AMERICAN RENAL ASSOCIATES HOLDINGS, INC. 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 unaudited condensed consolidated financial statements and notes thereto included e lsewhere in this Form 10-Q and the audited consolidated financial statements and the notes thereto included in our Form 10-K for the fiscal year endedDecember 31, 2019 (the "2019 Form 10-K"). 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 "Forward-Looking Statements" and the section entitled "Risk Factors" in this Form 10-Q and in the 2019 Form 10-K. You should read these sections carefully.
Executive Overview
We are the largest dialysis services provider inthe United States focused 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 nephrologist partners and staff members. We derive our patient service operating revenues from providing outpatient and inpatient dialysis treatments. The sources of payment of these patient service operating revenues are principally government-based programs, including Medicare,Medicaid andU.S. Department of Veterans Affairs ("VA") 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 principally through the joint venture ("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 inthe United States operate through a combination of wholly owned subsidiaries and joint ventures. Substantially all of our clinics are maintained as separate joint ventures 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 focus on a JV model makes us well-positioned to increase our market share by attracting nephrologistswho are interested in our service platform and want greater clinical autonomy and a potential return on capital investment associated with ownership of a noncontrolling interest in a dialysis clinic. We believe the 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 shared interest 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. Agreement and Plan of Merger Subsequent to quarter end, onOctober 1, 2020 , we entered into an Agreement and Plan of Merger (the "Merger Agreement") withIRC Superman Midco, LLC , aDelaware limited liability company ("Parent") and an affiliate ofNautic Partners, LLC , andSuperman Merger Sub, Inc. , aDelaware corporation and wholly owned subsidiary of Parent ("Merger Sub"), pursuant to which Parent will acquire ARA for$11.50 per share through the merger of Merger Sub with and into ARA, with ARA surviving as a wholly owned subsidiary of Parent (the "Merger"). The closing of the Merger is subject to customary closing conditions, including the approval of our stockholders and regulatory approvals.
Voting and Support Agreement
Concurrently with the execution of the Merger Agreement,Centerbridge Capital Partners, L.P. and certain of its affiliates (collectively, the "Centerbridge Stockholders"), which together beneficially own approximately 53.4% of the outstanding shares of ARA's common stock, entered into a Voting and Support Agreement with Parent pursuant to which, among other things and subject to the terms and conditions therein, the Centerbridge Stockholders agreed to vote their shares of 37 -------------------------------------------------------------------------------- Table of Contents Company common stock in favor of the adoption and approval of the Merger Agreement and the transactions contemplated thereby, including the Merger. In addition, each Centerbridge Stockholder waived appraisal rights. COVID-19 Pandemic InDecember 2019 , there was an outbreak of a new strain of severe acute respiratory syndrome coronavirus 2, or SARS-CoV-2 ("COVID-19"), and inMarch 2020 , theWorld Health Organization declared the outbreak of COVID-19, the disease caused by the SARS-CoV-2 virus, a pandemic. As a provider of essential healthcare services, we are significantly exposed to the health and economic effects of COVID-19 but have an obligation to continue providing our life-sustaining dialysis services and are doing so with a critical focus on the safety and well-being of our patients, staff and physician partners. We began to experience increased expenses and a reduction in treatment volume in connection with the pandemic beginning in March. The impacts on our operating and financial performance due to the COVID-19 pandemic became more significant in the second quarter and continued through the third quarter. We expect these impacts may continue beyond the fourth quarter. The situation surrounding COVID-19 remains fluid, and we continue to carefully monitor the impacts of the COVID-19 pandemic on our operating and financial performance. We cannot at this time accurately predict the ultimate impacts that COVID-19 will have on our operating and financial performance, but the adverse impacts may be material. We began to experience increased expenses and a reduction in treatment volume in connection with the pandemic beginning in March. For the nine months endedSeptember 30, 2020 , we incurred an additional$14.3 million in operating expenses as a result of the measures we have taken in response to COVID-19, of which$13.4 million were offset by grant funds received under the Coronavirus Aid, Relief, and Economic Security Act (the "CARES Act"). We expect the impacts to continue. We have undertaken measures designed to mitigate these impacts, including acceptance of government assistance intended to offset certain impacts, but these measures may not be sufficient to fully offset the operating and financial effects on our business from the pandemic. The amounts and types of future revenue, expense and cash flow impacts will depend on numerous factors, including the rate of spread of COVID-19, impacts on our employees, patients, physician partners, suppliers and other business partners, the pandemic's impact on theU.S. economy, the administrative developments related to the pandemic at the federal, state and local levels, and the results of our mitigation efforts, including our infectious disease prevention and control efforts. See "-Item 1A. Risk Factors-The ongoing COVID-19 pandemic and responses thereto have adversely affected, and we expect will continue to adversely affect, our business, results of operations and financial condition."
