America.
(14) Includes automobile related expenses of $5,329 and $1,957, respectively, for 2004 and 2005, and life insurance premiums of $2,454, $2,338 and $2,000, respectively, in 2004, 2003 and 2002, all of which were paid by Dialysis Corporation of America.
(15) Includes (i) a cash bonus of $50,000 accrued in fiscal 2003 and paid in 2004, and (ii) a bonus accrued in fiscal 2003 and paid in February 2004 relating to the exercise of director stock options which included the payment of the $.625 exercise price for 69,242 shares exercised under Mr. Everett's options (valued at $43,276) and a related cash distribution to Mr. Everett of $23,802, all of which was paid by Dialysis Corporation of America.
(16) Includes (i) $35,714 accrued in 2002 and paid in March, 2003 for the partial exercise of options; and (ii) a bonus of $50,000 accrued in 2002 and paid in January, 2003; all paid by Dialysis Corporation of America.
Option Grants in Fiscal Year Ended December 31, 2004
Medicore did not grant options to any of the named executives set forth in the Summary Compensation Table above during fiscal 2004.
Our dialysis subsidiary granted options to certain of our named executives as well as to its President and Chief Executive Officer during fiscal 2004 as follows:
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(1) Vest in equal annual increments of 12,500 shares each June 7, from 2005 to 2008.
Aggregated Option/SAR Exercises In Last Fiscal Year and FY-End Option/SAR Values
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(1) Vests in four equal annual installments of 12,500 shares each June 7 from 2005 through 2008.
(2) Mr. Everett has been the Chief Executive Officer of DCA since May, 2003. He is also the President and a director of DCA.
(3) Includes options for 66,000 shares exercisable at $.625 per share through January 1, 2006, which options vested on January 1, 2005. An aggregate of 150,000 of these options were exercised subsequent to December 31, 2004.
Compensation of Directors
There are no standard arrangements for compensating directors for services as directors or for participating on any committee. We reimburse directors for travel and related out-of-pocket expenses incurred in attending shareholder, board and committee meetings, which expenses have been minimal. In lieu of any cash compensation or per meeting fees to directors for acting as such, we have provided directors, among others, with options to purchase common stock of the company at exercise prices no less than the fair market value as of the date of grant. In January, 2004, bonuses were granted to the board members, including $266,801 bonused for exercise of a portion of their options, amounting to 193,335 shares at an exercise price of $1.38, and a cash award aggregating $133,400. See Item 12, "Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters."
In February, 2005, the company provided director fees of $15,000 to each director, except to Thomas K. Langbein, who received a $150,000 bonus from the company for his services as Chairman of the Board, Chief Executive Officer and President. See the Summary Compensation Table above.
Employment Contracts and Termination of Employment and Change-In-Control Arrangements
Mr. Langbein has an employment agreement with Medicore that will run through February 28, 2009 at an annual salary, presently of $353,500, with yearly increases in increments of not less than $12,000. The agreement provides for Mr. Langbein to serve as the Chairman, Chief Executive Officer and President.
The employment agreement also provides for
o monthly automobile allowance
o benefit plans and other fringe benefits available to Medicore employees and executives
o reimbursement for business expenses
o payment of universal and term life insurance owned by Mr. Langbein
o indemnification for acting as an officer and/or director of Medicore and subsidiaries
o non-competition for one year from termination within 10 miles of our then existing dialysis and medical products facilities
o full compensation for the first 180 days of disability, with Medicore then having the option to continue Mr. Langbein's employment with full compensation less disability payments
The employment agreement also contains different termination provisions as follows:
o upon death, termination due to disability, or Mr. Langbein's termination for cause or voluntarily by Mr. Langbein without good reason (defined below), Medicore will pay to Mr. Langbein a lump sum payment equal to three years of Mr. Langbein's salary, including expenses and benefits, determined as of the date of termination (for purposes of this discussion, the "lump sum payment")
o Mr. Langbein has the option, subject to shareholder approval, to take 400,000 shares of Medicore common stock instead of the lump sum payment; which shares would carry a two year right to demand registration of the shares, and a three year right to include the shares in any registration statement filed by Medicore during that time, such registration in either case being at Medicore's cost
o for good reason by Mr. Langbein or upon the wrongful termination of Mr. Langbein by Medicore, Medicore shall continue to pay Mr. Langbein's salary, benefits and expenses, and provide Mr. Langbein with the lump sum payment, with the option to Mr. Langbein to acquire the Medicore shares in lieu of the lump sum payment
o at expiration, if either of Medicore or Mr. Langbein does not renew or enter into new employment with the other party, Medicore shall pay Mr. Langbein a severance allowance which is the lump sum payment or Mr. Langbein's option to take Medicore shares
o upon Mr. Langbein's termination, other than for cause or Mr. Langbein's termination of his employment without good reason, there shall be full vesting of any warrants, options or similar rights held by Mr. Langbein; Mr. Langbein has the choice to keep those options, otherwise Medicore is required to repurchase them at a certain repurchase formula.
o in the agreement, "cause" is defined as the willful failure to perform duties under the employment agreement, and illegal or gross misconduct which damages the business or reputation of our company; and "good reason" is defined as assigning Mr. Langbein duties inconsistent with his position or any action that results in reducing Mr. Langbein's authority, duty or responsibilities; reduction of salary, expenses or benefits; or other substantial breach of the agreement
The employment agreement also provides for "change in control" provisions, including (a) the announcement of and/or acquisition by, any person not affiliated with Mr. Langbein, of 25% or more of Medicore's outstanding common stock, (b) a sale by Medicore of substantially all of its assets, or a merger or acquisition of Medicore, or (c) certain changes in the board other than through shareholder elections of members nominated by the existing board. Upon such a "change in control," Medicore or a successor entity shall pay Mr. Langbein the lump sum payment with the option for shares in lieu thereof, and the employment agreement shall remain in full force and effect and Mr. Langbein shall receive the compensation due under the agreement.
Stephen W. Everett, President and director of Dialysis Corporation of America, has a five-year employment contract with Dialysis Corporation of America through December 31, 2005. Effective for fiscal 2005, Mr. Everett's annual compensation was increased from $180,000 to $250,000. Mr. Everett's employment agreement also provides:
o employee and fringe benefits to the extent available by Dialysis Corporation of America to other similarly situated executive employees
o reimbursement for reasonable out-of-pocket expenses incurred in connection with his duties
o vacations normally taken by senior management
o termination
- death; three months' severance pay
- for cause; salary and expenses to date of termination ("cause" includes conviction for fraud or criminal conduct, habitual drunkenness or drug addition, embezzlement, regulatory agency sanctions against Mr. Everett or the company due to his wrongful acts, material breach of the agreement, dishonesty, or resignation, except if due to breach by Dialysis Corporation of America)
- by Dialysis Corporation of America after 13 weeks of disability; three months' severance pay
- by Mr. Everett upon breach by Dialysis Corporation of America; severance pay equal to the greater of six months of his then compensation or his remaining compensation under the agreement
o confidentiality restrictions two years from termination
o non-competition for one year from termination within the United States; provided, non-competition eliminated if Dialysis Corporation of America terminates Mr. Everett without cause or due to Dialysis Corporation of America's material breach of the agreement
o Mr. Everett to assign any patents, property rights, discovery or idea to Dialysis Corporation of America
Certain executive and accounting personnel and administrative facilities of Medicore and Dialysis Corporation of America, were common for fiscal 2004. The costs of executive and accounting salaries and other shared corporate overhead are charged based on the time spent. Mr. Langbein, as an officer and director of Medicore and Chairman of the Board of Dialysis Corporation of America, and Mr. Daniel Ouzts, as an officer of Medicore and Dialysis Corporation of America, divide their time and efforts among each company. See Item 13, "Certain Relationships and Related Transactions." These executive and accounting salaries and other shared corporate overhead will be eliminated upon the successful completion of the merger of Medicore with Dialysis Corporation of America. See Item 1, "Business - Recent Developments."
Options, Warrants or Rights
1989 Medicore Stock Option Plan
o expires May 18, 2009
o option grants are available to employees, officers, directors, consultants, advisors and similar persons
o options are non-qualified, having a five year term, and an exercise price equal to or greater than fair market value on date of grant
o options that have vested may be exercised with cash or Medicore common stock or both; if exercised with stock, optionee receives additional option for amount of shares used for exercise at an exercise price equal to the then current market price and exercisable for the term of the remainder of original option
o termination of optionee's affiliation with the company
- death, disability or retirement after age 65; exercisable for up to two years from such event but not beyond expiration date of option
- any other termination; right to exercise terminates immediately
o forced redemption at formulated prices upon change in control of Medicore which includes (i) sale of substantially all assets of Medicore or its merger or consolidation, (ii) majority of board changes other than by election of shareholders pursuant to board solicitation or vacancies filled by board caused by death or resignation, or (iii) any person acquires or makes a tender offer for at least 25% of Medicore's common stock; optionee may waive redemption
o options are non-transferable
o 1989 Medicore Plan history as of March 25, 2005:
- 1,000,000 shares reserved for issuance
- 865,000 granted at exercise prices ranging from $1.38 to $2.38 per share
- 3,000 exercised at $2.38 per share in March 2000
- 344,000 exercised at $1.38 per share in September
- 234,671 exercised at $1.38 per share in January 2004
- 7,000 exercised at $2.25 per share in July 2004
- 7,000 exercised at $2.25 per share in February 2005
- 231,995 outstanding and vested, 14,000 outstanding and unvested (held by a total of 14 persons including eight officers and directors of Medicore), and 151,000 available for future grant under the plan
2000 Medicore Stock Option Plan
o adopted February 17, 2000
o authorized the issuance of up to 500,000 options (incentive and non-qualified)
o 2000 Medicore Plan history:
- 475,000 granted on February 17, 2000
* 150,000 non-qualified options * 325,000 incentive options
- exercisable at $3.25 per share
- all options expired unexercised on February 16, 2003
o plan expired February 16, 2005
1999 Dialysis Corporation of America Stock Option Plan
o expires April 20, 2009
o terms substantially similar to Medicore's 2000 Stock Option Plan (see above)
o 1999 Plan history to March 25, 2005 (adjusted for the 2-for-1 stock split effected by Dialysis Corporation of America on January 28, 2004)
authorized: 3,000,000 issued: 2,241,000
vested: 232,116 non-vested: 282,500 exercised: 1,742,730 cancelled: 193,654 available: 742,654 exercise prices: range from $.625 to $3.085 exercise periods: range from 1/1/06 to 8/15/09
In September 2003 and in January 2004 Medicore awarded bonuses to its officers, directors and employees in the form of (a) the payment of the exercise price on certain of their outstanding and vested options granted under the 1989 Plan, and (b) a cash distribution equal to approximately one-third of the value of the option exercise. In accordance with the option exercise portion of the bonus, our directors, including our Chief Executive Officer and President, as well as our Vice President of Finance, exercised options for an aggregate of 406,666 shares. See Item 11, "Executive Compensation" above.
In September, 2003, we also granted non-qualified stock options for 21,000 shares of our common stock to each of Messrs. Charles B. Waddell and Robert P. Magrann, each of whom is an independent member of our board of directors. The options vest annually in three equal increments commencing September 25, 2003, and have an exercise price of $2.25 per share.
All options awarded have an exercise price equal to not less than 100% of the closing market price of our common stock on the date of grant.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The following table sets forth as of March 25, 2005 the names and beneficial ownership of the equity securities of Medicore and its subsidiary, Dialysis Corporation of America, for (i) our directors and each of our named executive officers set forth in the Summary Compensation Table above in the section entitled "Executive Compensation," individually itemized, (ii) our directors and executive officers as a group, and (iii) shareholders known to us to beneficially own more than 5% of our voting securities. All share and per-share data, including option information in the following table, has been adjusted to reflect a two-for-one stock split effected by Dialysis Corporation of America on January 28, 2004.
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# All addresses are c/o Medicore, Inc., 777 Terrace Avenue, Hasbrouck Heights, New Jersey 07604.
* less than 1%.
