ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This discussion contains management’s discussion and analysis of our financial condition and results of operations for the period covered by this Form 10-Q and should be read in conjunction with the respective consolidated financial statements and related footnotes included in both Part I of this Form 10-Q and the Company’s prospectus (the “Prospectus”), dated April 20, 2016, filed with the Securities and Exchange Commission pursuant to Rule 424(b) of the Securities Act of 1933, as amended, which is deemed to be part of the Company’s Registration Statement on Form S-1 (File No. 333-206686), as amended (the “Registration Statement”), as well as the section of the Prospectus entitled Management’s Discussion and Analysis of Financial Condition and Results of Operations.
On April 26, 2016, the Company completed the initial public offering (the “IPO”) of 8,625,000 shares of the common stock, par value $0.01 per share (the “Common Stock”) of the Company, for cash consideration of $22.00 per share ($20.515 per share net of underwriting discounts).
The following discussion contains forward-looking statements that reflect our plans, estimates and beliefs and involve numerous risks and uncertainties. Actual results may differ materially from those contained in any forward-looking statement, due to a number of factors, including those discussed in the section of this Form 10-Q entitled “Special Note Regarding Forward-Looking Statements” and the section entitled "Risk Factors.” in this Form 10-Q and in the Prospectus. You should read these sections carefully.
Unless otherwise indicated or the context otherwise requires, references in this Form 10-Q to "we," "our," "us" and the “Company” and similar terms refer to American Renal Associates Holdings, Inc. and its consolidated entities taken together as a whole, except where these terms refer to providers of dialysis services, in which case they refer to our dialysis clinic joint ventures, in which we have a controlling interest and our physician partners have the noncontrolling interest, or to the dialysis facilities owned by such joint venture companies, as applicable. References to "ARA" refer to American Renal Associates Holdings, Inc. and not any of its consolidated entities. References to "ARH" refer to American Renal Holdings Inc., an indirect wholly owned subsidiary of Holdings.
Executive Overview
We are the largest dialysis services provider in the United States focused exclusively on joint venture partnerships with physicians. We provide high-quality patient care and clinical outcomes through physicians, known as nephrologists, who specialize in treating patients suffering from end stage renal disease (“ESRD”). Our core values create a culture of clinical autonomy and operational accountability for our physician partners and staff members. We believe our joint venture model has helped us become one of the fastest-growing national dialysis services platforms, in terms of the growth rate of our non-acquired treatments since 2012.
We derive our patient service operating revenues from providing outpatient and inpatient dialysis treatments. The sources of these patient service operating revenues are principally government-based programs, including Medicare and Medicaid plans as well as commercial insurance plans. Substantially all of our payors (both government-based and commercial) have moved toward a bundled payment system of reimbursement, with a single lump-sum per treatment covering not only the dialysis treatment itself but also the ancillary items and services provided to a patient during the treatment, such as laboratory services and pharmaceuticals.
We operate our clinics exclusively through our JV model, in which we share the ownership and operational responsibility of our dialysis clinics with our nephrologist partners and other joint venture partners, while the providers of the majority of dialysis services in the United States operate through a combination of wholly owned subsidiaries and
joint ventures. Each of our clinics is maintained as a separate joint venture in which generally we have the controlling interest and our nephrologist partners and other joint venture partners have a noncontrolling interest. We believe that our exclusive focus on a JV model makes us well-positioned to increase our market share by attracting nephrologists who are not only interested in our service platform but also want greater clinical autonomy and a potential return on capital investment associated with ownership of a noncontrolling interest in a dialysis clinic. We believe our JV model best aligns our interests with those of our nephrologist partners and their patients. By owning a portion of the clinics where their patients are treated, our nephrologist partners have a vested stake in the quality, reputation and performance of the clinics. We believe that this enhances patient and staff satisfaction and retention, clinical outcomes, patient growth, and operational and financial performance.
Key Factors Affecting Our Results of Operations
Clinic Growth and Start-Up Clinic Costs
Our results of operations are dependent on increases in the number of, and growth at, our de novo clinics and acquired clinics as well as growth at our existing clinics. We have experienced significant growth since opening our first clinic in December 2000. As of September 30, 2016, we had
developed 156 de novo clinics and 51 acquired clinics. The following table shows the number of de novo and acquired clinics over the periods indicated:
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Three Months Ended September 30,
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Nine Months Ended September 30,
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|
|
|
2016
|
|
2015
|
|
2016
|
|
2015
|
|
De novo clinics(1)
|
|
5
|
|
6
|
|
13
|
|
12
|
|
Acquired clinics(2)
|
|
1
|
|
—
|
|
2
|
|
1
|
|
Total new clinics
|
|
6
|
|
6
|
|
15
|
|
13
|
|
|
|
(1)
|
Clinics formed by us which began to operate and dialyze patients in the applicable period.
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|
|
(2)
|
Clinics acquired by us in the applicable period.
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De novo clinics.
We have primarily grown through de novo clinic development. A typical de novo facility requires approximately $1.3 to $2.0 million of capital for equipment purchases, leasehold improvements and initial working capital. A portion of the total capital required to develop a de novo clinic may be equity capital funded by us and our nephrologist partners in proportion to our respective ownership interests. The balance of such development cost may be funded through third-party debt financing or through intercompany loans provided by one of our wholly owned subsidiaries to the joint venture entity that, in each case, we and our nephrologist partners generally guarantee on a basis proportionate to our respective ownership interests. For the three months ended September 30, 2016 and September 30, 2015 our development capital expenditures were $9.7 million and $6.4 million, respectively, representing 5.0% and 3.8% of our net revenues, respectively.
Our results of operations have been and will continue to be materially affected by the timing and number of openings, and the timing of certifications of de novo clinic openings and the amount of de novo clinic opening costs incurred. In particular, our patient care costs on an absolute basis and as a percentage of our patient service operating revenues may fluctuate from quarter to quarter due to the timing and number of de novo clinic openings, which affect our operating income in a given quarter. Our patient care costs reflect pre-opening expenses, which primarily consist of staff expenses, including the costs of hiring and training new staff, as well as rent and utilities. In addition, a de novo clinic builds its patient volumes over time and, as a result, generally has lower revenue than our existing clinics. Newly established de novo clinics, although contributing to increased revenues, have adversely affected our results of operations in the short term due to a smaller patient base to absorb operating expenses. We consider a de novo clinic to be a “start-up clinic” until the first month it generates positive clinic-level EBITDA. We typically achieve positive clinic-level monthly EBITDA within, on average, six months after the first treatment at a clinic. However, approximately 17% of our de novo clinics have exceeded six months from first treatment to positive clinic-level monthly EBITDA, averaging approximately 12 months to positive clinic-level monthly EBITDA. Clinic-level EBITDA differs from our consolidated EBITDA in that management fees, consisting of a percentage of the clinic’s net revenues paid to ARA for management services, are eliminated in consolidation but are reflected on a clinic-level basis.
Start-up clinic losses affect the comparability of our results from period to period and may disproportionately impact our operating margins in any given quarter, including quarters during which we have a significant number of clinics qualifying as start-up clinics. The following table sets forth the number of de novo clinics opened during the periods indicated.
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Three Months Ended
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March 31,
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June 30,
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September 30,
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December 31,
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Total
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2016
|
|
2
|
|
6
|
|
5
|
|
—
|
|
13
|
|
2015
|
|
1
|
|
5
|
|
6
|
|
4
|
|
16
|
|
2014
|
|
2
|
|
4
|
|
3
|
|
6
|
|
15
|
|
2013
|
|
1
|
|
3
|
|
2
|
|
11
|
|
17
|
|
Existing clinics.
Depending on demand and capacity utilization, we may have space within our existing clinics to accommodate a greater number of dialysis stations or operate additional shifts in order to increase patient volume without compromising our quality standards. Such expansions leverage the fixed cost infrastructure of our existing clinics. From January 1, 2012 to September 30, 2016, we added 139 dialysis stations to our existing clinics, representing the equivalent of nearly eight de novo clinics.
Acquired clinics.
Our results of operations have been and will continue to be affected by the timing and number of our acquisitions. We have also grown through acquisitions of existing clinics. Our acquisition strategy is primarily driven by the quality of the nephrologist in the market. We opportunistically pursue select acquisitions in situations where we believe the clinic offers us an attractive opportunity to enter a new market or expand within an existing market. Acquiring an existing dialysis clinic requires a greater initial investment, but an acquired clinic contributes positively to our results of operations sooner than a de novo clinic. Acquisition integration costs are typically minimal compared with start-up costs in connection with opening de novo clinics.
Our clinic growth drives our treatment growth. The following table summarizes the sources of our treatment growth for the periods indicated:
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|
Three Months Ended September 30,
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Nine Months Ended September 30,
|
|
Source of Treatment Growth:
|
|
2016
|
|
2015
|
|
2016
|
|
2015
|
|
Non-acquired treatment growth(1)
|
|
10.2
|
%
|
13.3
|
%
|
11.8
|
%
|
11.9
|
%
|
Acquired treatment growth(2)
|
|
1.2
|
%
|
4.0
|
%
|
0.9
|
%
|
4.0
|
%
|
Total treatment growth
|
|
11.4
|
%
|
17.3
|
%
|
12.7
|
%
|
15.9
|
%
|
|
|
(1)
|
Represents net growth in treatments attributable to clinics operating at the end of the period that were also open at the end of the prior period and de novo clinics opened since the end of the prior period.
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|
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(2)
|
Represents net growth in treatments attributable to clinics acquired since the end of the prior period.
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Sources of Revenues by Payor
Our patient service operating revenues are principally driven by our mix of commercial and government payor patients and commercial and government payment rates. We are generally paid more for services provided to patients covered by commercial healthcare plans than we are for patients covered by Medicare or Medicaid. ESRD patients covered by employer group health plans generally transition to Medicare coverage after a maximum of 33 months. Medicare payment rates are determined under the Medicare ESRD program's bundled payment system, which sets a base rate on an annual basis that is subject to adjustments to arrive at the actual payment rate for individual clinics. During the years ending December 31, 2014 and 2015, the Medicare ESRD PPS payment rates for our clinics were approximately $248 and $247, respectively, per treatment. The ESRD PPS final rule for 2016 released on October 29, 2015 (the “2016 Final Rule”) lowered the base rate from $239.43 to $230.39 and modified criteria for certain rate adjustments. Due to the various adjusters, the changes in the Medicare payment rates for 2016 will not be material to us. The Centers for Medicare and Medicaid Services (“CMS”) issues annual updates to the ESRD PPS which may impact the base rate as well as the various adjusters. The ESRD PPS final rule for 2017 was released on October 28, 2016 by CMS (the “2017 Final Rule”). The 2017 Final Rule includes a base rate of $231.55, representing a $1.16 increase from the 2016 base rate
of $230.39. CMS has estimated that the 2017 Final Rule would result in an overall increase of payments to ESRD facilities of 0.7%.