Taking Care of our Patients and Staff
The safety of our patients, staff and physician partners continues to be our primary focus, and we have undertaken and will continue to undertake steps to provide for their protection and enable our continued operation in the face of the pandemic. We are followingCenters for Disease Control and Prevention ("CDC") guidance and working closely with local and national health authorities to ensure we implement and maintain appropriate infection control and clinical best practices in response to COVID-19. In addition, our dedicated COVID-19 task force has proactively implemented business continuity plans and developed measures to ensure the ongoing availability of our dialysis services while maintaining patient and staff safety. Measures we have implemented include: •Restricting entry to our clinics to only patients, staff and medical professionals; •Screening all individuals for symptoms and exposure to COVID-19 before allowing access to our clinics; •Implementing a mask policy for every patient and staff memberwho enters our clinics and requiring that masks be worn at all times in our clinics; •Increased purchases and use of personal protective equipment for patients and staff and of cleaning and sanitization materials at our facilities to maintain infection control protocols that meetCDC guidelines; •Securing COVID-19 testing for patients and staff; •Implementing screening procedures for corporate office staff prior to entering our corporate offices, requiring social distancing within workspaces and throughout our corporate offices, and restricting access to our corporate offices to only ARA staff; •Engaging a physician infectious disease consultant to assist us in the development of policies and procedures to protect our patients and staff; 38 -------------------------------------------------------------------------------- Table of Contents •Establishing dedicated COVID-19 treatment shifts at certain of our clinics, where necessary, to care for patients with confirmed or suspected COVID-19 infection; and •Modifying our sick leave policy to accommodate quarantine and isolation when warranted. In addition to these safety measures, inMarch 2020 we implemented a hazard pay program to provide increased pay to our clinic staff on the front lines of the pandemic. This program remains in place for those clinic staffwho provide direct care to patientswho have been identified as COVID-19 positive, but it may be further amended or discontinued as appropriate in light of developments with the pandemic. These and other measures taken in response to COVID-19 have resulted in increased operating expenses, including higher salary and wage expense from the hazard pay program, incremental hours and overtime needed to staff the dedicated treatment shifts for patients with confirmed or suspected COVID-19, increased expenses from the higher utilization and cost of personal protective equipment, and additional costs to purchase additional supplies and cleaning materials. In addition, we have incurred additional corporate office costs related to legal, consulting costs and cleaning costs, as well as increased purchases of computer equipment and information technology to provide additional infrastructure for staffwho work remotely. For the nine months endedSeptember 30, 2020 , we estimate that we incurred an additional$14.3 million in operating expenses as a result of the measures we have taken in response to COVID-19,$13.4 million of which were offset by grant funds received under the CARES Act which was enacted onMarch 27, 2020 in response to the pandemic. The CARES Act is a relief package intended to assist many aspects of the American economy, and includes provisions to expand existing and introduce new programs to provide additional sources of liquidity to healthcare providers. We expect to incur many of these additional operating expenses for the duration of the pandemic, and if the severity of the pandemic increases, these additional expenses could increase.