(1) Based on 7,132,434 shares outstanding exclusive of (i) 231,995 shares underlying outstanding options under our 1989 Stock Option Plan (14,000 non-vested options not included); (ii) 400,000 shares of common stock available for issuance under certain conditions of Thomas K. Langbein's employment agreement; and (iii) 98,000 shares of common stock reserved for issuance under a key employee stock plan.
(2) Medicore owns 4,821,244 shares (56%) of the common stock of Dialysis Corporation of America. Officers and directors of Medicore, including those officers and directors who may be officers and/or directors and shareholders of each of Medicore and Dialysis Corporation of America, disclaim any indirect beneficial ownership of Dialysis Corporation of America common stock through Medicore's 56% ownership of Dialysis Corporation of America. Thomas K. Langbein, by virtue of his positions with our company and Dialysis Corporation of America and his stock ownership of our company, may be deemed to have indirect beneficial ownership of such Dialysis
shares through shared voting and investment power with respect to our company's ownership of Dialysis Corporation of America. Mr. Langbein disclaims such entire indirect beneficial ownership, but for his proportionate indirect interest, approximately 848,539 Dialysis shares or approximately 8.9%.
(3) Based on 8,661,815 Dialysis Corporation of America shares outstanding but exclusive of common stock issuable under (i) 232,116 options currently exercisable at prices ranging from $.625 to $4.02 per share; and (ii) 282,500 non-vested options outstanding, which options will vest over the period ranging from June 4, 2005 through August 16, 2008 at exercise prices ranging from $.75 to $4.02 per share.
(4) Includes an option for 100,000 shares of our common stock exercisable at $1.38 per share until July 26, 2005. Does not include up to 400,000 shares of our common stock reserved under Mr. Langbein's employment agreement and which is issuable under certain circumstances such as a change in control of Medicore, termination of his employment, and his retirement.
(5) Does not include a five year incentive option for 50,000 Dialysis shares exercisable at $4.02 per share which vests in equal annual increments of 12,500 shares on each June 7 from 2005 through 2008.
(6) Ms. Kaufman is the wife of Peter D. Fischbein, a director of Medicore and Dialysis Corporation of America. Ms. Kaufman's beneficial ownership of Medicore securities includes all of her husband's interest in Medicore other than 7,350 shares held in trust for their independent daughter, for which Mr. Fischbein is sole trustee and to which Ms. Kaufman has no interest or control. Ms. Kaufman's beneficial ownership also includes (i) 196,382 of our shares held directly in her name, of which Mr. Fischbein has no control and no beneficial interest; and (ii) 100,000 shares held in trust for their minor son. Ms. Kaufman, as trustee for the trust, has sole voting and dispositive power over such shares, and she is economically independent and maintains separate checking and investment accounts for the trust. Mr. Fischbein has no control over nor any interest in the shares held by the trust.
(7) Represents Dialysis securities beneficially owned by Mr. Fischbein over which Ms. Kaufman has shared beneficial ownership. See footnote (11) below.
(8) Includes an option for 16,666 shares of our common stock exercisable at $1.38 per share until July 26, 2005.
(9) Includes an option for 33,333 shares of our common stock exercisable at $1.38 per share until July 26, 2005.
(10) Includes (i) an option for 16,666 shares of our common stock exercisable at $1.38 per share until July 26, 2005; and (ii) 7,350 shares held in trust for Mr. Fischbein's majority age and independent daughter, for which Mr. Fischbein serves as sole trustee. Does not include (i) 196,382 shares beneficially owned by Ms. Kaufman, Mr. Fischbein's wife (see Footnote 6 above), who is economically independent of Mr. Fischbein and who maintains separate banking and brokerage accounts; and (ii) 100,000 shares held in trust for their minor son by Ms. Kaufman as trustee, over which trust Mr. Fischbein has no control nor any interest.
(11) Includes a non-qualified option for 5,000 Dialysis shares exercisable at $4.02 per share through June 6, 2009.
(12) Includes an option for 15,000 shares of our common stock exercisable at $1.38 per share until July 26, 2005.
(13) Includes the vested portion of an option for 14,000 shares of our common stock exercisable at $2.25 per share until September 24, 2006. Does not include the unvested portion of that option for 7,000 shares which is scheduled to vest on September 25, 2005.
(14) Does not include the unvested portion of an option for 7,000 shares exercisable at $2.25 per share until September 25, 2006, which is scheduled to vest on September 25, 2005.
(15) President and Chief Executive Officer of Dialysis Corporation of America. Mr. Everett is not an executive officer or director of Medicore. Mr. Everett is included as a named executive in the Summary Compensation table above in Section 11 entitled "Executive Compensation" on account of the relationship between Medicore and Dialysis Corporation of America, and consequently his beneficial ownership of Medicore is included herein. His ownership, however, is not included in the officers and directors of Medicore as a group.
(16) Includes an option for 8,333 shares of our common stock exercisable at $1.38 per share until July 26,2 005.
(17) Includes an incentive option for 123,616 shares exercisable at $.625 per share until January 1, 2006. Does not include an incentive option for 50,000 shares exercisable at $4.02 per share until June 6, 2009, which option vests in equal annual increments of 12,500 Dialysis shares on each June 7 from 2005 through 2008.
(18) Includes an aggregate of 212,331 shares of our common stock underlying currently exercisable options as set forth in the above footnotes. Does not include an aggregate of 14,000 shares of common stock underlying non-vested options that are currently outstanding as set forth in the above footnotes.
(19) Includes an aggregate of 5,000 Dialysis shares underlying currently exercisable options. Does not include (i) an aggregate of 50,000 Dialysis shares underlying non-vested options currently outstanding, and (ii) Dialysis shares owned by Medicore.
Item 13.
Item 13. Certain Relationships and Related Transactions
We own approximately 56% of the outstanding common shares of Dialysis Corporation of America, our public subsidiary which is engaged in operating outpatient dialysis centers providing dialysis and ancillary services to patients suffering from chronic kidney failure, providing acute inpatient dialysis treatments in hospitals, and providing homecare services.
Certain of our officers and directors are officers and/or directors of Dialysis Corporation of America, including Thomas K. Langbein, who holds the position of Chairman of the Board of Directors of our company and Dialysis Corporation of America, and also serves as an officer and/or director of the Dialysis Corporation of America subsidiaries. Daniel R. Ouzts is our Vice President of Finance and
Treasurer and our principal financial officer and is Vice President of Finance and Treasurer of Dialysis Corporation of America. Peter D. Fischbein is a director of each of our company and Dialysis Corporation of America. See item 10, "Directors and Executive Officers of the Registrant." Lawrence E. Jaffe is a director, Secretary and corporate counsel to Medicore, and is Secretary and corporate counsel to Dialysis Corporation of America. Mr. Jaffe, together with his son, Joshua M. Jaffe, devote a substantial portion of their professional services to us and Dialysis Corporation of America from which companies their law firm, Jaffe & Falk, LLC, receives approximately 60% of their professional fees, which for fiscal 2004 aggregated approximately $413,000, of which $177,000 was from Medicore. Mr. Langbein beneficially owns approximately 18.8% of Medicore, including an option for 100,000 shares, and approximately 5.2% of Dialysis Corporation of America. Mr. Ouzts has an approximate 2% beneficial interest in our company and less than 1% interest in Dialysis Corporation of America. Mr. Fischbein holds an approximate 2.5% beneficial interest in our company, including an option for 16,666 shares, and less than 1% interest in Dialysis Corporation of America. Mr. Lawrence Jaffe holds an approximate 3.1% beneficial interest in our company and 3.2% interest in Dialysis Corporation of America. See Item 12, "Security Ownership of Certain Beneficial Owners and Management."
We and Dialysis Corporation of America obtain and pay for group health insurance coverage and personal life insurance policies for several executive and key employees through George Langbein, brother of Thomas K. Langbein and until March, 2001, an employee of our medical products division. This insurance includes $100,000 of life insurance covering certain employees including Mr. Ouzts. We also pay for $1,600,000 of life insurance owned by Thomas K. Langbein. See Item 11, "Executive Compensation." Premiums on all life and group health insurance for our employees for fiscal 2004 totaled approximately $157,000. We are of the opinion that the cost and coverage of the insurance are as favorable as can be obtained from unaffiliated parties.
Certain of our executive and accounting personnel and administrative facilities and of Dialysis Corporation of America, are common. The costs of executive and accounting salaries and other shared corporate overhead for our companies are charged on the basis of time spent. Since the shared expenses are allocated on a cost basis, there is no intercompany profit involved. The amount of expenses for which we charged Dialysis Corporation of America was approximately $200,000 for the year ended December 31, 2004. Utilization of personnel and administrative facilities in this manner enables us to share the cost of qualified individuals with our subsidiary rather than duplicating the costs for the various entities. It is our opinion these services are on terms as favorable as we could receive from unaffiliated parties.
Dialysis Corporation of America effected a 2-for-1 stock split of its common stock on January 28, 2004. In April, 2000, certain officers and directors of Medicore, Messrs. Anthony C. D'Amore, Peter D. Fischbein, Seymour Friend and Robert Magrann, and Lawrence E. Jaffe, Secretary and corporate counsel to Dialysis Corporation of America, exercised Dialysis Corporation of America options granted under DCA's 1999 Stock Option Plan for 680,000 shares. The exercise was effected with cash for the par value, and the balance, an aggregate of $421,600 based on the number of underlying shares on the date of exercise, in the form of three-year non-recourse promissory notes due April 20, 2003 at a rate of interest of 6.2% per annum, which notes were extended to April 20, 2004. In February, 2004, each of the foregoing persons repaid the principal and accrued interest of their respective notes in full through the delivery of a sufficient amount of shares of Dialysis Corporation of America which, when multiplied by their fair market value on the date of repayment, equaled the aggregate outstanding indebtedness under the note. All of these notes have since been cancelled.
On March 17, 2004, we provided Dialysis Corporation of America with up to $1,500,000 of financing for equipment purchases, for which Dialysis Corporation of America issued to us a promissory note for the principal amount of financing received. The financing carries an annual interest rate of 1.25% over the prime rate. The financing was increased in June, 2004, to $5,000,000 and its purposes extended for working capital and other corporate purposes of Dialysis Corporation of America. At March 25, 2005, the outstanding balance on this financing was approximately $2,435,000 at an interest rate of 7.0%, with accrued interest payable on the note of approximately $30,000.
The relationships and related transactions discussed in this Item 13 will be eliminated assuming and upon completion of the merger of our company with and into Dialysis Corporation of America. See Item 1, "Business - Recent Developments."
In May, 2001, Dialysis Corporation of America loaned its President $95,000 at an annual interest of prime plus 1% (floating) payable on demand but no later than May 11, 2006. Accrued interest aggregated approximately $13,000 at December 31, 2004. The demand loan is collateralized by all of the President's options and underlying common stock of Dialysis Corporation of America, as well as any proceeds from the sale of such common stock.
Item 14.
Item 14. Principal Accountant Fees and Services
Audit Fees
Moore Stephens, P.C. performed the audit of our annual financial statements as of and for the years ended December 31, 2003 and 2004, and reviewed the financial statements included in our quarterly reports on Form 10-Q for 2004. The fees of Moore Stephens, P.C. for professional services rendered for the audit of our financial statements for fiscal 2003 were $15,000 and for fiscal 2004 are anticipated to be $15,000.
Moore Stephens' fees for professional services for review of the financial statements in our quarterly reports on Form 10-Q for fiscal 2004 were $6,000. The review of the financial statements included in our Forms 10-Q for 2003 was performed by our former accountants, Wiss & Company, LLP, for an aggregate fee of $1,500.
Audit Related Fees
Neither of Moore Stephens, P.C. nor Wiss & Company, LLP performed any assurance and related services for Medicore, or any other services reasonably related to the performance of the audit or review of our financial statements during fiscal 2004 and 2003 that were not otherwise audit services as described above.
Tax Fees
Moore Stephens, P.C. handled the calculation and preparation of materials related to estimated taxes and the preparation of tax returns for 2003 and 2004. The tax fees for 2003 were $5,000, and the fees for such services for 2004 to be billed in 2005 are $5,000.
All Other Fees
In addition to the professional services and fees billed as described above under "Audit Fees" and "Tax Fees," in 2004, Moore Stephens, P.C. performed research on accounting and tax matters for a fee of $2,200. Wiss & Company did not provide any other services or billed other fees to our company or any of our subsidiaries.