Medicare payment rates are generally insufficient to cover our total operating expenses allocable to providing dialysis treatments for Medicare patients. As a result, our ability to generate operating income is substantially dependent on revenues derived from commercial payors, which typically pay us either negotiated payment rates or a discount to our usual and customary fee schedule. Many commercial insurance programs have been moving towards a bundled payment system, which may not reimburse us for all of our operating costs, such as the cost of ESA’s and other pharmaceuticals.
The percentage of treatments by payor source does not necessarily correlate with our results of operations or margins in any given period because of a number of other factors, including the effect of the difference in rates per treatment associated with each commercial payor. For the three years ended December 31, 2015, commercial payors and others, including the veterans administration, accounted for an average of approximately 13.3% of the treatments we performed, while the average for the last four quarters ended September 30, 2016 is 16.6%. The change in the mix of patients and treatments has largely been driven by enrollment in Affordable Care Act (“ACA”) plans (both on-exchange and off-exchange).
During the third quarter of 2016, CMS issued a request for information (the “RFI”) seeking public comment on the concerns that some healthcare providers and provider-affiliated organizations may be steering patients eligible for, or receiving, Medicare and/or Medicaid benefits into ACA-compliant individual marketplace plans, including health insurance marketplace plans. The request for information also sought public comment about certain charities, which provide assistance to patients seeking to enroll in private insurance coverage. CMS also sent letters to all Medicare-enrolled dialysis facilities and centers, including ARA’s facilities, informing them of this request for information. CMS indicated that it is considering potential regulatory and operational options to prohibit or limit premium payments and routine waiver of cost-sharing for qualified health plans by health care providers, revisions to Medicare and Medicaid provider enrollment rules, potential changes that would allow individual market plans to limit their payment to health care providers to Medicare-based amounts for particular services and items of care, and the imposition of civil monetary penalties for individuals that fail to provide correct information about consumers enrolling in a plan. See Part II, Item 1A. “Risk Factors”. In response to the RFI, many commercial payors and trade associations demanded the prohibition of any charitable premium assistance for marketplace plans on and off the exchange. In addition, there were requests from commercial payors and certain trade associations that patients, and specifically ESRD patients, that have access to any form of alternate coverage, should not be allowed to select an ACA plan offered on or off the exchange.
Pending further policy guidance from CMS, in November 2016, for patients enrolled in minimum essential Medicaid coverage, we have temporarily suspended assistance in the application process for charitable premium support from the American Kidney Fund (“AKF”), which we expect will cause an adverse change in the mix of patients and treatments. This change will not affect our provision of such assistance in the application process to other patients.
A small but growing portion of ARA’s Medicaid patients have chosen to enhance their healthcare benefits by electing to enroll in an ACA plan. As of September 30, 2016, approximately 300 patients or 2% of ARAH’s total patients, had pre-existing minimum essential Medicaid coverage and also chose additional coverage through an ACA plan. Virtually all of these low-income patients have relied on charitable premium assistance because they are ineligible for federal premium tax credits. If CMS establishes new policies to restrict or limit charitable premium assistance for ACA plans to patients with pre-existing Medicaid coverage, these patients will likely revert back to Medicaid-only coverage. In addition, approximately 235 additional patients or 1.7% of ARA’s total patients, were enrolled in an ACA plan and not enrolled in the Medicaid program as of September 30, 2016. Approximately 85% of these patients have relied on charitable premium assistance. These patients chose ACA plans for a variety of reasons, including ineligibility for government programs, the shift of coverage options from the individual and/or small group markets to ACA exchanges, lack of requisite work credits to be eligible for Medicare coverage, the opportunity to consolidate family coverage under one insurance plan, and the lack of Medigap policy coverage due to certain state insurance department restrictions, among other reasons. Insurance coverage disruptions for these patients could result if CMS establishes new guidelines that extend to this subset of patients. The average revenue per treatment for ACA plans is below that of our overall average commercial revenue per treatment but above our Medicare rate.
The change in the patient insurance education policy to suspend activities in relation to applications to the AKF for charitable premium assistance by patients enrolled in minimum essential Medicaid coverage seeking additional coverage through an ACA plan would adversely impact patient service operating revenue by the aggregate difference in Medicaid rates and the rates under the ACA plans. If CMS were to issue broader guidance that made access to charitable premium assistance unavailable to all ESRD patients on ACA Plans, patient service operating revenue would be adversely impacted by an additional amount. The aforementioned impacts are described before any potential future offsetting actions that could be taken by the Company. See Part II, Item 1A. “Risk Factors”.
During the third quarter of 2016, in addition to the temporary suspension described above, the Company adopted policies and procedures to ensure that its patient insurance education program provides broad-based information to patients about their insurance options, so that the patients are in the best possible position to choose coverage based on their own best interests. Under this program, the Company informs patients, when appropriate, about insurance plans available under the ACA and other individual marketplace plans as alternatives or supplements to coverage under Medicare or Medicaid. The Company will continue to advise its patients about the potential availability of assistance with the payment of premiums from the AKF under the AKF Health Insurance Premium Program (“HIPP”), subject to the temporary suspension described above, and compliance with the AKF’s policies and procedures and approved regulatory guidance from CMS.
In addition, recently there have been other significant developments in the market that may affect our business, including the withdrawal of some insurers from offering ACA and individual marketplace plans in certain states, increases in premiums for ACA plans, and continuing efforts on the part of insurers to reduce the amount paid to providers per treatment. Further, there could be additional changes in our business in the future resulting from potential regulatory actions and other third party practices following the recent CMS request for information seeking public comment on concerns relating to steering of patients eligible for Medicare and Medicaid into ACA plans, and the recent changes to the AKF HIPP program announced by AKF. See Part II, Item 1 — “Legal Proceedings.”
The temporary suspension, and any CMS action relating to establishing policies to restrict or limit charitable assistance for ACA plans, will adversely impact the number of patients covered by ACA and other individual marketplace plans, the Company’s average reimbursement rate and its results of operations and cash flows, which impact may be material. Further, the other changes to the Company’s patient education program, whether or not the suspension continues or CMS restricts charitable assistance, together with the other developments in the market described above, including the impact of such changes on enrollment in ACA plans, and/or potential regulatory changes in the future, may adversely impact the number of the Company’s patients covered by ACA and other individual marketplace plans, as well as the Company’s average reimbursement rate in the future. While the Company is unable to predict the full effect the foregoing factors may have on its business, results of operations, and cash flows, the effect may be material.
The following table summarizes our patient service operating revenues by source for the periods indicated.
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|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30,
|
|
Nine Months Ended September 30,
|
|
Source of Revenues:
|
|
2016
|
|
2015
|
|
2016
|
|
2015
|
|
Government-based and other(1)
|
|
54.7
|
%
|
57.7
|
%
|
55.6
|
%
|
58.6
|
%
|
Commercial and other(2)
|
|
45.3
|
%
|
42.3
|
%
|
44.4
|
%
|
41.4
|
%
|
|
|
100.0
|
%
|
100.0
|
%
|
100.0
|
%
|
100.0
|
%
|
|
|
(1)
|
Principally Medicare and Medicaid and also includes hospitals and patient pay which we refer to collectively as “Government and other”. “Patient pay” revenues consist of payments received directly from patients who are either uninsured or self-pay a portion of the bill.
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|
|
(2)
|
Principally commercial insurance companies and also includes the veterans administration, which we refer to collectively as “Commercial and other”.
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Clinical Staff, Pharmaceutical and Medical Supply Costs
Because our ability to influence the pricing of our services is limited, our profitability depends not only on our ability to grow but also on our ability to manage patient care costs, including clinical staff, pharmaceutical and medical supply costs. The principal drivers of our patient care costs are clinical staff hours per treatment, salary rates and vendor pricing and utilization of pharmaceuticals, including ESA’s, principally EPO and Aranesp, and medical supplies. The price of EPO supplied by Amgen increased for us in 2016 while the price of Aranesp decreased. In the future any increase in price of EPO or Aranesp could adversely affect our operating results and financial condition. We may not have access to certain other ESAs that may be more cost-effective and due to product delays and availability, we expect our clinics will predominantly be using EPO and Aranesp in the foreseeable future. Furthermore, even if we do have access to other sources of ESAs, we cannot assure you that these alternatives would be cost-effective for us or work as effectively as EPO or Aranesp. Increased utilization of EPO or Aranesp for patients for whom the cost of ESAs is included in a bundled reimbursement rate, including Medicare patients, could increase our operating costs without any increase in revenue. In addition, shortage of supplies, such as the current shortage of peritoneal dialysis solution affecting dialysis providers throughout the United States, could have a negative impact on our revenues, earnings and cash flows. Other cost categories, such as employee benefit costs and insurance costs, can also result in significant cost changes from period to period. Our results of operations are also affected by the start-up clinic costs described above.
Seasonality
Our treatment volumes are sensitive to seasonal fluctuations due to generally fewer treatment days during the first quarter of the calendar year. Additionally, our patients are generally responsible for a greater percentage of the cost of their treatments during the early months of the year which may lead to lower total net revenues and lower net revenues per treatment during the early months of the year. Our quarterly operating results may fluctuate significantly in the future depending on these and other factors.
Future Charges
The completion of the IPO has had effects on our results of operations and financial conditions. In connection with the IPO, our results of operations are affected by one-time costs and recurring costs of being a public company, including increases in executive and board compensation (including equity based compensation), increased insurance, accounting, legal and investor relations costs and the costs of compliance with the Sarbanes-Oxley Act of 2002 and the costs of complying with the other rules and regulations of the SEC and the New York Stock Exchange. In addition, when the available exemptions under the Jumpstart Our Business Startups Act cease to apply, we expect to incur additional expenses and devote increased management effort toward ensuring compliance with the applicable regulatory and corporate governance requirements. In addition, we have incurred and expect to incur additional legal expenses in connection with various legal and regulatory matters described below and related matters. See “–Operating Expenses – Certain Legal Matters” and Part II, Item 1 – “Legal Proceedings.”
As a result of certain modifications made to our outstanding market and performance-based stock options at the time of the IPO, the amount of the unrecognized non-cash compensation costs increased by approximately $38.9 million. As of September 30, 2016,
we had approximately $33.0 million of unrecognized compensation costs related to unvested share-based compensation arrangements of which $27.7 million is attributable to share-based awards with market and performance conditions and $5.3 million is attributable to share-based awards with performance or time-based vesting. The compensation costs associated with time-based vesting awards are expected to be recognized as expense over a weighted average period of approximately two years. The compensation costs associated with the market and performance based option modification at the time of the IPO (the “Modification Expense”) will be recognized over a period of approximately 12 months from the date of the IPO.
In addition, in connection with the distribution (the “NewCo Distributions”) of membership interests in an entity holding assigned clinic loans (the “Assigned Clinic Loans”), described in “Note 8 – Debt” to our unaudited consolidated financial statements, since the interest on these loans will no longer be eliminated in consolidation, we expect to incur additional interest expense. This increase in interest expense is expected to be offset by the reduction in interest expense as a result of the refinancing of our second lien term loans.