Lost Revenue
Patients suffering from end-stage renal disease often have co-morbidities that place them at increased risk with COVID-19, which may result in increased patient hospitalizations, missed treatments and higher mortality. While many of our COVID-19 positive patients have recovered, missed treatments, including mortality, associated with COVID-19 positive patients during the third quarter resulted in an estimated 1.7% reduction in treatment volume compared to the three months endedSeptember 30, 2019 , which resulted in an estimated$2.8 million decrease in patient service operating revenues, net of direct patient care costs, during the quarter,$1.9 million of which were offset by grants under the CARES Act, which is reflected as Other income - CARES Act on the condensed consolidated statements of operations for the three months endedSeptember 30, 2020 . Since the end of the second quarter, we have seen an increase in the number of infected patients, but this number currently remains below peak levels experienced during the second quarter. The adverse impact on our treatment volume could increase in the event of a prolonged or increasingly severe pandemic. Further, broad economic factors resulting from the pandemic, including increasing unemployment rates, may lead to increases in uninsured patients and patients with lower-paying government insurance programs. The impact of this may be delayed or mitigated as a result of patients accessing COBRA and exchange plans but could have a material impact on our longer term earnings. A significant reduction in our treatment volume or in the number of patients with commercial insurance would have a material adverse effect on our revenues, earnings and cash flows.
Expense Management
In light of our increased expenses and the impact to revenue from the COVID-19 pandemic, we have and will continue to implement cost saving initiatives, including temporary reductions in executive compensation, reducing discretionary spending, including travel, increased management of existing corporate headcount and other temporary corporate expense initiatives. To date, these cost savings initiatives have not directly impacted clinic staff or regional operations teams that are providing on-site support to our clinics during the pandemic. We also have re-prioritized our capital expenditures and continued our slower pace of de novo clinic development. Our expense reduction initiatives may not offset the additional expenses and reductions in revenue resulting from the pandemic in the event we exhaust government funds provided for this purpose.
Balance Sheet, Cash Flow and Liquidity
As ofSeptember 30, 2020 , we had consolidated cash of$136.5 million , of which$59.5 million was provided by advance payments on future Medicare revenue under the Accelerated and Advance Payment Program ("Advance Payments") as expanded by theCenters for Medicare and Medicaid Services in a regulatory action unrelated to the CARES Act. 39 -------------------------------------------------------------------------------- Table of Contents In addition, as ofSeptember 30, 2020 , we had$9.8 million of restricted cash, representing CARES Act grant funds available for qualifying expenses and lost revenues for the remainder of the qualifying period. As ofSeptember 30, 2020 , we had$32.0 million of borrowing capacity available under our 2017 Revolving Credit Facility, and we were in compliance with the consolidated net leverage ratio covenant in our Credit Agreement. While we believe our cash balance and cash flows from operations provide sufficient liquidity for at least the next 12 months, we continue to take steps to enhance our financial flexibility, including the expense management initiatives discussed above. Additionally, we are closely managing our working capital as we continue to bill and collect for services rendered and extend payments on traditional accounts payables where appropriate. During the third quarter of 2020, we did not experience any significant issues in billing or cash collections directly associated with the COVID-19 pandemic; however, we may experience delays in the future due to lower claims operations staffing levels and longer call waiting times at certain of our commercial payors. In connection with the Merger, we agreed to limit our drawdowns under our 2017 Revolving Credit Facility through the date of the closing of the proposed merger to$2 million plus any fees incurred and limit total additional borrowings to$4 million . DuringApril 2020 , our facilities received approximately$27 million in the aggregate in healthcare provider relief grant funds provided under the CARES Act. These funds are subject to terms and conditions established by theU.S. Department of Health and Human Services , including that they may only be used to offset lost revenue and increased expenses attributable to the COVID-19 pandemic. As ofSeptember 30, 2020 , we had utilized$16.8 million of these funds. In accordance with the guidance issued by HHS, we can utilize these funds throughJune 30, 2021 , at which point any unused funds will be returned.. Our ability to utilize and retain some or all of