Our Audit Committee has established its pre-approval policies and procedures, pursuant to which it approved the foregoing audit and permissible non-audit services provided by Moore Stephens, P.C. and Wiss & Company, LLP, respectively, in 2004 and 2003. The Audit Committee's pre-approval policy provides that all audit and permitted non-audit services be reviewed in advance by the Audit Committee for a determination of approval of the performance by our independent auditors of such services. Requests or applications for specific services to be provided by the independent auditor are required to be submitted in writing to our Audit Committee and our Vice President of Finance, who is also our principal financial officer, and must include a detailed description of the services to be rendered. Our Vice President of Finance shall provide the Audit Committee with a written report as to the scope and applicability of the proposed services and further communications may be made between and among the independent auditors, the Vice President of Finance and the Audit Committee, as necessary for further clarification and evaluation. The Audit Committee will make the determination that any requested audit and/or non-audit services, upon the above mentioned review process, are necessary and within the scope of the company's operations and reporting responsibilities, will not, in its opinion and evaluation, impair the auditor's independence, nor be considered a prohibited non-audit service consistent with the SEC's rules relating to these issues. The Audit Committee will provide a report of its approval or disapproval of the requested audit and non-audit services to management and the board for implementation. The Audit Committee will monitor the performance of all services provided by the independent auditors and determine whether such services are in compliance with its approval policies. The Audit Committee will report to management on a periodic basis on the results of its monitoring, and recommend appropriate action, including termination of the independent accountants for breaches of the approved policies or the deficiency in providing services to the company.
PART IV
Item 15.
Item 15. Exhibits and Financial Statement Schedules
(a) The following is a list of documents filed as part of this report.
1. All financial statements - See Index to Consolidated Financial Statements.
2. Financial statement schedules - See Index to Consolidated Financial Statements.
3. Refer to subparagraph (b) below.
(b) Exhibits+
3.1 Restated Articles of Incorporation, as amended (incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1997 ("1997 Form 10-K"), Part IV, Item 14(c)(3)(i)).
3.2 By-laws, as amended (incorporated by reference to the Company's 1997 Form 10-K, Part IV, Item 14(c)(3)(ii)).
4 Instruments defining the rights of security holders, including indentures.
4.1 1989 Stock Option Plan (incorporated by reference to the Company's 1997 Form 10-K, Part IV, Item 14 (c)(10)(i)).
4.2 Form of Stock Option Agreement issued pursuant to the 1989 Stock Option Plan (incorporated by reference to the Company's 1997 Form 10-K, Part IV, Item 14 (c)(10)(ii)).
4.3 Form of Additional Non-Qualified Stock Option Agreement issuable under the Stock Option Agreement (incorporated by reference to the Company's 1997 Form 10-K, Part IV, Item 14 (c)(10)(iii)).
4.4 1999 Stock Option Plan of the Dialysis Corporation of America(1) (May 21, 1999) (incorporated by reference to Dialysis Corporation of America's Annual Report on Form 10-K for the year ended December 31, 1999 ("DCA 1999 Form 10-K"), Part IV, Item 14(c)(10)(xxiii)).
4.5 Form of Stock Option Certificate under the Dialysis Corporation of America 1999 Stock Option Plan (May 21, 1999) (incorporated by reference to the DCA 1999 Form 10-K, Part IV, Item 14(c)(10)(xxiv)).
10 Material contracts.
10.1 Lease between the Company and Heights Plaza Associates, dated April 30, 1981 (incorporated by reference to the Company's 1997 Form 10-K, Part IV, Item 14(c)(10)(ii)).
10.2 Amendment to lease between the Company and Heights Plaza Associates, dated February 12, 2001 (incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 2001 ("2001 Form 10-K"), Part IV, Item 14(c)10.3).
10.3 Lease between the Company and Viragen, Inc.(2) dated December 8, 1992 (incorporated by reference to the Company's 1997 Form 10-K, Part IV, Item 14(c)(10)(xi)).
10.4 Addendum to Lease between the Company and Viragen, Inc.(2) dated January 15, 1993 (incorporated by reference to the Company's 1997 Form 10-K, Part IV, Item 14(c)(10)(xii)).
10.5 Lease Renewal Letter by the Company to Gesualdo Vitale(2) dated August 5, 2002 (incorporated by reference to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 2002, Part II, Item 6(10)(i)).
10.6 Lease Agreement between the Company and Techdyne, Inc.(3) dated August 29, 2000 (incorporated by reference to the Company's Current Report on Form 8-K dated December 19, 2000, Item 7(c)(10)(i)).
10.7 Amendment No. 1 to the Lease Agreement between the Company and Techdyne, Inc.(3) dated November 29, 2001 (incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 2002 ("2002 Form 10-K"), Part IV, Item 15(c)10.8).
10.8 Lease Agreement between DCA of Wellsboro, Inc. (formerly Dialysis Services of PA., Inc. - Wellsboro)(4) and James and Roger Stager dated January 15, 1995 (incorporated by reference to the Company's 1994 Form 10-K, Part IV, Item 14(a) 3 (10)(lxii)).
10.9 Lease between Dialysis Corporation of America(1) and DCA of Lemoyne, Inc.(4) dated December 23, 1998 (incorporated by reference to Dialysis Corporation of America's Annual Report on Form 10-K for the year ended December 31, 1998 ("DCA's 1998 Form 10-K"), Part IV, Item 14(c)(ii)).
10.10 Medical Director Agreement(5) between DCA of Vineland, LLC(6) and Vineland Dialysis Professionals dated April 30, 1999 (incorporated by reference to the DCA 1999 Form 10-K, Part IV, Item 14(c)(10)(xxvi)).
10.11 Agreement for In-Hospital Dialysis Services(7) between DCA of Wellsboro, Inc. (formerly Dialysis Services of PA., Inc. - Wellsboro)(4) and Soldiers & Sailors Memorial Hospital dated September 28, 1994 [*] (incorporated by reference to the Company's September, 1994 Form 10-Q, Part II, Item 6(a)(10)(ii)).
10.12 Lease between DCA of Carlisle, Inc. (formerly Dialysis Services of PA., Inc. - Carlisle) (8) and Lester P. Burkholder, Jr. and Kirby K. Burkholder dated November 1, 1996 (incorporated by reference to Dialysis Corporation of America's Annual Report on Form 10-K for the year ended December 31, 1996 ("DCA's 1996 Form 10-K"), Part IV, Item 14(a) 3 (10)(xxiii)).
10.13 Lease between DCA of Manahawkin, Inc. (formerly Dialysis Services of NJ, Inc. - Manahawkin)(8) and William P. Thomas dated January 30, 1997 (incorporated by reference to DCA's 1996 Form 10-K, Part IV, Item 14(a) 3 (10)(xxiv)).
10.14 Renewal of Lease between DCA of Manahawkin, Inc.(8) and William P. Thomas dated February 20, 2004 (incorporated by reference Dialysis Corporation of America's Annual Report on Form 10-K for the year ended December 31, 2003 ("DCA 2003 Form 10-K"), Part IV, Item 15(c)10.8).
10.15 Equipment Master Lease Agreement BC-105 between Dialysis Corporation of America(1) and B. Braun Medical, Inc. dated November 22, 1996 (incorporated by reference to DCA's 1996 Form 10-K, Part IV, Item 14(a) 3 (10)(xxvii)).
10.16 Schedule of Leased Equipment 0597 commencing June 1, 1997 to Master Lease BC-105(9) (incorporated by reference to Dialysis Corporation of America's Quarterly Report on Form 10-Q for the quarter ended June 30, 1997 ("DCA's June, 1997 10-Q"), Part II, Item 6(a), Part II, Exhibit 10(i)).
10.17 Lease between DCA of Chambersburg, Inc. (formerly Dialysis Services of PA., Inc. - Chambersburg)(8) and BPS Development Group dated April 13, 1998 (incorporated by reference to DCA's March, 1998 Form 10-Q, Part II, Item 6(a), Part II, Item 10(i)).
10.18 Lease between DCA of Vineland, LLC(6) and Maintree Office Center, L.L.C. dated May 10, 1999 (incorporated by reference to the DCA 1999 Form 10-K, Part IV, Item 14(c)(10)(xxv)).
10.19 Management Services Agreement(10) between Dialysis Corporation of America(1) and DCA of Vineland, LLC(6) dated April 30, 1999 (incorporated by reference to the DCA 1999 Form 10-K, Part IV, Item 14(c)(10)(xxviii)).
10.20 Amendment No. 1 to Management Services Agreement between Dialysis Corporation of America(1) and DCA of Vineland, LLC(6) dated October 27, 1999 (incorporated by reference to the DCA 1999 Form 10-K, Part IV, Item 14(c)(10)(xxix)).
10.21 Indemnity Deed of Trust from Dialysis Corporation of America(1) to Trustees for the benefit of St. Michaels Bank dated December 3, 1999 (incorporated by reference to Dialysis Corporation of America's Current Report on Form 8-K dated December 13, 1999 ("DCA's December Form 8-K"), Item 7(c)(99)(i)).
10.22 Guaranty Agreement from Dialysis Corporation of America(1) to St. Michaels Bank dated December 3, 1999 (incorporated by reference to DCA's December Form 8-K, Item 7(c)(99)(ii)).
10.23 Lease between Dialysis Corporation of America(1) and DCA of So. Ga., LLC(4) dated November 8, 2000 (incorporated by reference to Dialysis Corporation of America's Current Report on Form 8-K dated January 3, 2001 ("DCA January, 2001 8-K"), Item 7(c)(10)(i)).
10.24 Lease between DCA of Fitzgerald, LLC(4) and Hospital Authority of Ben Hill County, dba Dorminy Medical Center, dated February 8, 2001 (incorporated by reference to Dialysis Corporation of America's Current Report on Form 8-K dated March 5, 2001 ("DCA March, 2001 8-K"), Item 7(c)(10)(i)).
10.25 Lease between Dialysis Corporation of America(1) and Renal Treatment Centers - Mid-Atlantic, Inc. dated July 1, 1999 (incorporated by reference to Dialysis Corporation of America's Annual Report on Form 10-K for the year ended December 31, 2000 ("DCA 2000 Form 10-K"), Part IV, Item 14 (c)(10)(xlii)).
10.26 Employment Agreement between Stephen W. Everett and Dialysis Corporation of America(1) dated December 29, 2000 (incorporated by reference to the DCA 2000 Form 10-K, Part IV, Item 14(c)(10)(vii)).
10.27 Commercial Loan Agreement between Dialysis Corporation of America(1) and Heritage Community Bank, dated April 3, 2001 (incorporated by reference to Dialysis Corporation of America's Current Report on Form 8-K dated June 14, 2001 ("DCA June, 2001 Form 8-K"), Item 7(c)(i)).
10.28 Promissory Note by Dialysis Corporation of America(1) to Heritage Community Bank, dated April 3, 2001 (incorporated by reference to the DCA June, 2001 Form 8-K, Item 7(c)(ii)).
10.29 Modification Agreement to Dialysis Corporation of America's(1) Promissory Note to Heritage Community Bank, dated December 16, 2002 (incorporated by reference to Dialysis Corporation of America's Annual Report on Form 10-K for the year ended December 31, 2002 ("DCA 2002 Form 10-K"), Part IV, Item 15(c) 10.24).
10.30 Lease between DCA of Mechanicsburg, LLC(4) and Pinnacle Health Hospitals dated July 24, 2001 (incorporated by reference to the DCA June, 2001 Form 10-Q, Part II, Item 6(a)(10)(ii)).
10.31 Lease between Dialysis Corporation of America(1) and Clinch Memorial Hospital dated September 29, 2000 (incorporated by reference to Dialysis Corporation of America's Annual Report on Form 10-K for the year ended December 31, 2001 ("DCA 2001 Form 10-K"), Part IV, Item 14(c) 10.37).
10.32 Lease between DCA of Central Valdosta, LLC(4) and W. Wayne Fann dated March 20, 2001 (incorporated by reference to DCA 2001 Form 10-K, Part IV, Item 14(c) 10.38).