On April 26, 2016, we entered into an income tax receivable agreement (the “TRA”) for the benefit of our pre-IPO stockholders, which provides for the payment by us to our pre-IPO stockholders on a pro rata basis of 85% of the amount of cash savings, if any, in U.S. federal, state and local income tax that we actually realize as a result of the option deductions (as defined in the TRA). While the actual amount and timing of any payments under the TRA will vary depending upon a number of factors, including the amount and timing of the taxable income we generate in the future and whether and when any relevant stock options, as defined in the TRA, are exercised and the value of our common stock at such time, we expect that during the term of the TRA the payments that we make will be material. See "Certain Relationships and Related Party Transactions—Income Tax Receivable Agreement” in the Prospectus. We recorded a liability for the value of the TRA at the time of the IPO. We calculated fair value of the TRA by using a Monte Carlo simulation-based approach that relies on significant assumptions about our stock price, stock volatility and risk-free rate as well as the timing and amounts of options exercised. Changes in assumptions based on future events, including changes in the price of our common stock from our initial public offering price, will change the amount of the liability for the TRA, and such changes may be material. Any changes to the TRA liability will be recognized in our statement of operations as Income tax receivable agreement income (expense) in future periods. See Note 12 to the consolidated financial statements included in Part I of this Form 10-Q.
FTC Decision and Order
We are subject to a Decision and Order entered In the Matter of American Renal Associates Inc. and Fresenius Medical Care Holdings, Inc. by the Federal Trade Commission. The Decision and Order was entered in 2007 following a nonpublic investigation by the Federal Trade Commission into proposed dialysis clinic acquisition activities in Rhode Island and the execution of an Agreement Containing Consent Order by the parties. The Decision and Order prohibits us for a period of ten years through October 17, 2017, without prior notice to the Federal Trade Commission from: (1) acquiring dialysis clinics located in ZIP codes in and around the cities of Cranston and Warwick, Rhode Island, and/or (2) entering into any contract to manage or operate dialysis clinics in ZIP codes in and around the cities of Cranston and Warwick. These prohibitions are subject to a number of exceptions that permit us to develop, own, manage or operate de novo dialysis clinics or dialysis clinics owned or operated as of the date the Decision and Order was entered, or to perform specified services, including offsite laboratory services, bookkeeping services, accounting services, billing services, supply services and purchasing and logistics services with the adherence to confidentiality requirements. We
have complied and intend to continue to comply with the terms of the Decision and Order and on September 19, 2016 we submitted an annual compliance report to the Federal Trade Commission. We do not believe that compliance with the Decision and Order will have a material impact on our revenues, earnings or cash flows.
Key Performance Indicators
We use a variety of financial and other information to evaluate our financial condition and operating performance. Some of this information is financial information that is prepared in accordance with GAAP, while other financial information, such as Adjusted EBITDA and Adjusted EBITDA-NCI, is not prepared in accordance with GAAP. The following table presents certain operating data, which we monitor as key performance indicators, for the periods indicated.
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30,
|
|
Nine Months Ended September 30,
|
|
Operating Data and Other Non-GAAP Financial Data:
|
|
2016
|
|
2015
|
|
2016
|
|
2015
|
|
Number of clinics (as of end of period)
|
|
|
207
|
|
|
187
|
|
|
207
|
|
|
187
|
|
Number of de novo clinics opened (during period)
|
|
|
5
|
|
|
6
|
|
|
13
|
|
|
12
|
|
Patients (as of end of period)
|
|
|
14,166
|
|
|
12,543
|
|
|
14,166
|
|
|
12,543
|
|
Number of treatments
|
|
|
516,043
|
|
|
463,181
|
|
|
1,497,077
|
|
|
1,328,842
|
|
Non-acquired treatment growth
|
|
|
10.2
|
%
|
|
13.3
|
%
|
|
11.8
|
%
|
|
11.9
|
%
|
Patient service operating revenues per treatment
|
|
$
|
378
|
|
$
|
365
|
|
$
|
371
|
|
$
|
363
|
|
Patient care costs per treatment
|
|
$
|
225
|
|
$
|
216
|
|
$
|
221
|
|
$
|
217
|
|
Adjusted patient care costs per treatment (1)
|
|
$
|
221
|
|
$
|
216
|
|
$
|
219
|
|
$
|
217
|
|
General and administrative expenses per treatment
|
|
$
|
65
|
|
$
|
42
|
|
$
|
58
|
|
$
|
43
|
|
Adjusted general and administrative expenses per treatment (2)
|
|
$
|
45
|
|
$
|
42
|
|
$
|
46
|
|
$
|
43
|
|
Provision for uncollectible accounts per treatment
|
|
$
|
4
|
|
$
|
3
|
|
$
|
3
|
|
$
|
3
|
|
Adjusted EBITDA (including noncontrolling interests)(3)
|
|
$
|
56,154
|
|
$
|
49,169
|
|
$
|
156,292
|
|
$
|
136,043
|
|
Adjusted EBITDA-NCI (3)
|
|
$
|
32,532
|
|
$
|
29,678
|
|
$
|
91,381
|
|
$
|
82,689
|
|
|
|
(1)
|
Excludes $1.9 million and $3.3 million Modification Expense during the three and nine months ended September 30, 2016, respectively. Additionally, the nine months ended September 30, 2016 excludes $0.1 million of stock compensation expense as a result of early adoption of ASU 2016-09, as it relates to the modified options. Refer to Note 1.
|
|
|
(2)
|
Excludes $10.3 million and $18.3 of Modification and other stock compensation expense related to the modification of options and other transactions at the time of the Company’s IPO (together with the Modification Expense, the “Modification and Other Stock Compensation Expense”) during the three and nine months ended September 30, 2016, all of which will be expensed within 12 months of the IPO. Additionally, the nine months ended September 30, 2016 excludes $0.3 million of stock compensation expense as a result of early adoption of ASU 2016-09, as it relates to the modified options. Refer to Note 1.
|
|
|
(3)
|
See “Non-GAAP Financial Measures” below.
|
Number of Clinics
We track our number of clinics as an indicator of growth. The number of clinics as of the end of the period includes all opened de novo clinics, acquired clinics and existing clinics. See “—Key Factors Affecting Our Results of Operations—Clinic Growth and Start-Up Clinic Costs” for a discussion of clinic growth and start-up costs as a factor affecting our operating performance.
Patient Volume
The number of patients as of the end of the period is an indicator we use to assess our performance. Our patient volumes are correlated with our de novo clinic openings, and to a lesser extent, our marketing efforts and certain external factors, such as the overall economic environment. We believe that patients choose to get their dialysis services at one of our clinics due to their relationship with our physicians, as well as the quality of care, comfort and amenities and convenience of location and clinic hours.
Non-Acquired Treatments
We evaluate our operating performance based on the growth in number of non-acquired treatments, or treatments performed at our existing and de novo clinics, including those de novo clinics opened during the applicable
period. Accordingly, our non-acquired treatment growth rate is affected by the timing and number of de novo clinic openings. We calculate non-acquired treatment growth by dividing the number of treatments performed during the applicable period by the number of treatments performed during the corresponding prior period, excluding the number of treatments performed at clinics acquired during the applicable period, and expressing the resulting number as a percentage.
Per Treatment Metrics
We evaluate our patient service operating revenues, patient care costs, general and administrative expenses and provision for uncollectible accounts on a per treatment basis to assess our operational efficiency. We believe our disciplined revenue cycle management has contributed to the consistency of our historical results.
Non-GAAP Financial Measures
This quarterly report on Form 10-Q makes reference to certain Non-GAAP measures. These non-GAAP measures are not recognized
measures under U.S. GAAP and do not have a standardized meaning prescribed by U.S. GAAP. When used, these measures are defined in such terms as to allow the reconciliation to the closest U.S. GAAP measure. These measures are therefore unlikely to be comparable to similar measures presented by other companies. Rather, these measures are provided as additional information to complement those U.S. GAAP measures by providing further understanding of the Company’s results of operations from management’s perspective. Accordingly, they should not be considered in isolation nor as a substitute for analysis of the Company’s financial information reported under U.S. GAAP. We use non-GAAP measures, such as Adjusted EBITDA and Adjusted EBITDA-NCI, to provide investors with a supplemental measure of our operating performance and thus highlight trends in our core business that may not otherwise be apparent when relying solely on U.S. GAAP financial measures.
Adjusted EBITDA
We use Adjusted EBITDA and Adjusted EBITDA-NCI to track our performance. “Adjusted EBITDA” is defined as net income before income taxes, interest expense, net, depreciation and amortization, as adjusted for stock-based compensation, loss on early extinguishment of debt, transaction-related costs, certain legal matters costs, income tax receivable agreement income and expense and management fees. “Adjusted EBITDA-NCI” is defined as Adjusted EBITDA less net income attributable to noncontrolling interests. We believe Adjusted EBITDA and Adjusted EBITDA-NCI provide information useful for evaluating our business and understanding our operating performance in a manner similar to management. We believe Adjusted EBITDA is helpful in highlighting trends because Adjusted EBITDA excludes the results of actions that are outside the operational control of management, but can differ significantly from company to company depending on long-term strategic decisions regarding capital structure, the tax jurisdictions in which companies operate and capital investments. We believe Adjusted EBITDA-NCI is helpful in highlighting the amount of Adjusted EBITDA that is available to us after reflecting the interests of our joint venture partners. Adjusted EBITDA and Adjusted EBITDA-NCI are not measures of operating performance computed in accordance with GAAP and should not be considered as a substitute for operating income, net income, cash flows from operations, or other statement of operations or cash flow data prepared in conformity with GAAP, or as measures of profitability or liquidity. In addition, Adjusted EBITDA and Adjusted EBITDA-NCI may not be comparable to similarly titled measures of other companies. Adjusted EBITDA and Adjusted EBITDA-NCI may not be indicative of historical operating results, and we do not mean for it to be predictive of future results of operations or cash flows. Adjusted EBITDA and Adjusted EBITDA-NCI have limitations as analytical tools, and you should not
consider these items in isolation, or as substitutes for an analysis of our results as reported under GAAP. Some of these limitations are that Adjusted EBITDA and Adjusted EBITDA-NCI:
|
|
●
|
do not include stock-based compensation expense;
|
|
|
●
|
do not include transaction-related costs;
|
|
|
●
|
do not include depreciation and amortization—because construction and operation of our dialysis clinics requires significant capital expenditures, depreciation and amortization are a necessary element of our costs and ability to generate profits;
|
|
|
●
|
do not include interest expense—as we have borrowed money for general corporate purposes, interest expense is a necessary element of our costs and ability to generate profits and cash flows;
|
|
|
●
|
do not include income tax receivable agreement income and expense;
|
|
|
●
|
do not include loss on early extinguishment of debt;
|
|
|
●
|
do not include costs related to certain legal matters;
|
|
|
●
|
do not include management fees;
|
|
|
●
|
do not include certain income tax payments that represent a reduction in cash available to us; and
|
|
|
●
|
do not reflect changes in, or cash requirements for, our working capital needs.
|
You should not consider Adjusted EBITDA and Adjusted EBITDA-NCI as alternatives to income from operations or net income, determined in accordance with GAAP, as an indicator of our operating performance, or as alternatives to cash flows from operating activities, determined in accordance with GAAP, as an indicator of cash flows or as a measure of liquidity. This presentation of Adjusted EBITDA and Adjusted EBITDA-NCI may not be directly comparable to similarly titled measures of other companies, since not all companies use identical calculations.