the remaining provider relief grant funds will depend on the magnitude, timing and nature of the impact of COVID-19. The CARES Act also provides for deferred payment of the employer portion of social security taxes through the end of 2020, with 50% of the deferred amount dueDecember 31, 2021 and the remaining 50% dueDecember 31, 2022 . For the third quarter, we deferred payment of$3.9 million as a result of this provision. We expect this provision of the CARES Act to provide an additional$3.5 to$4.5 million of liquidity during the remainder of the current year. Furthermore, the CARES Act also provides for tax code relief that we estimate will result in cash tax benefits of approximately$5 million during the current year. The CARES Act also suspended for the period fromMay 2020 throughDecember 2020 the 2% Medicare sequestration reimbursement reduction that has been in place sinceApril 1, 2013 . As a result, we received an increase in patient service operating revenues of$1.7 million during the third quarter from this suspension, and we currently expect to receive an estimated additional$2.0 million for the remainder of the year. InApril 2020 , our facilities also applied for and received an aggregate of approximately$83 million in Advance Payments. Funds received under this program represent 90 days' worth of advances on future Medicare payments to healthcare providers and will be required to be repaid, interest-free, by our facilities. We used$19 million of these Advance Payments to reduce clinic-level debt, and the remaining funds are included in our consolidated cash as ofSeptember 30, 2020 to provide us with additional liquidity during the current year. Medicare payments will be reduced for 11 months beginningApril 2021 by 25%. If the advances have not been fully recouped byMarch 2022 . Medicare payments will be reduced by 50% until all advanced funds are recouped. We continue to closely monitor legislative actions at federal and state levels, including the impact of the CARES Act and other governmental assistance, on our business. 40 --------------------------------------------------------------------------------
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. As ofSeptember 30, 2020 , we had developed 199 de novo clinics and acquired 53 clinics. The following table shows the number of de novo and acquired clinics over the periods indicated: Three Months Ended September 30, Nine Months Ended September 30, 2020 2019 2020 2019 De novo clinics(1) 1 1 6 5 Acquired clinics(2) - - - 2 Sold or merged clinics(3) (4) (2) (4) (4) Net new clinics (3) (1) 2 3
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(1)Clinics formed by us which began to operate and dialyze patients in the applicable period. (2)Clinics acquired by us in the applicable period. (3)Clinics sold or merged by us in the applicable period.
De novo clinics. We have primarily grown through de novo clinic development. A typical de novo facility requires approximately$1.9 to$2.2 million of capital for equipment purchases, leasehold improvements and initial working capital. For the three months endedSeptember 30, 2020 and 2019, our development capital expenditures incurred in connection with our de novo clinic development were$2.1 million and$2.9 million , respectively, representing 1.0% and 1.4% of our quarterly patient service operating revenues, respectively. 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. In the three months endedSeptember 30, 2020 , as in recent quarters as we emerged from the process of restating certain of our prior financial statements during the fiscal year endedDecember 31, 2019 , we had a slower pace of de novo clinic development. With the COVID-19 pandemic, we expect that our slower pace of de novo clinic development will continue through the remainder of 2020 and possibly beyond. Our results of operations have been and will continue to be affected by the timing and number of openings, the timing of certifications and the amount of clinic opening costs incurred in conjunction with our de novo clinics program. 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 earlier of 18 months or the first month it generates positive clinic-level EBITDA, which 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: 41 --------------------------------------------------------------------------------
Three Months Ended
March 31, June 30, September 30, December 31, Total
2020 1 4 1 - 6
2019 2 2 1 2 7
2018 1 5 2 5 13
2017 3 2 1 9 15
2016 2 6 5 7 20
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, 2015 to
September 30, 2020 , we added 127 dialysis stations to our existing clinics,
representing the equivalent of nearly eight de novo clinics.
Acquired clinics. We have also grown through acquisitions of existing clinics,
and our results of operations have been and will continue to be affected by the
timing and number of our acquisitions. Our acquisition strategy is primarily
driven by the quality of the nephrologist in the market. We opportunistically
pursue acquisitions in situations where we believe the clinic offers us an
attractive opportunity to enter a new market or expand within an existing
market.