10.33 Promissory Note Modification Agreement between DCA of Vineland, LLC(6) and St. Michaels Bank dated December 27, 2002 (incorporated by reference to DCA 2002 Form 10-K, Part IV, Item 15(c) 10.30).
10.34 Lease between Dialysis Corporation of America(1) and Dr. Gerald Light dated February 15, 2002 (incorporated by reference to Dialysis Corporation of America's Quarterly Report on Form 10-Q for the quarter ended March 31, 2002, Part II, Item 6(a)(99)(i)).
10.35 Lease between DCA of Royston, LLC(4) and Ty Cobb Healthcare System, Inc. dated March 15, 2002 (incorporated by reference to Dialysis Corporation of America's Current Report on Form 8-K dated April 22, 2002, Item 7(c)(10)(i)).
10.36 Lease Agreement between DCA of Chevy Chase, LLC(8) and BRE/Metrocenter LLC and Guaranty of Dialysis Corporation of America(1) dated August 8, 2002 (incorporated by reference to Dialysis Corporation of America's Current Report on Form 8-K dated September 25, 2002, Item 7(c)(10)(i)).
10.37 Dialysis Corporation of America's(1) Section 125 Plan effective September 1, 2002 (incorporated by reference to Dialysis Corporation of America's Quarterly Report on Form 10-Q for the quarter ended September 30, 2002, Part II, Item 6(99)).
10.38 Lease Agreement between Pupizion, Inc. and DCA of Cincinnati, LLC(11) dated December 11, 2002 (incorporated by reference to DCA 2002 Form 10-K, Part IV, Item 15(c) 10.35).
10.39 Promissory Note from DCA of Cincinnati, LLC(11) to Dialysis Corporation of America(1) dated February 3, 2003 (incorporated by reference to DCA 2002 Form 10-K, Part IV, Item 15(c) 10.36).
10.40 Lease Agreement between DCA of Warsaw, LLC(4) and Warsaw Village, L.P. dated July 23, 2003 (incorporated by reference to Dialysis Corporation of America's Current Report on Form 8-K dated August 5, 2003, Item 7(c)(10)(i)).
10.41 Lease Agreement between DCA of Pottstown, LLC(8) and Fisher Scheler, LLC dated August 19, 2003 (incorporated by reference to Dialysis Corporation of America's Current Report on Form 8-K dated August 27, 2003, Item 7(c)(iv)(i)).
10.42 Renewal of Lease between the Company and DCA of Lemoyne, Inc(4) dated December 30, 2003 (incorporated by reference to DCA 2003 Form 10-K, Part IV, Item 15(c)10.3).
10.43 Business Lease between the Company and Suzanne M. Anderson dated July 1, 2003 (incorporated by reference to the Company's Current Report on Form 8-K dated July 22, 2003, Item 7(c)(10)(i)).
10.44 Demand Promissory Note from Dialysis Corporation of America(1) to the Company dated March 1, 2004 (incorporated by reference to DCA 2003 Form 10-K, Part IV, Item 15(c)10.46).
10.45 Employment Agreement between Thomas K. Langbein and the Company dated April 27, 2004 (incorporated by reference to the Company's Current Report on Form 8-K dated April 28, 2004, Item 7(c)(i)).
10.46 Amendment No. 1 to the Employment Agreement between Thomas K. Langbein and the Company dated October 21, 2004 (incorporated by reference to the Company's Current Report on Form 8-K dated November 19, 2004, item 9.01(c)(i)).
10.47 Agreement of Lease by and between Copt Concourse, LLC and the Company dated March 31, 2004 (incorporated by reference to Dialysis Corporation of America's Current Report on Form 8-K dated March 31, 2004, Item 7(c)(10)(i)).
16 Letter re: Change in Certifying Accountant
16.1 Letter of Wiss & Company, LLP addressed to the Securities and Exchange Commission dated November 10, 2003 (incorporated by reference to the Company's Quarterly Report on Form 10-Q for the third quarter ended September 30, 2003, Part II, Item 6(a)(16)).
21 Subsidiaries of the Company.
31 Rule 13a-14(a)/15d-14(a) Certifications.
31.1 Certification of the Chief Executive Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934.
31.2 Certification of the Chief Financial Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934.
32 Section 1350 Certifications
32.1 Certification of the Chief Executive Officer and the Principal Financial Officer pursuant to Rule 13a-14(b) of the Securities Exchange Act of 1934 and 18 U.S.C. Section 1350.##
- ---------
+ Documents incorporated by reference not included in the Exhibit Volume.
[*] Confidential portions omitted have been filed separately with the Securities and Exchange Commission.
## In accordance with Release No. 34-47551, this exhibit is furnished to the SEC as an accompanying document and is not deemed to be "filed" for purposes of Section 18 of the Securities Exchange Act of 1934 or otherwise subject to the liabilities of that Section, and it shall not be deemed incorporated by reference into any filing under the Securities Act of 1933.
(1) 56% owned subsidiary.
(2) Viragen, Inc., a former subsidiary sold in 1993, sold the property to Gesualdo and Rosanna Vitale in 2000; the Vitales are the new landlords.
(3) Former 71% owned subsidiary sold in June, 2001. (4) 100% owned subsidiary of Dialysis Corporation of America.
(5) Each dialysis subsidiary has a Medical Director Agreement which is substantially similar to the exhibit filed but for the term, area of non-competition and compensation. Dialysis Corporation of America's affiliate, DCA of Toledo, LLC (40% owned), has a substantially similar Medical Director Agreement.
(6) 51% owned subsidiary of Dialysis Corporation of America.
(7) Dialysis Corporation of America's acute inpatient services agreements referred to as Agreement for In-Hospital Dialysis Services are substantially similar to the exhibit filed, but for the hospital involved, the term and the service compensation rates. Agreements for In-Hospital Dialysis Services include the following areas: Valdosta and Fitzgerald, Georgia; Bedford, Carlisle, Chambersburg, Harrisburg, Mechanicsburg and Wellsboro, Pennsylvania; Toledo, Ohio.
(8) 80% owned subsidiary of Dialysis Corporation of America.
(9) Certain dialysis equipment was leased from time to time by Dialysis Corporation of America and for each lease a new schedule is added to the Master Lease; other than the nature of the equipment and length of the lease, the schedules conform to the exhibit filed and the terms of the Master Lease remain the same.
(10) Each of Dialysis Corporation of America's dialysis subsidiaries has a Management Service Agreement which is substantially similar to the exhibit filed but for the name of the particular subsidiary which entered into the Agreement and the compensation. Dialysis Corporation of America also has a Management Services Agreement with DCA of Toledo, LLC, in which it holds a 40% interest.
(11) 60% owned subsidiary of Dialysis Corporation of America.
SIGNATURES
Pursuant to the requirements of Sections 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
MEDICORE, INC.
By /S/ THOMAS K. LANGBEIN --------------------------------- THOMAS K. LANGBEIN, Chairman of the Board of Directors, Chief Executive Officer and President
March 31, 2005
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
ANNUAL REPORT ON FORM 10-K
ITEM 8, ITEM 15(a) (1) and (2), and (d)
LIST OF FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES
FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA
CERTAIN EXHIBITS
FINANCIAL STATEMENT SCHEDULES
YEAR ENDED DECEMBER 31, 2004
MEDICORE, INC.
HIALEAH, FLORIDA
FORM 10-K--ITEM 15(a)(1) and (2)
MEDICORE, INC. AND SUBSIDIARIES
LIST OF FINANCIAL STATEMENTS
The following consolidated financial statements of Medicore, Inc. and subsidiaries are included in Item 8 of the Annual Report on Form 10-K:
Page
Consolidated Balance Sheets as of December 31, 2004 and 2003
Consolidated Statements of Operations--Years ended December 31, 2004, 2003, and 2002
Consolidated Statements of Stockholders' Equity-- Years ended December 31, 2004, 2003 and 2002
Consolidated Statements of Cash Flows-- Years ended December 31, 2004, 2003, and 2002
Notes to Consolidated Financial Statements--December 31, 2004
The following financial statement schedule of Medicore, Inc. and subsidiaries is included in Item 15(d):
Schedule II-Valuation and qualifying accounts
All other schedules for which provision is made in the applicable accounting regulation of the Securities and Exchange Commission are not required under the related instructions or are inapplicable, and therefore have been omitted.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Stockholders and Board of Directors Medicore, Inc.
We have audited the accompanying consolidated balance sheet of Medicore, Inc. and subsidiaries as of December 31, 2004 and 2003, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the two years in the period ended December 31, 2004. Our audit also included the financial statement schedule listed in the Index at Item 15(a). These consolidated financial statements and schedule are the responsibility of the company's management. Our responsibility is to express an opinion on these consolidated financial statements and schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Medicore, Inc. and subsidiaries at December 31, 2004 and 2003, and the consolidated results of their operations and their cash flows for each of the two years in the period ended December 31 2004, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
/S/ MOORE STEPHENS, P.C. ------------------------- MOORE STEPHENS, P.C.
Cranford, New Jersey
February 18, 2005, except for Note 19, for which the date is March 15, 2005
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
Stockholders and Board of Directors Medicore, Inc.
We have audited the consolidated balance sheet (not presented herein) at December 31, 2002 and the accompanying consolidated statements of income, stockholders' equity and cash flows of Medicore, Inc. and subsidiaries for the year ended December 31, 2002. Our audit also included the information related to the year ended December 31, 2002 on the financial statement schedule listed in the Index at Item 15(a). These financial statements and schedule are the responsibility of the company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audit.
We conducted our audit in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Medicore, Inc. and subsidiaries for the year ended December 31, 2002, in conformity with accounting principles generally accepted in the United States. Also, in our opinion, the related financial statement schedule for the year ended December 31, 2002, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
/s/ WISS & COMPANY, LLP ----------------------- WISS & COMPANY, LLP
March 12, 2003 Livingston, New Jersey
MEDICORE, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
See notes to consolidated financial statements.
MEDICORE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
See notes to consolidated financial statements.
MEDICORE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
See notes to consolidated financial statements.
MEDICORE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
See notes to consolidated financial statements.
MEDICORE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2004
NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Business: The company has three reported business segments. The medical services segment, operated by Medicore's 57% owned subsidiary, Dialysis Corporation of America and subsidiaries ("Dialysis Corporation of America"), owns 21 kidney dialysis outpatient treatment centers located in Georgia, Maryland, New Jersey, Ohio, Pennsylvania, South Carolina and Virginia, manages two other dialysis facilities, one a 40% owned Ohio affiliate and the other unaffiliated Georgia center, and has five dialysis centers under development; has agreements to provide inpatient dialysis treatments to various hospitals; and provides supplies and equipment for dialysis home patients. The medical products segment is engaged in the distribution of medical products. A third segment, investment in technology companies, was initiated in January, 2000 with an investment in and financing to Linux software companies.
Consolidation: The consolidated financial statements include the accounts of Medicore, Inc. and Dialysis Corporation of America. All material intercompany accounts and transactions have been eliminated in consolidation. Dialysis Corporation of America has a 40% interest in an Ohio dialysis center it manages, which is accounted for by the equity method and not consolidated for financial reporting purposes.
Estimates: The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.
The company's principal estimates are for estimated uncollectible accounts receivable as provided for in our allowance for doubtful accounts, estimated losses from obsolete or unsaleable inventory as provided for in our allowance for inventory obsolescence, estimated useful lives of depreciable assets, estimates for patient revenues from non-contracted payors, and the valuation allowance for deferred tax assets based on the estimated realizability of deferred tax assets. Our estimates are based on historical experience and assumptions believed to be reasonable given the available evidence at the time of the estimates. Actual results could differ from those estimates.
Government Regulation: A substantial portion of the revenues of the company's medical services segment are attributable to payments received under Medicare, which is supplemented by Medicaid or comparable benefits in the states in which the company operates. Reimbursement rates under these programs are subject to regulatory changes and governmental funding restrictions. Laws and regulations governing the Medicare and Medicaid programs are complex and subject to interpretation. The company believes that it is in compliance with all applicable laws and regulations and is not aware of any pending or threatened investigations involving allegations of potential wrongdoing. While no such regulatory inquiries have been made, compliance with such laws and regulations can be subject to future government review and interpretation as well as significant regulatory action including fines, penalties, and exclusion from the Medicare and Medicaid programs.