The following table presents Adjusted EBITDA and Adjusted EBITDA-NCI for the periods indicated and the reconciliation from net income to such amounts:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30,
|
|
Nine Months Ended September 30,
|
|
(in thousands)
|
|
2016
|
|
2015
|
|
2016
|
|
2015
|
|
Net Income
|
|
$
|
36,046
|
|
$
|
23,596
|
|
$
|
71,645
|
|
$
|
65,357
|
|
Add:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock-based compensation
|
|
|
12,673
|
|
|
449
|
|
|
23,251
|
|
|
1,052
|
|
Depreciation and amortization
|
|
|
8,687
|
|
|
7,670
|
|
|
24,616
|
|
|
22,842
|
|
Interest expense, net
|
|
|
7,372
|
|
|
11,816
|
|
|
28,571
|
|
|
34,639
|
|
Income tax expense (benefit)
|
|
|
(101)
|
|
|
3,276
|
|
|
1,413
|
|
|
8,821
|
|
Transaction-related costs(a)
|
|
|
—
|
|
|
2,105
|
|
|
2,239
|
|
|
2,105
|
|
Loss on early extinguishment of debt(b)
|
|
|
—
|
|
|
—
|
|
|
4,708
|
|
|
—
|
|
Income tax receivable agreement income(c)
|
|
|
(12,565)
|
|
|
—
|
|
|
(4,730)
|
|
|
—
|
|
Certain legal matters(d)
|
|
|
4,042
|
|
|
—
|
|
|
4,042
|
|
|
—
|
|
Management fees(e)
|
|
|
—
|
|
|
257
|
|
|
537
|
|
|
1,227
|
|
Adjusted EBITDA (including noncontrolling interests)
|
|
|
56,154
|
|
|
49,169
|
|
|
156,292
|
|
|
136,043
|
|
Less: Net income attributable to noncontrolling interests
|
|
|
(23,622)
|
|
|
(19,491)
|
|
|
(64,911)
|
|
|
(53,354)
|
|
Adjusted EBITDA –NCI
|
|
$
|
32,532
|
|
$
|
29,678
|
|
$
|
91,381
|
|
$
|
82,689
|
|
|
|
(a)
|
Represents costs related to debt refinancing and other transactions. See “Note 8 – Debt” and “Note 12 – Related Party Transactions.”
|
|
|
(b)
|
Represents costs related to debt refinancing. See “Note 8 – Debt.
|
|
|
(c)
|
Represents costs related to Income tax receivable agreement. See “Note 4 – Fair Value Measurements.”
|
|
|
(d)
|
Represents costs related to various legal and regulatory matters as described under “ – Operating Expenses – Certain Legal Matters”.
|
|
|
(e)
|
Represents management fees paid to Centerbridge. See “Note 12-Related Party Transactions.”
|
Components of Earnings
Net Patient Service Operating Revenues
Patient service operating revenues.
The major component of our revenues, which we refer to as patient service operating revenues, is derived from dialysis services. Our patient service operating revenues primarily consist of reimbursement from government-based programs and other (Medicare, Medicaid, state workers’ compensation programs and hospitals) and commercial insurance payors and other (including the VA) for dialysis treatments and related services at our clinics. Patient service operating revenues are recognized as services are provided to patients. We maintain a usual and customary fee schedule for dialysis treatment and other patient services; however, actual collectible revenues are normally at a discount to the fee schedule. Medicare and Medicaid programs are billed at predetermined net realizable rates per treatment that are established by statute or regulation. Revenue for contracted payors is recorded at contracted rates and other payors are billed at usual and customary rates, and a contractual allowance is recorded to reflect the expected net realizable revenue for services provided.
Provision for uncollectible accounts.
Patient service operating revenues are reduced by the provision for uncollectible revenues to arrive at net patient service operating revenues. Provision for uncollectible accounts represents reserves established for amounts for which patients are primarily responsible that we believe will not be collectible.
Contractual allowances, along with provisions for uncollectible amounts, are estimated based upon contractual terms, regulatory compliance and historical collection experience. Net revenue recognition and allowances for uncollectible billings require the use of estimates of the amounts that will actually be realized.
Operating Expenses
Patient care costs.
Patient care costs are those costs directly associated with operating and supporting our dialysis clinics. Patient care costs consist principally of salaries, wages and benefits, pharmaceuticals, medical supplies, facility costs and laboratory testing. Salaries, wages and benefits consist of compensation and benefits to staff at our clinics, including stock-based compensation expense. Salaries, wages and benefits also include certain labor costs associated with de novo clinic openings. Facility costs consist of rent and utilities and also include rent in connection with de novo clinic openings. Patient care costs also include medical director fees and insurance costs.
General and administrative expenses.
General and administrative expenses generally consist of compensation and benefits to personnel at our corporate office for clinic and corporate administration, including accounting, billing and cash collection functions, as well as regulatory compliance and legal oversight; charitable contributions; and professional fees. General and administrative expenses also include stock-based compensation expense in connection with stock awards to our corporate officers and employees.
Transaction-related costs.
Transaction-related costs represent costs associated with our debt refinancing and other IPO related transactions. These costs include legal, accounting, valuation and other professional or consulting fees.
Depreciation and amortization.
Depreciation and amortization expense is primarily attributable to our clinics’ equipment and leasehold improvements and amortizing intangible assets. We calculate depreciation and amortization expense using a straight-line method over the assets’ estimated useful lives.
Certain Legal Matters.
Certain legal matters cost includes professional fees and other expenses associated with the Company’s handling of, and response to, the UnitedHealth Group litigation, the SEC inquiry, the CMS request for information, the securities litigation, and the Company’s internal review and analysis of factual and legal issues relating to the aforementioned matters. See Part II, Item 1 – “Legal Proceedings.”
Operating Income
Operating income is equal to our net patient service operating revenues minus our operating expenses. Our operating income is impacted by the factors described above and reflects the effects of losses relating to our start up clinics.
Interest, Loss on Early Extinguishment of Debt, and Taxes
Interest expense, net.
Interest expense represents charges for interest associated with our corporate level debt and credit facilities entered into by our dialysis clinics.
Loss on early extinguishment of debt.
Loss on early extinguishment of debt represents the write-off of unamortized debt issuance costs.
Income tax receivable agreement income/expense.
Income tax receivable agreement income/expense is the income/expense associated with the change in the fair value of the TRA from the prior quarter end.
Income tax expense (benefit).
Income tax expense relates to our share of pre-tax income from our wholly owned subsidiaries and joint ventures as these entities are pass-through entities for tax purposes. We are not taxed on the share
of pre-tax income attributable to noncontrolling interests, and net income attributable to noncontrolling interests in our financial statements has not been presented net of income taxes attributable to these noncontrolling interests.
Net Income Attributable to Noncontrolling Interests
Noncontrolling interests represent the equity interests in our consolidated entities that we do not wholly own, which is primarily the equity interests of our nephrologist partners in our JV clinics. Our financial statements reflect 100% of the revenues and expenses for our joint ventures (after elimination of intercompany transactions and accounts) and 100% of the assets and liabilities of these joint ventures (after elimination of intercompany assets and liabilities), although we do not own 100% of the equity interests in these consolidated entities. Our net income attributable to noncontrolling interests may fluctuate in future periods depending on the purchases or sales by us of non-controlling interests in our clinics from our nephrologist partners, including pursuant to put obligations as described below under “Liquidity and Capital Resources – Put Obligations”. The net income attributable to owners of our consolidated entities, other than us, is classified within the line item
Net income attributable to noncontrolling interests
. See also “—Critical Accounting Policies and Estimates—Noncontrolling Interests” and Note 7. “Noncontrolling Interests Subject to Put Provisions”.
Results of Operations
Three Months Ended September 30, 2016 Compared With Three Months Ended September 30, 2015
The following table summarizes our results of operations for the periods indicated.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30,
|
|
Increase (Decrease)
|
|
|
|
|
|
|
|
|
|
|
|
|
Percentage
|
|
|
|
2016
|
|
2015
|
|
Amount
|
|
Change
|
|
Patient service operating revenues
|
|
$
|
194,857
|
|
$
|
169,190
|
|
$
|
25,667
|
|
15.2
|
%
|
Provision for uncollectible accounts
|
|
|
(1,902)
|
|
|
(1,244)
|
|
|
(658)
|
|
52.9
|
%
|
Net patient service operating revenues
|
|
|
192,955
|
|
|
167,946
|
|
|
25,009
|
|
14.9
|
%
|
Operating expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
Patient care costs
|
|
|
116,115
|
|
|
100,110
|
|
|
16,005
|
|
16.0
|
%
|
General and administrative
|
|
|
33,359
|
|
|
19,373
|
|
|
13,986
|
|
72.2
|
%
|
Transaction-related costs
|
|
|
—
|
|
|
2,105
|
|
|
(2,105)
|
|
NM
|
|
Depreciation and amortization
|
|
|
8,687
|
|
|
7,670
|
|
|
1,017
|
|
13.3
|
%
|
Certain legal matters
|
|
|
4,042
|
|
|
—
|
|
|
4,042
|
|
NM
|
|
Total operating expenses
|
|
|
162,203
|
|
|
129,258
|
|
|
32,945
|
|
25.5
|
%
|
Operating income
|
|
|
30,752
|
|
|
38,688
|
|
|
(7,936)
|
|
(20.5)
|
%
|
Interest expense, net
|
|
|
7,372
|
|
|
11,816
|
|
|
(4,444)
|
|
(37.6)
|
%
|
Income tax receivable agreement income
|
|
|
(12,565)
|
|
|
—
|
|
|
(12,565)
|
|
NM
|
|
Income before income taxes
|
|
|
35,945
|
|
|
26,872
|
|
|
9,073
|
|
33.8
|
%
|
Income tax expense (benefit)
|
|
|
(101)
|
|
|
3,276
|
|
|
(3,377)
|
|
NM
|
|
Net income
|
|
|
36,046
|
|
|
23,596
|
|
|
12,450
|
|
52.8
|
%
|
Less: Net income attributable to noncontrolling interests
|
|
|
(23,622)
|
|
|
(19,491)
|
|
|
(4,131)
|
|
21.2
|
%
|
Net income attributable to American Renal Associates Holdings, Inc.
|
|
$
|
12,424
|
|
$
|
4,105
|
|
$
|
8,319
|
|
NM
|
|
___________________
NM – Not Meaningful
Net Patient Service Operating Revenues
Patient service operating revenues
. Patient service operating revenues for the three months ended September 30, 2016 were $194.9 million, an increase of 15.2% from $169.2 million for the three months ended September 30, 2015. The increase in patient service operating revenues was primarily due to an increase of approximately 11.4% in the number of dialysis treatments. The increase in treatments resulted principally from non-acquired treatment growth of 10.2% from existing clinics and de novo clinics. Patient service operating revenues relating to start-up clinics for the three months ended September 30, 2016 were $4.3 million compared to $2.8 million for the three months ended September 30, 2015, an increase of $1.5 million due to the timing of opening and certification of de novo clinics, as described under “Key Factors Affecting our Results of Operations – Clinic Growth and Start-Up Clinic Costs”. Patient service operating revenues per treatment for the three months ended September 30, 2016 was $378 compared with $365 for the three months ended September 30, 2015 driven by a meaningful improvement in commercial and other mix, primarily related to an increase in patients covered by ACA and other individual marketplace plans. As a source of revenue by payor type, government-based and other payors accounted for 54.7% and 57.7%, respectively, of our revenues for the three months ended September 30, 2016 and 2015.