Our clinic growth drives our treatment growth. The following table summarizes the sources of our treatment growth for the periods indicated:
Three Months Ended September 30, Nine Months Ended September 30,
Source of Treatment Growth: 2020 2019 2020 2019
Non-acquired treatment growth(1) 0.1 % 5.8 % 2.1 % 4.9 %
Normalized non-acquired treatment growth(2) 3.2 % 5.7 % 3.7 % 5.6 %
Acquired treatment growth(3) - % 2.3 % 0.1 % 2.1 %
Total treatment growth 0.1 % 8.1 % 2.2 % 7.1 %
Normalized total treatment growth(2) 3.2 % 7.9 % 3.8 % 7.7 %
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(1)Represents net growth in treatments attributable to clinics operating at the end of the period that were also open at the end of the prior period and de novo clinics opened since the end of the prior period. (2)We calculate normalized total treatment growth and normalized 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 divested subsequent to the corresponding prior period and, for the three and nine months endedSeptember 30, 2020 , the number of missed treatments, which includes mortality, associated with COVID-19 positive patients, and expressing the resulting number as a percentage. The calculation of normalized treatment growth and normalized non-acquired treatment growth is further adjusted to equalize the number of treatment days during the applicable period with the corresponding prior period, to the extent there are differences due to the calendar. We estimate that missed treatments associated with COVID-19 positive patients resulted in an approximately 1.7% and 0.9% impact to our treatment growth for the three and nine months endedSeptember 30, 2020 , respectively. (3)Represents net growth in treatments attributable to clinics acquired since the end of the prior period.
Sources of Payment 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 prospective payment rate system
("PPS"), a 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. Effective January 1, 2018 , under the Medicare ESRD PPS
Transitional Drug Add-on Payment Adjustment Program ("TDAPA"), calcimimetic
pharmaceuticals became reimbursable as an add-on to the base rate. During the
years ended December 31, 2019 , 2018 and 2017, the Medicare ESRD PPS payment
rates for our clinics were approximately $279 , $281 and $248 , respectively, per
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treatment, including payments under the TDAPA program for the years ended
December 31, 2019 and 2018. 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 2019 released on
November 1, 2018 by CMS increased the base rate from $232.37 to $235.27 . The
ESRD PPS final rule for 2020 was released on October 31, 2019 by CMS (the "2020
Final Rule"). The 2020 Final Rule includes a base rate of $239.33 , representing
a $4.06 increase from the 2019 base rate, as well as certain changes to the
TDAPA program, including an extension to the TDAPA program for calcimimetics to
a third year while also reducing the basis of payment for the TDAPA program for
calcimimetics in 2020 from the Average Selling Price ("ASP") plus 6% to ASP plus
0%. CMS has estimated that the 2020 Final Rule, including the TDAPA program
changes, would result in an overall increase of payments to ESRD facilities of
1.6%.
On November 2, 2020 , CMS issued the ESRD PPS final rule for 2021 (the "2021
Final Rule"). The 2021 Final Rule includes a base rate of $253.13 , representing
a $13.80 increase from the 2020 base rate of $239.33 . However, the 2021 base
rate includes the addition of $9.93 to reflect the inclusion of calcimimetics
rather than as a separate add-on to the base rate under the TDAPA program. We
are in the process of evaluating the impact of the 2021 Final Rule on our
business.
Medicare and Medicaid payment rates are generally insufficient to cover our
total operating expenses allocable to providing dialysis treatments for Medicare
and Medicaid 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 at a discount to our usual
and customary fee schedule. Negotiated in-network rates paid by commercial
payors are generally lower than out-of-network payment rates. Pressure from
commercial payors over pricing and related matters and our strategy of
increasing our in-network payor relationships has resulted in lower average
commercial payment rates.