MEDICORE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2004
NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--Continued
Vendor Concentration: The company's medical services segment purchases erythropoietin (EPO) from one supplier which comprised 36% in 2004, 37% in 2003 and 34% in 2002 of medical service cost of sales. There is only one supplier of EPO in the United States without alternative products available to dialysis treatment providers. Revenues from the administration of EPO which amounted to approximately $11,381,000 in 2004, $8,308,000 in 2003 and $6,447,000 in 2002, comprised 28% in 2004, 28% in 2003 and 26% in 2002 of medical service revenue.
Sale of Stock By Subsidiaries: The company follows an accounting policy of recognizing income on sales of stock by its public subsidiaries, which includes exercise of warrants issued in subsidiary stock offerings.
Inventories: Inventories are valued at the lower of cost (first-in, first-out and/or weighted average cost method) or market value and consists of inventory of the company's medical products division and the company's Medical Services Division.
Property and Equipment: Property and equipment is stated at cost. Depreciation is computed for book purposes by the straight-line method over the estimated useful lives of the assets, which range from 5 to 34 years for buildings and improvements; 3 to 10 years for machinery, computer and office equipment, and furniture; and 5 to 15 years for leasehold improvements based on the shorter of the lease term or estimated useful life of the property. Depreciation expense was $1,539,103 in 2004, $1,227,363 in 2003 and $1,117,462 in 2002. Replacements and betterments that extend the lives of assets are capitalized. Maintenance and repairs are expensed as incurred. Upon the sale or retirement of assets, the related cost and accumulated depreciation are removed and any gain or loss is recognized.
Long-lived Asset Impairment: Pursuant to Financial Accounting Standards Board Statement No. 121 "Accounting for the Impairment of Long-lived Assets and for Long-lived Assets to be Disposed of," impairment of long-lived assets, including intangibles related to such assets, is recognized whenever events or changes in circumstances indicate that the carrying amount of the asset, or related groups of assets, may not be fully recoverable from estimated future cash flows and the fair value of the related assets is less than their carrying value. Financial Accounting Standards Board Statement No. 144 "Accounting for the Impairment or Disposal of Long-lived Assets" (FAS 144) clarifies when a long-lived asset held for sale should be classified as such. It also clarifies previous guidance under FAS 121. The company, based on current circumstances, does not believe any indicators of impairment are present.
Goodwill: Goodwill represents cost in excess of net assets acquired. The company adopted Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets" (FAS 142) effective January 1, 2002. Under FAS 142, goodwill and intangible assets with indefinite lives are no longer amortized but are reviewed annually (or more frequently if impairment indicators are present) for impairment. Pursuant to the provisions of FAS 142, the goodwill resulting from the company's acquisition of minority interests in August 2001 and June 2003 and the acquisition of Georgia dialysis centers in April 2002 and April 2003 and acquisition of a Pennsylvania dialysis business at the close of business on August 31, 2004, are not being amortized for book purposes and are subject to the annual impairment testing provisions of FAS 142, which testing indicated no impairment for goodwill. See Note 9.
MEDICORE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2004
NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--Continued
Deferred Expenses: Deferred expenses, except for deferred loan costs, are amortized on the straight-line method, over their estimated benefit period ranging to 60 months. Deferred loan costs are amortized over the lives of the respective loans. Deferred expenses of approximately $80,000 at December 31, 2004 and $4,000 at December 31, 2003 are recorded as other assets. Amortization expense was $6,243 in 2004, $2,314 in 2003 and $6,190 in 2002.
Income Taxes: Deferred income taxes at the end of each period are determined by applying enacted tax rates applicable to future periods in which the taxes are expected to be paid or recovered to differences between the financial accounting and tax basis of assets and liabilities.
Dialysis Corporation of America files separate income tax returns with its income tax liability reflected on a separate return basis.
Other Income
Operating:
Other operating income is comprised as follows:
Year Ended December 31, ------------------------------------------ 2004 2003 2002 -------- -------- -------- Management fee income $402,251 $320,580 $191,213 Litigation settlement 134,183 -- -- -------- -------- -------- $536,434 $320,580 $191,213 ======== ======== ========
Non-Operating:
Other income, net, is comprised as follows:
Year Ended December 31, --------------------------------------------- 2004 2003 2002 --------- --------- --------- Rental income $ 346,236 $ 313,183 $ 294,227 Interest income 119,144 94,738 322,989 Interest (expense) (162,791) (201,651) (242,442) Other 69,688 80,420 40,169 --------- --------- --------- Other income, net $ 372,277 $ 286,690 $ 414,943 ========= ========= =========
MEDICORE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2004
NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--Continued
Accrued Expenses: Accrued expenses and other current liabilities is comprised as follows:
Stock-Based Compensation: The company follows the intrinsic method of Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" (APB 25) and related Interpretations in accounting for its employee stock options because, as discussed below, Financial Accounting Standards Board Statement No. 123, "Accounting for Stock-Based Compensation" (FAS 123) requires use of option valuation models that were not developed for use in valuing employee stock options. FAS 123 permits a company to elect to follow the intrinsic method of APB 25 rather than the alternative fair value accounting provided under FAS 123 but requires pro forma net income and earnings per share disclosures as well as various other disclosures not required under APB 25 for companies following APB 25. The company has adopted the disclosure provisions required under Financial Accounting Standards Board Statement No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure" (FAS 148). Under APB 25, because the exercise price of the company's stock options equals the market price of the underlying stock on the date of grant, no compensation expense was recognized. See "New Pronouncements."
Pro forma information regarding net income and earnings per share is required by FAS 123 and FAS 148, and has been determined as if the company had accounted for its employee stock options under the fair value method of that Statement. The fair value of options granted in 2003 was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted-average assumptions: risk-free interest rate of 1.76% for option grants during 2003 and 1.83% for the January 2000 options modified in January 2002; no dividend yield; volatility factor of the expected market price of the company's common stock of .78 for option grants during 2003 and .67 for the January 2000 options modified in January 2002; and an expected life of 2.17 years for option grants during 2003 and 1 year for the January 2000 options modified in January 2002. There were no Medicore options granted in 2004.
The fair value of Dialysis Corporation of America's options was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted-average assumptions for option grants during 2004, 2003, 2002 and 2001, respectively: risk-free interest rate of 3.83%, 1.44%, 3.73% and 5.40%; no dividend yield; volatility factor of the expected market price of the company's common stock of 1.31, 1.07, 1.15, and 1.14, and a weighted-average expected life of 5 years, 4.7 years, 5 years, and 4 years.
The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective input assumptions including the expected stock price volatility.
MEDICORE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2004
NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--Continued
Because the company's employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable measure of the fair value of its employee stock options.
For purposes of pro forma disclosures, the estimated fair value of options is amortized to expense over the options' vesting period. The company's pro forma information, which includes the pro forma effects related to the company's interest in Dialysis Corporation of America pro forma adjustments, follows:
Earnings Per Share: Diluted earnings per share gives effect to potential common shares that were dilutive and outstanding during the period, such as stock options and warrants, using the treasury stock method and average market price.
The company had various potentially dilutive stock options during the periods presented. See Note 5.
MEDICORE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2004
NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--Continued
Cash and Cash Equivalents: The company considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents. The carrying amounts, reported in the balance sheet for cash and cash equivalents approximate their fair values. The credit risk associated with cash and cash equivalents are considered low due to the high quality of the financial institutions in which these assets are invested.
Credit Risk: The company's primary concentration of credit risk is with accounts receivable which consist primarily of amounts owed by governmental agencies, insurance companies and private patients to our medical services division, and amounts owed by commercial customers to our medical products division. Receivables of our medical services division from Medicare and Medicaid comprised 52% of that division's receivables at December 31, 2004 and 59% at December 31, 2003.
Customer Payment Terms: The majority of the company's sales are made at payment terms of net amount due in 30-45 days, depending on the customer.
Estimated Fair Value of Financial Instruments: The carrying value of cash, accounts receivable and debt in the accompanying financial statements approximate their fair value because of the short-term maturity of these instruments, and in the case of debt because such instruments bear variable interest rates which approximate market.
Business Segments: The company follows the provisions of Financial Accounting Standards Board Statement No. 131, "Disclosures About Segments of an Enterprise and Related Information" (FAS 131) which contains standards for reporting information about operating segments in annual financial statements with operating segments representing components of an enterprise evaluated by the enterprise's chief operating decision maker for purposes of making decisions regarding resource allocation and performance evaluation. The adoption of FAS 131 has not changed the company's reported business segments, but has resulted in changes in the company's segment reporting disclosures.
Comprehensive Income: The company follows Financial Accounting Standards Board Statement No. 130, "Reporting Comprehensive Income" (FAS 130) which contains rules for the reporting of comprehensive income and its components. Comprehensive income consists of net income.
Revenue Recognition: Net medical service revenues are recognized as services are rendered at the net realizable amount from Medicare, Medicaid, commercial insurers, other third-party payors, and directly from patients. The medical services division occasionally provides dialysis treatments on a charity basis to patients who cannot afford to pay; however, the amount is not significant and the medical services division does not record revenue related to these charitable treatments. Product sales are recorded pursuant to stated shipping terms.
MEDICORE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2004
NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--Continued
New Pronouncements
On November 24, 2004, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 151, "Inventory Costs" an amendment of ARB No. 43, Chapter 4 ("FAS 151). FAS 151 requires companies to recognize as current period charges abnormal amounts of idle facility expense, freight, handling costs and wasted materials (spoilage). FAS 151 also requires manufacturers to allocate fixed production overheads to inventory based on normal capacity of their production facilities. FAS 151 is effective for inventory costs incurred during fiscal years beginning after June 15, 2005. The company does not expect FAS 151 to have a significant effect on its consolidated financial statements.
On December 16, 2004, the FASB issued Statement of Financial Accounting Standards No. 153, "Exchange of Nonmonetary Assets', an amendment of APB Opinion No. 29 ("FAS 153"). The amendments made by FAS 153 are based on the principle that exchanges of nonmonetary assets should be measured based on the fair value of the assets exchanged. The amendments eliminate the narrow exception for nonmonetary exchanges of similar productive assets and replace it with an exception for exchanges of nonmonetary assets that do not have commercial substance. Previous to FAS 153 some nonmonetary exchanges, although commercially substantive were recorded on a carryover basis rather than being based on the fair value of the assets exchanged. FAS 153 is effective for nonmonetary assets exchanges occurring in fiscal periods beginning after June 15, 2005. The company does not expect FAS 153 to have a significant effect on its financial statements.
On December 16, 2004, the FASB issued Statement of Financial Accounting Standards No. 123 (revised), "Share-Based Payment" ("FAS 123(R)). Provisions of FAS 123(R) requires companies to recognize the fair value of stock option grants as a compensation costs in their financial statements. Public entities, other than small business issuers, will be required to apply FAS 123(R) in the first interim or annual reporting period that beginning after June 15, 2005. The company will be subject to the provisions of FAS 123(R) effective July 1, 2005. In addition to stock options granted after the effective date, companies will be required to recognize a compensation cost with respect to any unvested stock options outstanding as of the effective date equal to the grant date fair value of those options (as previously disclosed in the notes to the financial statements) with the cost related to the unvested options to be recognized over the vesting period of the options. The company is in the process of determining the impact that FAS 123(R) will have on its consolidated financial statements.
Advertising Costs: The company expenses advertising costs as they are incurred. Advertising costs amounted to $115,000, $76,000 and $60,000 during the years ended December 31, 2004, 2003 and 2002, respectively.
Reclassification: Certain prior year amounts have been reclassified to conform with the current year's presentation.
MEDICORE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2004
NOTE 2--TRANSACTIONS WITH VIRAGEN, INC.
The company has a royalty agreement with a former subsidiary, Viragen, Inc., pursuant to which it is to receive a royalty on Viragen's gross sales of interferon and related products. The agreement provides for aggregate royalty payments of $2.4 million to be paid based on the following percentages of Viragen sales: 5% of the first $7 million, 4% of the next $10 million, and 3% of the next $55 million. The effective date of the agreement was November 15, 1994, with royalty payments due quarterly, commencing March 31, 1995. A payment of approximately $108,000, earned under a previous royalty agreement, is due as the final payment under the existing royalty agreement. In August 2002, the company initiated a legal action against Viragen for breach of the royalty agreement and for an accounting of sales pursuant to the royalty agreement.