Provision for uncollectible accounts.
Provision for uncollectible accounts for the three months ended September 30, 2016 was $1.9 million, or 1.0% of net patient service operating revenues, as compared to $1.2 million, or 0.7% of net patient service operating revenues, for the same period in 2015. Our accounts receivable, net of the bad debt allowance, represented approximately 37 and 42 days of patient service operating revenues as of September 30, 2016 and 2015, respectively.
Operating Expenses
Patient care costs.
Patient care costs for the three months ended September 30, 2016 were $116.1 million, an increase of 16.0% from $100.1 million for the three months ended September 30, 2015. This increase was primarily due to an increase in the number of treatments as well as $1.9 million of Modification and Other Stock Compensation Expense described above. As a percentage of net patient
service operating revenues, patient care costs were approximately 60.2% (or 59.2% excluding the Modification and Other Stock Compensation Expense) for the three months ended September 30, 2016 compared to 59.6% for the three months ended September 30, 2015. Excluding the Modification and Other Stock Compensation Expense, the change was primarily attributable to higher revenues per treatment described above and lower ancillary and pharmaceutical costs as a percentage of net patient service operating revenues, offset by increases in start-up clinic expenses related to our de novo development program, including expenses incurred due to delays in certifications. Patient care costs per treatment for the three months ended September 30, 2016 were $225, compared to $216 for the three months ended September 30, 2015. Patient care costs per treatment excluding the Modification and Other Stock Compensation Expense were $221 for the three months ended September 30, 2016.
General and administrative expenses.
General and administrative expenses for the three months ended September 30, 2016 were $33.4 million, an increase of 72.2% from $19.4 million for the three months ended September 30, 2015, primarily due to corporate costs associated with becoming a public company, including $10.3 million of Modification and Other Stock Compensation Expense described above, an increase in the number of treatments and increased legal costs in addition to the legal costs relating to Certain Legal Matters described below. As a percentage of net patient service operating revenues, general and administrative expenses were approximately 17.3% (or 12.0% excluding the Modification and Other Stock Compensation Expense) for the three months ended September 30, 2016 compared to 11.5% for the three months ended September 30, 2015. General and administrative expenses per treatment for the three months ended September 30, 2016 were $65, compared to $42 for the three months ended September 30, 2015. General and administrative expenses per treatment excluding the Modification and other Stock Compensation Expense were $45 for the three months ended September 30, 2016.
Transaction-related costs.
There were no transaction-related costs for the three months ended September 30, 2016. Transaction-related costs for the three months ended September 30, 2015 were $2.1 million, which are costs associated with the forgiveness of indebtedness and accrued interest under a line of credit extended to an executive.
Depreciation and amortization.
Depreciation and amortization expense for the three months ended September 30, 2016 was $8.7 million, compared to $7.7 million for the three months ended September 30, 2015. As a percentage of net patient service operating revenues, depreciation and amortization expense was approximately 4.5% for the three months ended September 30, 2016 compared to 4.6% for the three months ended September 30, 2015.
Certain Legal Matters.
Certain legal matter costs for the three months ended September 30, 2016 was $4.0 million. See Part II, Item 1 – “Legal Proceedings.”
Operating Income
Operating income for the three months ended September 30, 2016 was $30.8 million, a decrease of $7.9 million, or 20.5%, from $38.7 million for the three months ended September 30, 2015. The decrease was primarily due to the factors described above, but was partially offset by the impact of the rebasing reimbursement environment for Medicare. In addition, for the three months ended September 30, 2016 and 2015, start-up clinics reduced operating income by $4.6 million and $2.3 million, respectively, an increase of $2.3 million reflecting the timing of opening and certification of de novo clinics each year as described under “Key Factors Affecting our Results of Operations – Clinic Growth and Start-Up Clinic Costs”. As a percentage of net patient service operating revenues, operating income was 15.9% for the three months ended September 30, 2016 compared to 23.0% for the three months ended September 30, 2015, reflecting the factors described above. Excluding the impact of the Modification and Other Stock Compensation Expense of $12.2 million, as a percentage of net patient service operating revenues, operating income was 22.3% for the three months ended September 30, 2016 compared to 23.0% for the three months ended September 30, 2015, reflecting the factors described above.
Interest and Taxes
Interest expense, net.
Interest expense, net for the three months ended September 30, 2016 was $7.4 million, and $11.8 million for the three months ended September 30, 2015, a decrease of 37.6% primarily due to our debt refinancing, offset by an increase in third party clinic debt, including the Assigned Clinic Loans.
Income tax receivable agreement income/expense.
Income tax receivable agreement income for the three months ended September 30, 2016 was $12.6 million. This income represents the change in the estimated fair value of the TRA liability during the period.
Income tax expense (benefit)
The provision (benefit) for income taxes for the three months ended September 30, 2016 and September 30, 2015 represented an effective tax rate of (0.3%) and 12.2%, respectively. The variation from the statutory federal rate of 35% on our share of pre-tax income during the three months ended September 30, 2016 and 2015 is primarily due to the tax impact of the noncontrolling interest in the clinics as a result of our joint venture model and the change in fair value of the TRA liability, which is not deductible for income tax purposes.
Net Income Attributable to Noncontrolling Interests
Net income attributable to noncontrolling interests for the three months ended September 30, 2016 was
$23.6 million, representing an increase of 21.2% from $19.5 million for the three months ended September 30, 2015. The increase was primarily due to growth in the earnings of our existing joint ventures, offset by an increase in our ownership interest in an existing clinic.
Nine Months Ended September 30, 2016 Compared With Nine Months Ended September 30, 2015
The following table summarizes our results of operations for the periods indicated.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended September 30,
|
|
Increase (Decrease)
|
|
|
|
|
|
|
|
|
|
|
|
|
Percentage
|
|
|
|
2016
|
|
2015
|
|
Amount
|
|
Change
|
|
Patient service operating revenues
|
|
$
|
555,349
|
|
$
|
482,119
|
|
$
|
73,230
|
|
15.2
|
%
|
Provision for uncollectible accounts
|
|
|
(4,696)
|
|
|
(3,349)
|
|
|
(1,347)
|
|
40.2
|
%
|
Net patient service operating revenues
|
|
|
550,653
|
|
|
478,770
|
|
|
71,883
|
|
15.0
|
%
|
Operating expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
Patient care costs
|
|
|
331,349
|
|
|
288,343
|
|
|
43,006
|
|
14.9
|
%
|
General and administrative
|
|
|
86,800
|
|
|
56,663
|
|
|
30,137
|
|
53.2
|
%
|
Transaction-related costs
|
|
|
2,239
|
|
|
2,105
|
|
|
134
|
|
6.4
|
%
|
Depreciation and amortization
|
|
|
24,616
|
|
|
22,842
|
|
|
1,774
|
|
7.8
|
%
|
Certain legal matters
|
|
|
4,042
|
|
|
—
|
|
|
4,042
|
|
NM
|
|
Total operating expenses
|
|
|
449,046
|
|
|
369,953
|
|
|
79,093
|
|
21.4
|
%
|
Operating income
|
|
|
101,607
|
|
|
108,817
|
|
|
(7,210)
|
|
(6.6)
|
%
|
Interest expense, net
|
|
|
28,571
|
|
|
34,639
|
|
|
(6,068)
|
|
(17.5)
|
%
|
Loss on early extinguishment of debt
|
|
|
4,708
|
|
|
—
|
|
|
4,708
|
|
NM
|
|
Income tax receivable agreement income
|
|
|
(4,730)
|
|
|
—
|
|
|
(4,730)
|
|
NM
|
|
Income before income taxes
|
|
|
73,058
|
|
|
74,178
|
|
|
(1,120)
|
|
(1.5)
|
%
|
Income tax expense
|
|
|
1,413
|
|
|
8,821
|
|
|
(7,408)
|
|
NM
|
|
Net income
|
|
|
71,645
|
|
|
65,357
|
|
|
6,288
|
|
9.6
|
%
|
Less: Net income attributable to noncontrolling interests
|
|
|
(64,911)
|
|
|
(53,354)
|
|
|
(11,557)
|
|
21.7
|
%
|
Net income attributable to American Renal Associates Holdings, Inc.
|
|
$
|
6,734
|
|
$
|
12,003
|
|
$
|
(5,269)
|
|
(43.9)
|
%
|
NM – Not Meaningful
Net Patient Service Operating Revenues
Patient service operating revenues
. Patient service operating revenues for the nine months ended September 30, 2016 were $555.3 million, an increase of 15.2% from $482.1 million for the nine months ended September 30, 2015. The increase in patient service operating revenues was primarily due to an increase of approximately 12.7% in the number of dialysis treatments. The increase in treatments resulted principally from non-acquired treatment growth of 11.8% from existing clinics and de novo clinics. The Company estimates that the extra leap year day during the nine months ended September 30, 2016 added approximately 0.4% to the non-acquired growth rate during the period. Patient service operating revenues relating to start-up clinics for the nine months ended September 30, 2016 were $8.3 million compared to $8.0 million for the nine months ended September 30, 2015, an increase of $0.3 million due to an increase in the number of start-up clinics offset by the effects of the timing of opening and delays in certification of de novo clinics. Patient service operating revenues per treatment for the nine months ended September 30, 2016 was $371 compared with $363 for the nine months ended September 30 2015 driven by a meaningful improvement in commercial and other mix, primarily related to an increase in patients covered by ACA and other individual marketplace plans. As a source of revenues, government-based and other payors accounted for 55.6% and 58.6%, respectively, of our revenues for the nine months ended September 30, 2016 and 2015.
Provision for uncollectible accounts.