In July, 2003, we reached an agreement with Viragen pursuant to mediation proceedings following our obtaining a partial summary judgment against Viragen in March, 2003, for amounts owed to us under a royalty agreement with Viragen. Viragen agreed to remit $30,000 on each of August 1, 2003, August 1, 2004 and August 1, 2005, with annual interest accruing at 5% on the August 2004 and 2005 payments. Viragen remitted the $30,000 payment due August 1, 2003. Viragen also agreed to commence remitting the quarterly royalty payments due under the royalty agreement and has remitted quarterly payments of $2,580 in October 2003, $2,905 in January 2004, $3,735 in April 2004, $3,426 in July 2004, $1,521 in November 2004 and $2,543 in January 2005.
NOTE 3--LONG-TERM DEBT
The company's medical products division had a $350,000 line of credit with a local Florida bank, with interest at prime plus 1% payable monthly. This line of credit matured January 22, 2003 and was secured by the accounts receivable and inventory of the company's medical products division. The line of credit and accrued interest were paid off in January 2003 prior to maturity. The company did not renew this line of credit.
Dialysis Corporation of America through its subsidiary, DCA of Vineland, LLC, pursuant to a December 3, 1999 loan agreement obtained a $700,000 development loan with interest at 8.75% through December 2, 2001, 1 1/2% over the prime rate thereafter through December 15, 2002 and 1% over prime thereafter, with an interest rate of 5% at December 31, 2003 and 5.25% at December 31, 2002, which is secured by a mortgage on Dialysis Corporation of America's real property in Easton, Maryland. Outstanding borrowings were subject to monthly payments of interest only through December 2, 2001 with monthly payments thereafter of $2,917 principal plus interest through December 2, 2002 and monthly payments thereafter of $2,217 plus interest with any remaining balance due December 2, 2007. This loan had an outstanding principal balance of $610,000 at December 31, 2004 and $636,000 at December 31, 2003.
In April 2001, Dialysis Corporation of America obtained a $788,000 five-year mortgage through April 2006 secured by its land and building in Valdosta, Georgia with interest at 8.29% until March 2002, 7.59% thereafter until December 16, 2002 and prime plus 1/2% with a minimum of 6.0% effective December 16, 2002, with an interest rate of 6% at December 31, 2003 and December 31, 2002. Payments are $6,800 including principal and interest commencing May 2001 with a final payment consisting of a balloon payment and any unpaid interest due April 2006. The remaining principal balance under this mortgage amounted to approximately $675,000 at December 31, 2004 and $715,000 at December 31, 2003.
MEDICORE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2004
NOTE 3--LONG TERM DEBT--Continued
The Dialysis Corporation of America equipment financing agreement is for financing for kidney dialysis machines for Dialysis Corporation of America's facilities in Pennsylvania and Maryland, New Jersey and Georgia. Financing, which is secured by the financed equipment, totaled approximately $399,000 in 2002 with no additional financing during 2003 or 2004. Monthly payments under the agreement, which totaled approximately $46,000 as of December 31, 2004, are pursuant to various schedules extending through August 2007 with interest at rates ranging from 4.13% to 10.48%. Financing under the equipment financing agreement is a noncash financing activity which is a supplemental disclosure required by FAS 95, "Statement of Cash Flows." See Note 14. The remaining principal balance under this financing amounted to approximately $814,000 at December 31, 2004 and $1,321,000 at December 31, 2003.
Long-term debt is as follows:
The prime rate was 5.25% as of December 31, 2004 and 4.00% as of December 31, 2003. For interest payments, see Note 14.
Scheduled maturities of long-term debt outstanding at December 31, 2004 are approximately:
2005 $ 513,000 2006 956,000 2007 630,000 2008 -- 2009 -- Thereafter -- ---------- $2,099,000
The company's two mortgage agreements contain certain restrictive covenants that, among other things, restrict the payment of dividends above 25% of the net worth of Dialysis Corporation of America, require lenders' approval for a merger, sale of substantially all the assets, or other business combination of the company, and require maintenance of certain financial ratios. The company was in compliance with the debt covenants at December 31, 2004 and December 31, 2003.
MEDICORE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2004
NOTE 4--INCOME TAXES
Deferred income taxes reflect the net tax effect of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the company's deferred tax liabilities and assets are as follows:
Due to the uncertainty as to the realizability of deferred tax assets, a valuation allowance of $430,000 and $126,000, which relates to net operating loss carryforwards, was recorded as of December 31, 2004 and 2003, respectively, reflecting an increase of $304,000 for 2004. The company has approximately $1,200,000 of net operating loss carryforwards expiring in 2024.
Deferred taxes in the accompanying balance sheets consist of the following components:
MEDICORE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2004
NOTE 4--INCOME TAXES--Continued
The deferred tax liability includes $683,000 at December 31, 2004 and $691,000 at 2003, resulting from income tax expense recorded on gains recognized for financial reporting purposes, but not for income tax purposes. The result is a difference between book and tax basis of the company's investment in Dialysis Corporation of America. This temporary difference would reverse upon the occurrence of certain events relating to the divestiture of Dialysis Corporation of America. This deferred tax liability has been classified as non-current. See Note 1.
Significant components of the provision (benefit) for income taxes are as follows:
Year Ended December 31, ------------------------------------------------ 2004 2003 2002 ----------- ----------- ----------- Current:
Federal $ 1,221,498 $ 383,984 $ 395,667 State 330,809 264,305 124,213 City 7,985 -- -- ----------- ----------- ----------- 1,560,292 648,289 519,880 ----------- ----------- -----------
Deferred:
Federal 135,364 3,000 328,000 State (106,364) (15,000) (201,000) ----------- ----------- ----------- 29,000 (12,000) 127,000 ----------- ----------- ----------- $ 1,589,292 $ 636,289 $ 646,880 =========== =========== ===========
The reconciliation of income tax attributable to income (loss) before income taxes, minority interests and equity in affiliate earnings (loss) computed at the U.S. federal statutory rate (34%) to income tax expense is as follows:
The exercise of 70,348 Dialysis Corporation of America non-qualified stock options during 2004 resulted in a tax deduction for Dialysis Corporation of America of approximately $304,000 corresponding to the difference in the market value of the shares obtained on exercise and the exercise price of the options. The deduction resulted in a decrease in income taxes payable of approximately $120,000 and a corresponding increase in Dialysis Corporation of America's equity which in turn resulted in an increase of approximately $68,000 in the company's additional paid in capital related to its 57% interest in Dialysis Corporation of America and a $52,000 increase in minority interest in the company's consolidated balance sheet related to the 43% minority interest in Dialysis Corporation of America.. This represents a non-cash financing activity, which is a supplemental disclosure required by Accounting Standards Board Statement No. 95, "Statement of Cash Flows." See Note 14.
For income tax payments, see Note 14.
MEDICORE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2004
NOTE 5--STOCK OPTIONS AND STOCK COMPENSATION
On May 6, 1996, the company adopted a Key Employee Stock Plan reserving 100,000 shares of our common stock for issuance from time to time to officers, directors, key employees, advisors and consultants as bonus or compensation for performances and or services rendered to the company or otherwise providing substantial benefit for the company. As of December 31, 2004, 2,000 shares have been issued under this Plan.
In July, 2000, the company granted, under its 1989 Stock Option Plan, five-year non-qualified stock options for 820,000 shares to officers, directors and employees of Medicore and its subsidiaries. The options have an exercise price of $1.38, the market price on the date of grant. Options for 16,000 shares were cancelled during 2003 due to employee terminations and resignations. In June, 2001, 115,000 options were exercised. In September, 2003, the company's board of directors authorized the granting of bonuses to its officers, directors and employees, which bonuses were partially comprised of the exercise of one-third of the options then held by these individuals as of September 11, 2003 resulting in the exercise of 229,668 options. In January, 2004, the company's board of directors authorized the granting of bonuses to the company's officers, directors and employees, which bonuses were partially comprised of the exercise of a portion of the options then held by these individuals resulting in the exercise of 234,671 options. At December 31, 2004, a total of 224,661 options were outstanding under the 1989 Stock Option Plan.
As part consideration for a May, 2003 consulting agreement, the company granted options to purchase 200,000 shares of common stock exercisable for two years at $2.50 per share. The fair value of these options was $56,000 pursuant to a Black-Scholes computation. The $56,000 expense was being deferred and amortized over the one year life of the consulting agreement which expired on May 30, 2004. Approximately $23,000 of such expense was recorded during the year ended December 31, 2004 and $33,000 during the year ended December 31, 2003. The option was exercised on February 28, 2005 through a cashless exercise with the consultant receiving a net of 130,000 shares from the option exercise. The consulting agreement was continued on a month-to-month basis through December 2004. See Note 8.
On September 25, 2003, the company granted options for 21,000 common shares to each of two directors for their service on several of its board committees, including its audit committee. The options were granted under the company's 1989 Stock Option Plan and are exercisable at $2.25 per share through September 24, 2006. The options vest in equal annual increments of 7,000 shares each September 25, 2003, 2004 and 2005. On July 14, 2004, one of the directors acquired an aggregate of 2,016 shares by effecting a "cashless" exercise of the vested portion of his option with respect to 7,000 shares. The director agreed to forego the balance of 4,984 shares underlying the option in lieu of making cash payment for the exercise price. See Note 14.
The company issued 875,000 shares of stock as compensation to officers and directors in June 2001. In connection with a revaluation of this issuance of shares, officers and directors who received these shares paid the company $52,500 during 2004.
MEDICORE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2004
NOTE 5--STOCK OPTIONS AND STOCK COMPENSATION--Continued
On January 28, 2004, Dialysis Corporation of America effected a two-for-one stock split of its outstanding common stock. All option amounts and exercise prices with respect to Dialysis Corporation of America have been adjusted to reflect the stock split. Split-adjusted option exercise prices resulting in a fraction of a cent have been rounded up to the nearest cent for purposes of these notes to the financial statements of the company.
In June, 1998, Dialysis Corporation of America's board of directors granted an option under its now expired 1995 Stock Option Plan to a board member for 10,000 shares exercisable at $1.13 per share through June 9, 2003. This option was exercised in June, 2003.
In April, 1999, Dialysis Corporation of America adopted a stock option plan pursuant to which its board of directors granted 1,600,000 options exercisable at $.63 per share to certain of its officers, directors, employees and consultants with 680,000 options exercisable through April 20, 2000 and 920,000 options exercisable through April 20, 2004, of which 120,000 options have been cancelled to date as a result of terminations. In April, 2000, the 680,000 one-year options were exercised for which Dialysis Corporation of America received cash payment of the par value amount of $3,400 and the balance in three-year promissory notes with interest at 6.2%. The notes were repaid with 91,800 shares of Dialysis Corporation of America stock with a fair market value of approximately $521,000 on February 9, 2004. Interest income on the notes amounted to approximately $3,000 for the six months ended June 30, 2004, all of which was earned during the first quarter. In March, 2003, 155,714 of the remaining 800,000 options outstanding were exercised for $97,322 with the exercise price satisfied by director bonuses accrued in 2002. In January, 2004, 130,278 of these options were exercised for $81,424 with the exercise price satisfied by director bonuses accrued in 2003. In February, 2004, 158,306 of these options were exercised for $98,941 with the exercise price satisfied by payment of 18,152 shares of Dialysis Corporation of America's stock for cancellation. In March, 2004, 355,702 of these options were exercised for $222,314 with the exercise price satisfied by the optionee's payment of 54,223 shares of Dialysis Corporation of America for cancellation. The exercises and share payments to the company represents a noncash investing activity, which is a supplemental disclosure required by Financial Accounting Standards Board Statement No. 95, "Statements of Cash Flows." See Note 14.
In January, 2001, Dialysis Corporation of America's board of directors granted to its CEO and President a five-year option for 330,000 shares exercisable at $.63 per share with 66,000 options vesting January, 2001, and 66,000 options vesting annually on January 1 through 2005. In January, 2004, 56,384 of these options were exercised for $35,240, with the exercise price satisfied by a Dialysis Corporation of America director bonuses accrued in 2003.