Provision for uncollectible accounts for the nine months ended September 30, 2016 was $4.7 million, or 0.9% of net patient service operating revenues, as compared to $3.3 million, or 0.7% of net patient service operating revenues, for the same period in 2015. Our accounts receivable, net of the bad debt allowance, represented approximately 37 and 42 days of patient service operating revenues as of both September 30, 2016 and 2015, respectively.
Operating Expenses
Patient care costs.
Patient care costs for the nine months ended September 30, 2016 were $331.3 million, an increase of 14.9% from $288.3 million for the nine months ended September 30, 2015. This increase was primarily due to an increase in the number of treatments. As a percentage of net patient
service operating revenues, patient care costs were approximately 60.2% for the nine months ended September 30, 2016 (or 59.6% excluding the Modification and Other Stock Compensation Expense), the same percentage as for the nine months ended September 30, 2015. Excluding the Modification and Other Stock Compensation Expense of $3.3 million, the change was primarily attributable to personnel cost increases offset by lower ancillary and pharmaceutical costs as a percentage of net patient service operating revenues. Patient care costs per treatment for the nine months ended September 30, 2016 and 2015 were $221 and $217, respectively. Patient care costs per treatment excluding the Modification and Other Stock Compensation Expense were $219 for the nine months ended September 30, 2016.
General and administrative expenses.
General and administrative expenses for the nine months ended September 30, 2016 were $86.8 million, an increase of 53.2% from $56.7 million for the nine months ended September 30, 2015, primarily due to an increase in corporate costs associated with becoming a public company, including the Modification and Other Stock Compensation Expense of $18.3 million, and increased legal costs in addition to the legal costs relating to Certain Legal Matters described below. As a percentage of net patient service operating revenues, general and administrative expenses were approximately 15.8% (or 12.4% excluding the Modification and Other Stock Compensation Expense) for the nine months ended September 30, 2016 compared to 11.8% for the nine months ended September 30, 2015. General and administrative expenses per treatment for the nine months ended September 30, 2016 were $58, compared to $43 for the nine months ended September 30, 2015. General and administrative expenses per treatment excluding the applicable Modification and Other Stock Compensation Expense are $46 for the nine months ended September 30, 2016.
Transaction-related costs.
Transaction-related costs for the nine months ended September 30, 2016 were $2.2 million. These costs are associated with our debt refinancing and other transactions associated with our IPO. Transaction-related costs for the nine months ended September 30, 2015 were $2.1 million, which are costs associated with the forgiveness of indebtedness and accrued interest under a line of credit extended to an executive.
Depreciation and amortization.
Depreciation and amortization expense for the nine months ended September 30, 2016 was $24.6 million, compared to $22.8 million for the nine months ended September 30, 2015. As a percentage of net patient service operating revenues, depreciation and amortization expense was approximately 4.5% for the nine months ended September 30, 2016 compared to 4.8% for the nine months ended September 30, 2015.
Certain Legal Matters.
Certain legal matter costs for the nine months ended September 30, 2016 was $4.0 million. See Part II, Item 1 – “Legal Proceedings.”
Operating Income
Operating income for the nine months ended September 30, 2016 was $101.6 million, a decrease of $7.2 million, or 6.6%, from $108.8 million for the nine months ended September 30, 2015. The decrease was primarily due to the factors described above, but was partially offset by the impact of the rebasing reimbursement environment for Medicare. In addition, for the nine months ended September 30, 2016 and 2015, start-up clinics reduced operating income by $10.4 million and $5.9 million, respectively, an increase of $4.5 million reflecting the timing of opening de novo clinics each year as described under “Key Factors Affecting our Results of Operations – Clinic Growth and Start-Up Clinic Costs”. As a percentage of net patient service operating revenues, operating income was 18.5% for the nine months ended September 30, 2016, a decrease compared to 22.7% for the nine months ended September 30, 2015, reflecting the factors described above. Excluding the impact of the Modification and Other Stock Compensation Expense of $21.6 million, as a percentage of net patient service operating revenues, operating income was 22.4% for the nine months ended September 30, 2016, reflecting the factors described above.
Interest and Taxes
Interest expense, net.
Interest expense, net for the nine months ended September 30, 2016 was $28.6 million, and $34.6 million for the nine months ended September 30, 2015, a decrease of 17.5% primarily due to the debt refinancing, offset by an increase in clinic level debt, including Assigned Clinic Loans.
Loss on early extinguishment of debt.
Loss on early extinguishment of debt for the nine months ended September 30, 2016 was $4.7 million as a result of our debt refinancing activities. The loss was comprised of a write-off of unamortized debt issuance costs.
Income tax receivable agreement income.
Income tax receivable agreement income for the nine months ended September 30, 2016 was $4.7 million, or 0.9% of net patient service operating revenues. This income represents the change in the fair value of the tax receivable agreement during the period.
Income tax expense.
The provision for income taxes for the nine months ended September 30, 2016 and September 30, 2015 represented an effective tax rate of 1.9% and 11.9%, respectively. The variation from the statutory federal rate of 35% on our share of pre-tax income during the nine months ended September 30, 2016 and 2015 is primarily due to the tax impact of the noncontrolling interest in the clinics as a result of our joint venture model and the change in fair value of the TRA liability, which is not deductible for income tax purposes.
Net Income Attributable to Noncontrolling Interests
Net income attributable to noncontrolling interests for the nine months ended September 30, 2016 was
$64.9 million, representing an increase of 21.7% from $53.4 million for the nine months ended September 30, 2015. The increase was primarily due to growth in the earnings of our existing joint ventures, offset by an increase in our ownership interest in an existing clinic.
Liquidity and Capital Resources
Our primary sources of liquidity are funds generated from our operations, short-term borrowings under our revolving credit facility and borrowings of long-term debt. Our principal needs for liquidity are to pay our operating expenses, to fund the development and acquisition of new clinics, to fund capital expenditures, to service our debt and may in the future be to fund purchases of put rights held by our physician partners. In addition, a significant portion of our cash flows is used to make distributions to the noncontrolling equity interests held by our nephrologist partners in our joint venture clinics. Except as otherwise indicated, the following discussion of our liquidity and capital resources presents information on a consolidated basis, without adjusting for the effect of noncontrolling interests.
We believe our cash flows from operations, combined with availability under our revolving credit facility, provide sufficient liquidity to fund our current obligations, projected working capital requirements and capital spending for a period that includes the next 12 months. If existing cash and cash generated from operations and borrowings under our revolving credit facility are insufficient to satisfy our liquidity requirements, we may seek to obtain additional debt or equity financing. If additional funds are raised through the issuance of debt, this debt could contain covenants that would restrict our operations. Any financing may not be available in amounts or on terms acceptable to us. If we are unable to obtain required financing, we may be required to reduce the scope of our planned growth efforts, which could harm our financial condition and operating results.
If we decide to pursue one or more acquisitions, we may incur additional debt or sell additional equity to finance such acquisitions.
Cash Flows
The following table shows a summary of our cash flows for the periods indicated.
|
|
|
|
|
|
|
|
|
|
Nine Months Ended September 30,
|
|
(dollars in thousands)
|
|
2016
|
|
2015
|
|
Net cash provided by operating activities
|
|
$
|
141,903
|
|
$
|
104,519
|
|
Net cash used in investing activities
|
|
|
(51,126)
|
|
|
(38,497)
|
|
Net cash used in financing activities
|
|
|
(76,616)
|
|
|
(37,649)
|
|
Net increase in cash
|
|
$
|
14,161
|
|
$
|
28,373
|
|
Cash Flows from Operations
Net cash provided by operating activities for the nine months ended September 30, 2016 was $141.9 million compared to $104.5 million for the same period in 2015, an increase of $37.4 million, or 35.8%, primarily attributable to an increase in net income excluding the impact of the non-cash Modification and other Stock Compensation Expense as well as an increase in the payor refund liability included in accrued expenses, offset by a decrease in the deferred tax liability.
Cash Flows from Investing Activities
Net cash used in investing activities for the nine months ended September 30, 2016 was $51.1 million compared to $38.5 million for the same period in 2015, an increase of $12.6 million, or 32.8%, due to fluctuations in the timing and number of our de novo clinic openings, as well as the timing of acquisitions.
Cash Flows from Financing Activities
Net cash used in financing activities for the nine months ended September 30, 2016 was $76.6 million compared to $37.6 million for the same period in 2015, an increase of $39.0 million. Our distributions to our partners were $67.0 million for the nine months ended September 30, 2016 compared to $59.6 million for the same period in 2015. Additionally, our purchases of noncontrolling interests in existing clinics were $8.4 million for the nine months ended September 30, 2016, compared to $3.3 million for the same period in 2015. The following table displays the factors impacting cash from financing activities during the nine months ended September 30, 2016:
|
|
|
|
|
|
|
|
|
Nine Months Ended September 30,
|
(dollars in thousands)
|
|
2016
|
|
2015
|
Proceeds from issuance of common stock sold in initial public offering, net of underwriting discounts and offering expense
|
|
$
|
175,254
|
|
|
—
|
Dividends and dividend equivalents paid
|
|
|
(30,223)
|
|
|
—
|
Net cash paid due to debt refinancing
|
|
|
(207,390)
|
|
|
(19,047)
|
Distributions to noncontrolling interests
|
|
|
(66,985)
|
|
|
(59,648)
|
Purchases of noncontrolling interests
|
|
|
(8,397)
|
|
|
(3,326)
|
Capital Expenditures
For the nine months ended September 30, 2016 and 2015, we made capital expenditures of $46.7 million and $37.9 million, respectively, of which $38.2 million and $29.7 million, respectively, were development capital expenditures and $8.5 million and $8.2 million, respectively, were maintenance capital expenditures. During the fourth quarter of 2016, we expect to spend approximately 5% to 6% of total net revenues for development capital expenditures and 1% to 2% of total net revenues on maintenance capital expenditures.
Debt Facilities
As of September 30, 2016, we had outstanding $568.3 million in aggregate principal amount of indebtedness, with an additional $100.0 million of borrowing capacity available under our revolving credit facility (and no outstanding letters of credit). Our outstanding indebtedness included $434.9 million of term B loans under our first lien credit agreement as of September 30, 2016. Our outstanding indebtedness included $3.2 million of other corporate debt as of September 30, 2016. Our outstanding indebtedness also included our third-party clinic-level debt, which includes term loans and lines of credit (other than assigned clinic loans) totaling $130.2 million as of September 30, 2016 with maturities ranging from November 2016 to December 2023 and interest rates ranging from 3.15% to 7.34%. In addition, our clinic level debt includes our assigned clinic loans held by NewCo of $21.7 million as of September 30, 2016 with maturities ranging from November 2016 to September 2020 and interest rates ranging from 3.46% to 8.08%. See “Note 8—Debt” in the notes to our unaudited consolidated financial statements.
On April 26, 2016, the Company entered into the first amendment (“the Amendment”) to the First Lien Credit Agreement. The Amendment increased the borrowing capacity under the first lien revolving credit facility by $50.0 million to an aggregate amount of $100.0 million, increased the interest rate margin by 0.25% on the first lien term loans, and provided for additional borrowings of $60.0 million of incremental first lien term loans. The Company also applied $165.6 million of the net proceeds from the IPO, proceeds from the additional first lien term loans, and cash on hand to repay the outstanding balance on the second lien term loans. We refer to such increase of revolving credit facility borrowing capacity, borrowings under our first lien credit facility and repayment of second lien term loans as the “Refinancing”. See “Description of Indebtedness” in the Prospectus.
Initial Public Offering
On April 26, 2016, the Company completed its initial public offering of 8,625,000 shares of Common Stock for cash consideration of $22.00 per share ($20.515 per share net of underwriting discounts). Net proceeds of $176.9 million from the initial public offering, together with borrowings under our first lien credit facility and cash on hand, were used in the Refinancing to repay in full, all outstanding amounts under our second lien credit facility.
Contractual Obligations and Commitments
The following is a summary of contractual obligations and commitments as of September 30, 2016 (excluding put obligations relating to our joint ventures, dividend equivalent payments due to our pre-IPO option holders and obligations under our Income Tax Receivable Agreement, which are described separately below):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Scheduled payments under contractual obligations (dollars in thousands)
|
|
Total
|
|
Less than 1
year
|
|
1-3 years
|
|
3-5 years
|
|
More than 5
years
|
|
Third-party clinic-level debt
|
|
$
|
130,190
|
|
$
|
8,504
|
|
$
|
72,786
|
|
$
|
41,299
|
|
$
|
7,601
|
|
Term B loans(1)
|
|
|
434,917
|
|
|
1,159
|
|
|
9,272
|
|
|
424,486
|
|
|
—
|
|
Other corporate debt
|
|
|
3,165
|
|
|
123
|
|
|
3,042
|
|
|
—
|
|
|
—
|
|
Operating leases(2)
|
|
|
168,976
|
|
|
5,147
|
|
|
49,063
|
|
|
41,277
|
|
|
73,489
|
|
Interest payments(3)
|
|
|
73,126
|
|
|
6,816
|
|
|
49,303
|
|
|
16,807
|
|
|
200
|
|
Total
|
|
$
|
810,374
|
|
$
|
21,749
|
|
$
|
183,466
|
|
$
|
523,869
|
|
$
|
81,290
|
|
|
|
(1)
|
Bear interest at a variable rate, with principal payments of $1.2 million and interest payments due quarterly.
|
|
|
(2)
|
Net of estimated sublease proceeds of approximately $1.0 million per year from 2016 through 2022 and approximately $0.5 million or less thereafter.
|
|
|
(3)
|
Represents interest payments on debt obligations, including the term B loans, the term loans under the second lien credit agreement and the loans under the revolving credit facility. To project interest payments on floating rate debt, we have used the rate as of September 30, 2016
|
Put Obligations
We also have potential obligations with respect to some of our non-wholly owned subsidiaries in the form of put provisions, which are exercisable at our nephrologist partners’ future discretion at certain time periods (“time-based puts”) or upon the occurrence of certain events (“event-based puts”) as set forth in each specific put provision, which may include the sale of assets, closure of the clinic, acquisitions over a certain dollar amount, departure of key executives and other events. The time when some of the time-based put rights were exercised may be accelerated as a result of the IPO. If the put obligations are exercised by a physician partner, we are required to purchase, at fair market value calculated as set forth in the applicable joint venture agreements, a previously agreed upon percentage of such physician partner’s ownership interest. See “Note 7—Noncontrolling Interests Subject to Put Provisions” in the notes to our unaudited consolidated financial statements for discussion of these put provisions. The table below summarizes our potential obligation as of September 30, 2016.
|
|
|
|
|
Noncontrolling interest subject to put provisions
(dollars in thousands)
|
|
As of September 30, 2016
|
|
Time-based puts
|
|
$
|
110,373
|
|
Event-based puts
|
|
|
29,963
|
|
Total Obligation
|
|
$
|
140,336
|
|
As of September 30, 2016, $17.0 million of time-based put obligations were exercisable by our nephrologist partners. The following is a summary of the estimated potential cash payments in each of the specified years under all time-based puts existing as of September 30, 2016 and reflects the payments that would be made, assuming (a) all vested puts as
of September 30, 2016 were exercised on October 1, 2016 and paid according to the applicable agreement and (b) all puts exercisable thereafter were exercised as soon as they vest and are paid accordingly.
|
|
|
|
|
(dollars in thousands)
Year
|
|
Amount
Exercisable
|
|
2016
|
|
|
21,131
|
|
2017
|
|
|
10,495
|
|
2018
|
|
|
15,323
|
|
2019
|
|
|
17,929
|
|
2020
|
|
|
18,591
|
|
Thereafter
|
|
|
26,904
|
|
Total
|
|
$
|
110,373
|
|
The estimated fair values of the interests subject to these put provisions can also fluctuate and the implicit multiple of earnings at which these obligations may be settled will vary depending upon clinic performance, market conditi
on
s and access to the credit and capital markets, and may increase as a result of the IPO completed by the Company on April 26, 2016. In addition, our estimates are subject to challenges by our partners which could cause an increase to the amount we owe. As of September 30, 2016, we had recorded liabilities of approximately $110.4 million for all existing time-based obligations,
of which we have estimated approximately $30.2 million may be accelerated as a result of physicians with IPO put rights having elected to potentially exercise the puts. The estimated potential cash payments in the next twelve months, if all puts as to which partners have expressed interest in exercising are exercised, is approximately $17.0 million. The actual purchase price for the puts is currently being determined, which may affect our estimates described above. Once the determination is complete, the physician partners will have the right to decide how much of their put rights, if any, they will exercise.
In addition, as of September 30, 2016, we had $30.0 million of event-based put obligations (including certain time-based put obligations that became event-based put obligations but are not currently exercisable), none of which were exercisable by our nephrologist partners at September 30, 2016.
Dividend Equivalent Payments
On April 26, 2016, the Company declared and paid a cash dividend to our pre-IPO stockholders equal to $1.30 per share, or $28.9 million in the aggregate. In connection with the dividend, all employees with outstanding options had their option exercise price reduced and in some cases were awarded a future dividend equivalent payment, which were paid on vested options and becomes due upon vesting for unvested options. Additionally, in connection with the cash dividend, the Company has made payments to date equal to $1.30 per share, or $1.2 million in the aggregate, to option holders, and, in the case of some performance and market options, as of September 30, 2016 a future payment will be due upon vesting totaling $6.2 million
.
In connection with the NewCo Distribution, as described in Note 8, the Company also equitably adjusted the outstanding stock options by reducing exercise prices and making cash dividend equivalent payments of $2.5 million, of which $0.2 million was paid to vested option holders and as of September 30, 2016 $2.4 million is payable to unvested option holders only if such unvested options become vested.
In March 2013, the Company declared and paid a dividend to holders of the Company’s common stock equal to $7.90 per share. In connection with the dividend, all employees with outstanding 2010 Plan options had their option exercise price reduced and in some cases were awarded a future dividend equivalent payment, which becomes due upon vesting, of $2.6 million, of which an immaterial amount was paid to vested option holders and as of September 30, 2016 $2.6 million is payable to unvested option holders only if such unvested options become vested.
Assuming that all currently outstanding options entitled to cash dividend equivalent payments vest according to their respective vesting schedules, the Company anticipates a payment of approximately $8.8 million will be made during 2017, with an additional approximately $2.3 million to be paid thereafter.
Income Tax Receivable Agreement
On April 26, 2016, upon the completion of the IPO, we entered into the TRA, which provides for the payment by us to our pre-IPO stockholders on a pro rata basis of 85% of the amount of cash savings, if any, in U.S. federal, state and local income tax that we actually realize as a result of any Option Deductions (as defined in the TRA). We plan to fund the payments under the TRA with cash flows from operations and, to the extent necessary, the proceeds of borrowings under our credit facilities. The amounts and timing of our
obligations under the TRA are subject to a number of factors, including the amount and timing of the taxable income we generate in the future, whether and when any Relevant Stock Options are exercised and the value of our common stock at the time of such exercise, and to uncertainty relating to the future events that could impact such obligations. Estimating the amount of payments that may be made under the TRA is by its nature imprecise given such uncertainty. However, we expect that during the term of the TRA the payments that we make will be material. Such payments will reduce the liquidity that would otherwise have been available to us. Assuming the Company generates profits for the remainder of 2016, the amount of cash savings for 2016 is estimated to be $0.8 million as of September 30, 2016. See "Certain Relationships and Related Party Transactions—Income Tax Receivable Agreement” in the Prospectus.
Off Balance Sheet Arrangements
We have no off-balance sheet arrangements that have, or are reasonably likely to have, a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures, or capital resources that would be material to investors.
Recent Accounting Pronouncements
See Note 1 of Part I “Financial Information – Notes to Consolidated Financial Statements – Presentation – Recent Accounting Pronouncements”.
Critical Accounting Policies and Estimates
For a description of the Company’s critical accounting policies and use of estimates, refer to “Management’s Discussion and Analysis of Financial Condition and Results of Operations—
Critical Accounting Policies and Estimates” in the Prospectus. There have been no material changes to our critical accounting policies and use of estimates from those described in the Prospectus, which the exception of stock-based compensation noted below.
Stock-Based Compensation
The Company adopted the provision of ASU 2016-09,
Compensation – Stock Compensation (Topic 718) –
Improvements
to Employee Share-Based Payment Accounting
as of July 1, 2016. Upon early adoption, the Company elected to change its accounting policy to account for forfeitures as they occur. The change was applied on a modified retrospective basis.
See "Note 10—Stock-Based Compensation" for discussion of the key assumptions included in determining the fair value of our equity awards at grant date.
ITEM 3.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
There have been no material changes from the information previously disclosed under “Management’s Discussion and Analysis of Financial Condition and Results of Operations—
Quantitative and Qualitative Disclosure About Market Risk” included in the Prospectus.
ITEM 4.
CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure Controls and Procedures.
Our management, with the participation of our Chief Executive Officer, or CEO, and Chief Financial Officer, or CFO, evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act) as of
September 30, 2016
. In designing and evaluating our disclosure controls and procedures, our management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives, and our management necessarily applied its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on this evaluation, our CEO and CFO concluded that our disclosure controls and procedures were effective at the reasonable assurance level as of
September 30, 2016
.
(b) Changes in Internal Control over Financial Reporting.
There have been no changes in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act) during the quarter ended September 30, 2016 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
PART II
OTHER INFORMATION
ITEM 1.
LEGAL PROCEEDINGS
From time to time, we are subject to various legal actions and proceedings involving claims incidental to the conduct of our business, including contractual disputes and professional and general liability claims, as well as audits and investigations by various government entities, in the ordinary course of business. Based on information currently available, established reserves, available insurance coverage and other resources, we do not believe that the outcomes of any such pending actions, proceedings or investigations are likely to be, individually or in the aggregate, material to our business, financial condition, results of operations or cash flows. However, legal actions and proceedings are subject to inherent uncertainties and it is possible that the ultimate resolution of such matters, if unfavorable, may be materially adverse to our business, financial condition, results of operations or cash flows.