In September, 2001, Dialysis Corporation of America's board of directors granted five-year options for an aggregate of 150,000 shares exercisable at $.75 per share through September 5, 2006, to certain officers, directors and key employees. 30,000 of the options vested immediately and the
MEDICORE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2004
NOTE 5--STOCK OPTIONS AND STOCK COMPENSATION--Continued
remaining 120,000 options vest in equal increments of 30,000 options each September 5, commencing September 5, 2002. In March, 2003, 3,570 of these options were exercised for $2,678 with the exercise price satisfied by Dialysis Corporation of America director bonuses accrued in 2002. In January, 2004, 4,576 of these options were exercised for $3,432 with the exercise price satisfied by Dialysis Corporation of America director bonuses accrued in 2003. These exercises represent a noncash investing activity, which is a supplemental disclosure required by Financial Accounting Standards Board Statement No. 95, "Statement of Cash Flows." See Note 15. In January, 2004, 7,200 of these options were exercised with Dialysis Corporation of America receiving a $5,400 cash payment for the exercise price. Of the 30,000 immediately exercisable options, 15,346 have been exercised and 14,654 cancelled due to the resignation of a Dialysis Corporation of America director in June 2004. Of the remaining 120,000 options, 90,000 had vested as of December 31, 2004.
In March, 2002, Dialysis Corporation of America's board of director's granted a five-year option to an officer for 60,000 shares exercisable at $1.58 per share through February 28, 2007. The option was to vest in equal annual increments of 15,000 shares each February 28 from 2003 through 2006. 15,000 options that vested in February, 2003, were exercised in October, 2003, and the remaining 45,000 options expired unvested due to the July 31, 2003 resignation of the officer.
In May, 2002, Dialysis Corporation of America's board of directors granted five-year options for an aggregate of 21,000 shares to certain of its employees of which 11,000 were outstanding and vested at December 31, 2004. These options are exercisable at $2.05 per share through May 28, 2007. Options for 10,000 shares have been cancelled as a result of the termination of several employee option holders.
In June, 2003, Dialysis Corporation of America's board of directors granted to an officer a five-year stock option for 50,000 shares exercisable at $1.80 per share through June 3, 2008. The option vests annually in increments of 12,500 shares each June 4 from 2004 through 2007.
In August, 2003, Dialysis Corporation of America's board of directors granted a three-year option to a director who is also a member of several of its committees, for 10,000 shares exercisable at $2.25 per share through August 18, 2006. The option vests in two annual increments of 5,000 shares on August 19, 2004 and 2005.
In January, 2004, Dialysis Corporation of America's board of directors granted a five-year option for 20,000 shares exercisable at $3.09 per share through January 12, 2009. The option vests in annual increments of 5,000 shares on each January 13 from 2005 through 2008.
In June 2004, Dialysis Corporation of America's board of directors granted 160,000 options to officers and directors exercisable at $4.02 per share through June 6, 2009. 15,000 options vested immediately and the remaining 145,000 options vest annually in equal 25% increments commencing June 7, 2005.
In August 2004, Dialysis Corporation of America's board of directors granted 50,000 incentive stock options to an officer exercisable at $4.02 per share through August 12, 2009. The options vest 25% annually commencing August 16, 2005.
MEDICORE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2004
NOTE 5--STOCK OPTIONS AND STOCK COMPENSATION--Continued
A summary of the company's stock option activity, and related information for the years ended December 31, follows, with modified options being reflected as grants and the original grants being modified reflected as cancellations:
The remaining contractual life at December 31, 2004 is .6 years for the July 2000 options, .4 years for the May 2003 options and 1.7 years for the September 2003 options.
The company has 957,661shares reserved for future issuance at December 31, 2004, including: 224,661 shares for the 1989 plan; 200,000 shares for the May 2003 options; 35,000 shares for the September 2003 options; 98,000 shares for key employee stock plan; and 400,000 shares for an employment agreement.
A summary of Dialysis Corporation of America's stock option activity, and related information for the years ended December 31, follows:
MEDICORE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2004
NOTE 5--STOCK OPTIONS AND STOCK COMPENSATION--Continued
The remaining contractual life at December 31, 2004 is 4 years for the January 2004 options, 4.4 years for the June 2004 options, 4.5 years for the August 2004 options, 3.4 years for the June 2003 options, 1.7 years for the August 2003 options, 2.4 years for the May 2002 options, 1.7 years for the September 2001 options and 1 year for the January 2001 options.
All options of the company and Dialysis Corporation of America were issued at fair market value on the date of grant.
MEDICORE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2004
NOTE 6--BUSINESS SEGMENT DATA
The following summarizes information about the company's three reported business segments, which are managed separately. The medical products division has been shown separately even though not required by FAS 131. Corporate activities include general corporate revenues and expenses. Corporate assets include unallocated cash and other current assets, deferred income taxes and corporate fixed assets and other non-current assets not allocated to any of the segments. Intersegment sales, of which there were none for the periods presented, are generally intended to approximate market price. The company's operations are primarily domestic, with all property, plant and equipment located in the United States and minimal sales outside the Untied States. See Notes 1 and 12.
BUSINESS SEGMENT OPERATING REVENUES
MEDICORE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2004
NOTE 6--BUSINESS SEGMENT DATA--Continued
MAJOR CUSTOMERS
Medical services revenues represent revenues of the company's dialysis division. A significant portion of medical service revenue pertains to services provided to individuals receiving Medicare and Medicaid benefits or comparable benefits in the states in which the company operates. Reimbursement rates under these programs are subject to regulatory changes and governmental funding restrictions. Although the company is not aware of any future rate changes, significant changes in reimbursement rates could have a material effect on the company's operations. Approximately 56%, 62% and 58% of medical service revenues for the years ended December 31, 2004, 2003 and 2002, respectively, were derived from Medicare and Medicaid reimbursement.
NOTE 7--COMMITMENTS
Commitments
The company and its subsidiaries have leases on facilities housing its dialysis operations, medical products operations and administrative offices and equipment leases, which expire at various dates.
MEDICORE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2004
NOTE 7--COMMITMENTS --Continued
Total rent expense was approximately $1,355,000, $953,000 and $688,000 in fiscal 2004, 2003 and 2002, respectively The aggregate lease commitments at December 31, 2004 for the Company's non-cancelable operating leases with a term of one year or more are approximately:
2005 $1,580,000 2006 1,552,000 2007 1,460,000 2008 1,401,000 2009 1,030,000 Thereafter 2,150,000 ---------- $9,173,000
Effective January 1, 1997, Dialysis Corporation of America established a 401(k) savings plan (salary deferral plan) with an eligibility requirement of one year of service and 21 year old age requirement. The company and Techdyne adopted the 401(k) profit sharing plan of Lytton, a Techdyne subsidiary, as participating employers effective July 1, 1998. Subsequent to the sale of its interest in Techdyne in June 2001, the company remained as a participating employer in this multi-employer plan until January 2003 when the company and Dialysis Corporation of America established a new 401(k) plan containing employer match provisions on a portion of employee contributions. The expense for employer match amounted to $29,000 for 2004, $17,000 for 2003, and $10,000 for 2002.
The company has a five-year employment agreement with Thomas K. Langbein, its CEO, President and Chairman of the Board, through February 25, 2009, which provides for annual increases in base salary in $12,000 increments and which was $353,500 as of March 1, 2004. The employment agreement also provided for a monthly automobile allowance, participation in benefit plans and fringe benefits available to the company's employees and executives, reimbursement for business expenses and the payment of life insurance policies owned by Mr. Langbein. The agreement also provides for the non-competition by Mr. Langbein for a period of two years from termination of the relationship within a geographic area of the company's primary operations. Under the agreement, Mr. Langbein is entitled to certain severance payments in the event of termination as a result of death, extended disability, wrongful termination or change of control or for good reason by Mr. Langbein.
Dialysis Corporation of America has a five-year employment contract with Stephen W. Everett, its CEO, President and director, through December 31, 2005, currently at an annual salary of $250,000. The employment agreement also provides for certain fringe benefits, reimbursement of reasonable out-of-pocket expenses, and a one-year non-compete within the United States.
We entered into a one-year consulting agreement with an investment relations firm in May, 2003, with a monthly fee of $4,000. The agreement also provided for the issuance of an option to purchase 200,000 shares of our common stock. The option was exercised through a cashless exercise on February 28, 2005 with the consultant selling the company 70,000 shares to pay the $500,000 exercise price and receiving 130,000 shares of the company's common stock. The agreement was continued on a month-to-month basis through December 2004. In June, 2003, two of the partners of the investment relations firm together with Thomas K. Langbein, our Chief Executive Officer and President, became three of the five directors of Xandros, Inc., a majority owned subsidiary of Linux Global Partners, Inc., which is a privately held Linux software company to which we made loans and in which we hold an approximate 14% interest. Mr. Langbein resigned his positions with Xandros on August 12, 2003. See Notes 5 and 11.
MEDICORE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2004
NOTE 8--RELATED PARTY TRANSACTIONS
During 2004, 2003 and 2002, the company and Dialysis Corporation of America paid premiums of approximately $736,000, $612,000 and $448,000, respectively, for insurance through a director and stockholder, and the relative of a director and stockholder.
During 2004, 2003 and 2002, legal fees of approximately $413,000, $342,000 and $310,000, respectively, were incurred by the company and Dialysis Corporation of America for an attorney who is general counsel and secretary of the company (of which he is also a director), and serves as general counsel and secretary to Dialysis Corporation of America. In addition, the attorney was granted $60,000 in bonuses during fiscal 2003.
In May 2001, Dialysis Corporation of America loaned its president $95,000 to be repaid with accrued interest at prime minus 1% (floating prime) on or before maturity on May 11, 2006. This demand loan is collateralized by all Dialysis Corporation of America's President's stock options in Dialysis Corporation of America, as well as common stock from exercise of the options and proceeds from sale of such stock. Interest income on the loan amounted to approximately $4,000, $4,000 and $5,000 during the years ended December 31, 2004, 2003 and 2002, respectively.
The 20% minority interest in DCA of Vineland, LLC, a subsidiary of Dialysis Corporation of America, was held by a company owned by the medical director of that facility, who became a director of Dialysis Corporation of America in 2001. This physician was provided with the right to acquire up to 49% of DCA of Vineland. In April, 2000, another company owned by this physician acquired an interest in DCA of Vineland, resulting in Dialysis Corporation of America holding a 51.3% ownership interest in DCA of Vineland and this physician's companies holding a combined 48.7% ownership interest in DCA of Vineland. See Note 10.
In July, 2000, one of the companies owned by this physician, acquired a 20% interest in DCA of Manahawkin, Inc. (formerly known as Dialysis Services of NJ, Inc. - Manahawkin). Under agreements with DCA of Vineland and DCA of Manahawkin, this physician serves as medical director for each of those dialysis facilities.
Effective March 17, 2004, the company agreed to provide Dialysis Corporation of America with up to $1,500,000 of financing which was evidenced by a demand promissory note issued by Dialysis Corporation of America to the company with annual interest of 1.25% over the prime rate. The financing was provided for equipment purchases to be made by Dialysis Corporation of America. The financing was subsequently modified by increasing the maximum amount of advances that can be made to $5,000,000, and by adding to the purposes of the financing working capital and other corporate needs. As of December 31, 2004, this note had an outstanding balance of approximately $1,435,000 and an interest rate of 6.5%. Interest on the note amounted to approximately $51,000 for the year ended December 31, 2004. Accrued interest receivable from Dialysis Corporation of America on the note amounted to approximately $27,000 as of December 31, 2004. The outstanding principal balance of $1,435,000 on the promissory note and $27,000 of accrued interest have been eliminated in consolidation.
MEDICORE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2004
NOTE 8--RELATED PARTY TRANSACTIONS--Continued
In certain situations, minority members in Dialysis Corporation of America subsidiaries may fund a portion of required capital contributions by issuance of an interest bearing note payable to Dialysis Corporation of America which minority members may repay directly or through their portion of capital distributions of the subsidiary. The minority members funded approximately $324,000 in capital contributions during 2004 and $223,000 during the preceding year under notes with Dialysis Corporation of America accruing interest at prime plus 2%, with an aggregate of approximately $74,000 of subsidiary distributions applied against the notes and accrued interest during 2004 and $54,000 during the preceding year. These transactions represent non-cash investing activities, which is a supplemental disclosure required by Financial Accounting Standards Board Statement No. 95, "Statement of Cash Flows." See Note 14.
NOTE 9--ACQUISITIONS
In August, 2001, Dialysis Corporation of America acquired the 30% minority interest in one of its Georgia dialysis centers for $600,000. This transaction resulted in $523,000 of goodwill representing the excess of the purchase price over the fair value of the net assets acquired. The goodwill is being amortized for tax purposes over a 15-year period. Dialysis Corporation of America's decision to make this investment was based largely on its expectation of continued profitability of this center. The party from whom Dialysis Corporation of America acquired the minority interest is the medical director of another of Dialysis Corporation of America's subsidiaries. See Note 1.
In April, 2002, Dialysis Corporation of America acquired a Georgia dialysis center. This transaction resulted in $400,000 of goodwill representing the excess of the purchase price over the fair value of the net assets acquired. The goodwill is being amortized for tax purposes over a 15-year period. Dialysis Corporation of America's decision to make this investment was based on its expectation of future profitability resulting from its review of this dialysis center's operations prior to making the acquisition. See Note 1.
Effective April 8, 2003, Dialysis Corporation of America acquired the assets of a Georgia dialysis center, and effective June 1, 2003, acquired the 30% minority interests in each of two of its existing Georgia dialysis centers for a total consideration of $1,415,000, of which $745,000 was paid and the remaining balance of $670,000 was paid during the 2nd quarter of 2004. The results of operations of the acquired center have been included in the consolidated financial statements since its acquisition. Minority interest in the results of operations of the centers for which Dialysis Corporation of America acquired the outstanding minority interest was included in the consolidated financial statements until Dialysis Corporation of America acquired the minority interests. These acquisitions resulted in $1,368,000 of goodwill, representing the excess of the purchase price over the fair value of the net assets acquired. The goodwill is being amortized for tax purposes over a 15-year period. Dialysis Corporation of America's decision to make these acquisitions was based on its expectation of profitability resulting from its management's evaluation of the operations of these dialysis centers. The party from whom the 30% minority interests were purchased was the medical director of one of the facilities at which the 30% interest was acquired and is the medical director of two other of Dialysis Corporation of America's Georgia dialysis facilities. See Note 1.
MEDICORE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2004
NOTE 9--ACQUISITIONS--Continued
Effective as of the close of business on August 31, 2004 Dialysis Corporation of America acquired a Pennsylvania dialysis company for an estimated net purchase price of $1,521,000. Of that amount, $761,000 is currently in escrow, with the balance of $760,000 to be paid in equal installments, each on the first and second anniversary of the effective date of the purchase agreement. This transaction resulted in $1,358,000 of goodwill representing the excess of the net purchase price over the estimated $164,000 fair value of the net assets acquired, including an $83,000 valuation of an eight year non-competition agreement that is being amortized over the life of the agreement. The goodwill is not amortizable for tax purposes since the transaction was a stock acquisition. The initial allocation of purchase cost at fair value was based upon available information and will be finalized as any contingent purchase amounts are resolved and estimated fair values of assets are finalized. Dialysis Corporation of America began recording the results of operations for the acquired company as of the effective date of the acquisition. Dialysis Corporation of America's decision to make this investment was based on its expectation of future profitability resulting from its review of the acquired company's operations prior to making the acquisition. See Note 1.
The following table summarizes the estimated fair values of the assets acquired and liabilities assumed at the date of acquisition for the August 2004 Pennsylvania acquisition:
Accounts receivable, net $ 215,825 Inventory and other current assets 79,383 Property, plant and equipment, net 88,231 Intangible assets 82,500 Goodwill 1,357,681 ----------
Total assets acquired 1,823,620 Total liabilities assumed 302,429 ----------
Net assets acquired $1,521,191 ==========
NOTE 10--LOAN TRANSACTIONS
Dialysis Corporation of America has provided and may continue to provide funds in excess of capital contributions to meet working capital requirements of its dialysis facility subsidiaries, usually until they become self-sufficient. The operating agreements for the Dialysis Corporation of America subsidiaries provide for cash flow and other proceeds to first pay any such financing, exclusive of any tax payment distributions.
NOTE 11--INVESTMENT
During the period January, 2000 through December, 2002, the company made various loans aggregating approximately $2,450,000 with a 10% annual interest rate, to Linux Global Partners, a company investing in Linux software companies, one of which initiated the marketing of a Linux desktop operating system. In conjunction with the original loan the company acquired an ownership interest in
MEDICORE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2004
NOTE 11--INVESTMENT--Continued
Linux Global Partners. In consideration for the company's extending the due date on the loans on several occasions it received additional shares of Linux Global Partners' common stock. Both the company and Dialysis Corporation of America presently own an interest in Linux Global Partners
Interest on the notes evidencing the company's loans to Linux Global Partners amounted to approximately $15,000 during 2003 (through January 24, 2003).
The unpaid loans and accrued interest were satisfied through the company's foreclosure in January, 2003, of 4,115,815 shares of Ximian, Inc.'s series A convertible preferred stock which were part of the collateral securing Linux Global Partners' indebtedness to the company. On January 24, 2003, Xandros, Inc., a 95% owned subsidiary of Linux Global Partners, purchased the Ximian preferred shares at the public foreclosure sale and deposited 775,000 shares of its common stock (approximately 1.5% of Xandros) as a good faith deposit with the full amount due in cash. Upon Xandros' failure to make the payment, the company, as the next highest bidder, obtained the Ximian preferred stock and, in accordance with the terms of the public auction retained the Xandros shares in satisfaction of the indebtedness due from Linux Global Partners. Thereafter, in connection with a third-party's acquisition of Ximian in August, 2003, the company sold the Ximian preferred stock for approximately $3,541,000 in cash proceeds resulting in a gain of approximately $784,000. An additional approximately $805,000 was placed in escrow, with approximately $402,000 of the escrowed funds released to the company in August 2004 and the remaining balance to be released in August 2005, pending fulfillment by the parties to the Ximian acquisition of certain conditions. The company recorded a gain of $402,000 in August 2004 and will record an additional gain based on future proceeds received.
NOTE 12--SALE OF INTEREST IN FORMER SUBSIDIARY
On April 6, 2001, the company entered into an agreement with Simclar International to sell its 71.3% ownership interest in Techdyne, Inc. (now Simclar, Inc.) to Simclar International for $10,000,000. The agreement provided for an earn-out consisting of 3% of consolidated Techdyne sales for the three fiscal years commencing January 1, 2001. Limitations on the earn-out ranged from a $5,000,000 maximum to a $2,500,000 minimum earn-out. The earn-out was payable in cash each year for the earn-out period just ended. In April, 2002, the company received the first earn-out payment of $1,105,000. In April, 2003, the company received the second earn-out payment of $1,011,000. In April, 2004, the company received a third earn-out payment of $930,248. The total earn-out payments received of approximately $3,046,000 exceeded the $2,500,000 minimum earn-out previously recorded by approximately $546,000, which has been reflected as a non-operating gain in the consolidated statement of operations. Based on Techdyne (Simclar, Inc.) consolidated sales of $36,187,105 for 2003 on which the earn-out payment is supposed to be computed based on the Agreement for Sales and Purchase of Shares, the earn-out payment received in April, 2004, should have been $1,085,613. The company has demanded payment of the $155,365 balance due from Simclar International, and on April 10, 2004, the company filed an action in the 11th Judicial Circuit in Miami-Dade County, Florida to collect the balance of the earn-out payment due. Simclar has filed a counterclaim against the company, alleging that it erroneously overpaid the company $316,464 as a result of Simclar certifying erroneous sales amounts for the years 2001, 2002 and 2003. The company believes the counterclaim is without merit.
MEDICORE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2004
NOTE 13--STOCK REPURCHASES
In December, 2002, the company's board of directors authorized the purchase of up to approximately 1,000,000 shares of the company's outstanding common stock based on current market prices. The company repurchased and cancelled 48,500 shares for approximately $70,000 in 2003. No repurchases were made during 2004.
NOTE 14--SUPPLEMENTAL CASH FLOW INFORMATION
The following amounts (rounded to the nearest thousand) represent non-cash financing and investing activities and other cash flow information:
NOTE 15--SUBSIDIARY STOCK SPLIT
The board of directors of Dialysis Corporation of America declared a two-for-one stock split with respect to Dialysis Corporation of America's 3,968,772 shares of outstanding common stock. The record date of the split was January 28, 2004; the distribution date was February 9, 2004; and the date Nasdaq reported the adjusted price of the common stock was February 10, 2004. The two-for-one stock split increased the outstanding shares of Dialysis Corporation of America's common stock at that time to 7,937,344 shares. The split also required adjustment in the outstanding stock options of Dialysis Corporation of America by doubling the number of shares obtainable upon exercise, and halving the exercise price of the options. See Note 5.
MEDICORE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2004
NOTE 16--QUARTERLY FINANCIAL INFORMATION (Unaudited)
The following summarizes certain quarterly operating data (in thousands except per share data):
Since the computation of earnings per share is made independently for each quarter using the treasury stock method, the total of four quarters earnings do not necessarily equal earnings per share for the year.
NOTE 17--FOURTH QUARTER DATA (Unaudited)
The company recorded an income tax benefit adjustment to the valuation allowance relating to its deferred tax asset of approximately $102,000 during the fourth quarter of 2002.
MEDICORE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2004
NOTE 18--AFFILIATE FINANCIAL INFORMATION
The following amounts represent certain operating data of Dialysis Corporation of America's 40% owned Ohio affiliate that is accounted for on the equity method and not consolidated for financial reporting purposes (see Note 1):
2004 2003 2002 ---------- ---------- ---------- Revenues $2,275,000 $1,547,000 $1,600,000 ========== ========== ========== Gross profit $1,244,000 $ 600,000 $ 665,000 ========== ========== ========== Net income $ 707,000 $ 111,000 $ 174,000 ========== ========== ==========
The following amounts are from the balance sheet of Dialysis Corporation of America's 40% owned Ohio affiliate:
December 31, --------------------------- 2004 2003 ---------- ---------- Current assets $ 945,321 $ 451,104 Non-current assets 160,504 206,540 ---------- ---------- Total assets $1,105,825 $ 657,644 ========== ==========
Current liabilities $ 244,570 $ 211,221 Non-current liabilities -- 50,953 Capital 861,255 395,470 ---------- ---------- Total liabilities and capital $1,105,825 $ 657,644 ========== ==========
NOTE 19--SUBSEQUENT EVENTS
On March 15, 2005, the company and Dialysis Corporation of America jointly announced that they have agreed to terms whereby the company, which owns approximately 56% of Dialysis Corporation of America (57% at December 31, 2004), will be acquired by Dialysis Corporation of America for a total consideration of approximately 5,289,000 shares of Dialysis Corporation of America common stock. Upon completion of the merger, each shareholder of the Company is anticipated to receive .68 shares of Dialysis Corporation of America common stock for each share of the Company's common stock, and the Company's ownership of Dialysis Corporation of America will be retired, resulting in approximately 9,000,000 shares of Dialysis Corporation of America to remain outstanding. Completion of the transaction is subject to shareholder approval of each company.
The merger is intended to simplify the corporate structure and enable the ownership of the control interest in Dialysis Corporation of America to be held by public shareholders. The merger will provide Dialysis Corporation of America with additional capital resources to continue to build its dialysis business.
Schedule II - Valuation and Qualifying Accounts Medicore, Inc. and Subsidiaries
December 31, 2004
(1) Net (write-offs) recoveries against receivables allowance. (2) Net write-offs against inventory reserves.
Exhibits
to
MEDICORE, INC
Annual Report on Form 10-K For the Fiscal Year Ended December 31, 2004
21 Subsidiaries of the Company
31.1 Certification of Chief Executive Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934.
31.2 Certification of Chief Financial Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934.
32.1 Certification of Chief Executive Officer and Principal Financial Officer pursuant to Rule 13a-14(b) of the Securities Exchange Act of 1934 and 18 U.S.C. Section 1350.