As previously disclosed, American Renal Associates Holdings, Inc. (“ARA”) and its wholly owned operating subsidiary American Renal Associates LLC (“ARA OpCo”) were named as defendants in a complaint filed by three affiliates of UnitedHealth Group Inc. (“United”) in the United States District Court for the Southern District of Florida on July 1, 2016. On August 12, 2016, ARA and ARA OpCo each filed a motion to dismiss the action. On September 2, 2016, plaintiffs filed an amended complaint. On September 30, 2016, ARA and ARA OpCo each filed a motion to dismiss the amended complaint. The amended complaint relates to 30 patients who have received, and some of whom continue to receive, dialysis at 12 clinics in Florida and Ohio and who elected to obtain coverage under one of United’s Affordable Care Act (“ACA”) compliant individual marketplace plans, effective on or after January 1, 2016. The plaintiffs assert various state law claims and allege violations of certain state laws that prohibit false insurance claims, health care kickbacks, patient brokering, and violations of the applicable commercial plan agreements in connection with, among other things, premium payment assistance by a third party charitable organization. The complaint seeks unspecified actual, consequential and punitive monetary damages, together with interest and costs, and declaratory and injunctive relief, as well as attorney's fees and court costs. The Company has moved to dismiss the amended complaint in full, and is vigorously defending itself in this legal matter. The Company has received a letter from another insurance company seeking information regarding matters relating to the insurance company’s covered patients similar in nature to the matters underlying the United complaint.
In addition, as previously disclosed, on July 26, 2016, the Staff of the SEC sent a letter to the Company stating that it is conducting an inquiry and requesting that the Company provide certain documents and information relating to the subject matter covered by the United complaint described above. The Company has subsequently received follow up and additional requests for documents and information with respect to the same subject matter. The Company is fully cooperating with SEC Staff.
On August 18, 2016, the Centers for Medicare and Medicaid Services (“CMS”) issued a request for information seeking public comment on the concerns that some healthcare providers and provider-affiliated organizations may be steering patients eligible for, or receiving, Medicare and/or Medicaid benefits into ACA-compliant individual marketplace plans, including health insurance marketplace plans. The request for information also sought comment about certain charities that provide assistance to patients seeking private insurance coverage. CMS also sent letters to all Medicare-enrolled dialysis facilities and centers informing them of this request for information. The Company provided a response to the CMS request for information which response is publicly available on the U.S. Government’s Regulations.gov website.
On August 31, 2016 and September 2, 2016, putative shareholder class action complaints were filed in the United States District Court for the Southern District of New York and the United States District Court for the District of Massachusetts, respectively, against the Company and certain officers and directors of the Company. Both complaints assert federal securities law claims against the Company and the individual defendants under Sections 10(b) and 20(a) of the Exchange Act and Rule 10b-5 promulgated thereunder by the SEC and in addition, the complaint filed in the United States District Court for the Southern District of New York asserts claims under Sections 11 and 15 of the Securities Act. The complaints allege that the Company made material misstatements or omissions, including in connection with its initial public offering filings and other public filings. The complaints seek unspecified damages on behalf of the
individuals or entities that purchased or otherwise acquired the Company’s securities from April 20, 2016 to August 18, 2016. On October 26, 2016, the complaint filed in the Southern District of New York was voluntarily dismissed by the plaintiff without prejudice. The Company intends to vigorously defend itself against these claims.
No assurance can be given as to the timing or outcome of the legal matters discussed above, nor can any assurance be given as to whether the filing of these lawsuits and any inquiries will affect the Company’s other relationships, or the Company’s business generally. We cannot predict the outcome of any of these matters and an adverse result in one or more of them could have a material adverse effect on our business, results of operation and financial condition.
Although we are not currently subject to any regulatory proceedings, in light of the heightened scrutiny with respect to the matters described above, there is no assurance that formal regulatory investigations or proceedings will not be commenced by any U.S. federal or state healthcare and other regulatory agencies. In addition, we may in the future be subject to additional litigation or other proceedings or actions, regulatory or otherwise, arising in relation to the matters described above. An unfavorable outcome of any such litigation or regulatory proceeding or action could have a material adverse effect on our business, financial condition and results of operations
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ITEM 1A.
RISK FACTORS
Investing in our Common Stock involves a high degree of risk. You should carefully consider the risk factors previously disclosed in the “Risk Factors” section of the Prospectus and our Form 10-Q for the period ended June 30, 2016 (the “Second Quarter 10-Q”), together with other information in the Prospectus and our Second Quarter 10-Q, and this Form 10-Q, including our consolidated financial statements and related notes included in the Prospectus, the Second Quarter 10-Q, and this Form 10-Q, before deciding whether to invest in shares of our Common Stock. The occurrence of any of the events described in these risk factors could materially adversely affect our business, financial condition, cash flows, results of operations and growth. Except as described below, or as set forth in the Second Quarter 10-Q, there have been no material changes to the risk factors disclosed in the Prospectus.
Increased government scrutiny in our industry and potential regulatory changes could adversely affect our operating results and financial condition.
Our dialysis operations are subject to extensive federal, state and local government regulations, all of which are subject to change. On August 18, 2016, Centers for Medicare and Medicaid Services (“CMS”) issued a request for information (the “RFI”) seeking public comment on the concerns that some healthcare providers and provider-affiliated organizations may be steering patients eligible for, or receiving, Medicare and/or Medicaid benefits into ACA-compliant individual marketplace plans, including health insurance marketplace plans. The request for information also sought public comment about certain charities, which provide assistance to patients seeking to enroll in private insurance coverage. CMS also sent letters to all Medicare-enrolled dialysis facilities and centers, including ARA’s facilities, informing them of this request for information. See Part II, Item 1 — “Legal Proceedings.” CMS has indicated that it is also considering potential regulatory and operational options to prohibit or limit premium payments and routine waiver of cost-sharing for qualified health plans by health care providers, revisions to Medicare and Medicaid provider enrollment rules, potential changes that would allow individual marketplace plans to limit their payment to health care providers to Medicare-based amounts for particular services and items of care, and the imposition of civil monetary penalties for individuals that fail to provide correct information about consumers enrolling in a plan. In response to the RFI, many commercial payors and trade associations demanded the prohibition of any charitable premium assistance for marketplace plans on and off the exchange. In addition, there were requests from commercial payors and certain trade associations that patients, and specifically ESRD patients, that have access to any form of alternate coverage, should not be allowed to select an ACA plan offered on or off the exchange.
The increased government scrutiny could adversely impact the enrollment of patients treated at our clinics in ACA and other individual commercial plans, including during the current enrollment period that commenced on November 1, 2016, and could cause a reduction in our average reimbursement rates. In addition, the Company is unable to predict the outcome of the CMS request for information, or whether it will result in new legislation, regulation or restrictions on its dialysis operations. Adverse regulatory developments resulting from this request for information,
which could include restrictions on premium and cost-sharing assistance from charitable organizations such as the American Kidney Fund ("AKF") or other changes in the regulatory framework applicable to our dialysis operations or the imposition of civil monetary penalties, could materially adversely affect our business, results of operations, and cash flows.
Pending further policy guidance from CMS, in November 2016, for patients enrolled in minimum essential Medicaid coverage, we have temporarily suspended assistance in the application process for charitable premium support from the American Kidney Fund (“AKF”), which we expect will cause an adverse change in the mix of patients and treatments. This change will not affect our provision of such assistance in the application process to other patients.
A small but growing portion of ARA’s Medicaid patients have chosen to enhance their healthcare benefits by electing to enroll in an ACA plan. As of September 30, 2016, approximately 300 patients or 2.1% of ARA’s total patients, had pre-existing minimum essential Medicaid coverage and also chose additional coverage through an ACA plan. Virtually all of these low-income patients have relied on charitable premium assistance because they are ineligible for federal premium tax credits. If CMS establishes new policies to restrict or limit charitable premium assistance for ACA Plans to patients with minimum essential Medicaid coverage, these patients will likely revert back to Medicaid-only coverage.
In addition, approximately 235 additional patients or 1.7% of ARA’s total patients, were enrolled in an ACA plan and not enrolled in the Medicaid program as of September 30, 2016. Approximately 85% of these patients have relied on charitable premium assistance. These patients chose ACA plans for a variety of reasons, including ineligibility for government programs, the shift of coverage options from the individual and/or small group markets to ACA exchanges, lack of requisite work credits to be eligible for Medicare coverage, the opportunity to consolidate family coverage under one insurance plan, and the lack of Medigap policy coverage due to certain state insurance department restrictions, among other reasons. Insurance coverage disruptions for these patients could result if CMS establishes new guidelines that extend to this subset of patients, which include both on-exchange and off-exchange ACA plan enrollees.
We estimate that the annual financial impact to Adjusted EBITDA less noncontrolling interests of the patient insurance education policy change to temporarily suspend application assistance to the AKF for charitable premium assistance by patients enrolled in pre-existing minimum essential Medicaid coverage seeking additional coverage through an ACA Plan would be up to approximately $17 million. If CMS were to issue broader guidance that made access to charitable premium assistance unavailable to all ESRD patients on ACA Plans, the estimated annual financial impact to Adjusted EBITDA less noncontrolling interests would increase by up to an estimated $7 million. The aforementioned estimated annual financial impacts are based on the Company’s patient population as of September 30, 2016, take ARAH’s weighted average dialysis facility ownership into account, and are presented before any potential future offsetting actions that could be taken by the Company.
ITEM 6.
EXHIBITS
The following is a list of all exhibits filed or furnished as part of this Report:
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EXHIBIT
NUMBER
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EXHIBIT DESCRIPTION
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3.1
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Amended and Restated Certificate of Incorporation of American Renal Associates Holdings, Inc. (incorporated by reference to Exhibit 3.1 to the Registrant’s Current Report on Form 8-K filed on April 26, 2016)
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3.2
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Amended and Restated Bylaws of American Renal Associates Holdings, Inc. (incorporated by reference to Exhibit 3.2 to the Registrant’s Current Report on Form 8-K filed on April 26, 2016)
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31.1*
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Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
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31.2*
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Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
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32.1*
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Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
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32.2*
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Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
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101*
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The following financial information from the Quarterly Report on Form 10-Q for the fiscal quarter ended September 30, 2016, formatted in XBRL (Extensible Business Reporting Language) and furnished electronically herewith: (i) the Consolidated Balance Sheets; (ii) the Consolidated Statements of Operations ; (iii) the Consolidated Statements of Cash Flows; and (iv) the Notes to the Consolidated Financial Statements.
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* Filed or furnished herewith
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
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AMERICAN RENAL ASSOCIATES HOLDINGS INC.
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(Registrant)
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/s/ Jonathan L. Wilcox
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Name: Jonathan L. Wilcox
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Title: Chief Financial Officer
(Principal Financial Officer and Authorized Signatory)
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