The following table summarizes our percentage of patient service operating revenues by payor source for the periods indicated:
Three Months Ended September 30, Nine Months Ended September 30,
Percentage of Revenues by Payor: 2020 2019 2020 2019
Medicare and Medicare Advantage 69 % 69 % 69 % 68 %
Commercial and other(1) 27 % 26 % 27 % 27 %
Medicaid and Managed Medicaid 4 % 5 % 4 % 5 %
Other(2) - % - % - % - %
100 % 100 % 100 % 100 %
The following table summarizes the percentage of total dialysis treatments performed by payor source for the periods indicated:
Three Months Ended September 30, Nine Months Ended September 30,
Percentage of Treatments by Payor: 2020 2019 2020 2019
Medicare and Medicare Advantage 80 % 80 % 80 % 80 %
Commercial and other(1) 12 % 12 % 12 % 12 %
Medicaid and Managed Medicaid 7 % 7 % 7 % 7 %
Other(2) 1 % 1 % 1 % 1 %
100 % 100 % 100 % 100 %
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(1)Principally commercial insurance companies and also includes theVA . Treatments covered by Affordable Care Act ("ACA")-compliant plans ("ACA plans") were 1.0% and 0.6% for the three months endedSeptember 30, 2020 and 2019, respectively and 0.8% and 0.7% for the nine months endedSeptember 30, 2020 and, 2019, respectively. Treatments covered byVA plans were 3.0% and 2.9% in the three months endedSeptember 30, 2020 and, 2019, respectively, and 3.0% and 2.8% for the nine months endedSeptember 30, 2020 and 2019, respectively. (2)Other sources of payment of revenues include hospitals and patient self-pay. "Patient self-pay" revenues consist of payments received directly from patientswho are either uninsured or self-pay for a portion of the bill. 43 -------------------------------------------------------------------------------- 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 payor. We have experienced an increase in our commercial treatment mix and the percentage of our commercial treatment mix represented by in-network commercial payors as a result of our strategy to increase our in-network commercial payor relationships. This trend has adversely affected our margins and profitability because negotiated in-network rates paid by commercial payors are generally lower than out-of-network payment rates. Effective inNovember 2016 , for patients enrolled in minimum essential Medicaid coverage, we suspended assistance in the application process for charitable premium support from theAmerican Kidney Fund ("AKF"), which caused an adverse change in the mix of patients and treatments in 2017. Prior to the 2017 ACA open enrollment period, approximately 2% of our total patients chose to enhance their pre-existing minimum Medicaid coverage by electing to enroll in an ACA plan. Virtually all of these low-income patients relied on charitable premium assistance because they were ineligible for federal premium tax credits. Due to the suspension of assistance in the application process for charitable premium support from the AKF, virtually all of our patients with ACA primary insurance coverage and secondary minimum essential Medicaid coverage reverted back to Medicaid-only coverage during 2017. We continue to advise our other patients about the potential availability of assistance with the payment of premiums from the AKF under the AKF Health Insurance Premium Program, subject to the suspension described above, and compliance with the AKF's policies and procedures and approved regulatory guidance from CMS. The aforementioned suspension has adversely impacted, and any CMS action relating to establishing policies to restrict or limit charitable assistance for ACA plans or other individual marketplace plans could adversely impact, the number of patients covered by ACA plans and other individual marketplace plans, our average reimbursement rate and our results of operations and cash flows, which impact has been and may continue to be material. Further, the other changes to our patient insurance education program, whether or not the suspension continues or CMS restricts charitable premium assistance, together with the other developments in the market, including the impact of such changes on enrollment in ACA plans and other individual marketplace plans, other insurance coverage, and/or potential regulatory changes in the future, have adversely impacted, and are expected to continue to adversely impact, the number of our patients covered by insurance, as well as our average reimbursement rate in the future. In addition to charitable premium support for patients enrolled in ACA plans, the AKF provides charitable premium support to patients with other insurance coverage, including Medicare supplemental insurance and commercial insurance. We have, from time to time, received letters from certain insurance companies indicating that they will not insure patientswho receive premium payment assistance from third-party charitable organizations. There have also been legislative efforts to impose restrictions and obligations relating to the use by patients on commercial plans of charitable premium support, including aCalifornia bill (AB 290) that was signed into law inOctober 2019 , but is currently enjoined, that limits the amount of reimbursement paid to certain providers for services provided to patients with commercial insurancewho receive charitable premium assistance. Furthermore, the AKF has suspended charitable premium assistance payments from time to time and may continue to do so in the future. If patients are unable to obtain or to continue to receive AKF charitable premium support as a result of AKF suspension or otherwise, or if payments that a dialysis provider can retain for treatment to patients receiving such support is restricted, whether due to insurance company challenges to covering patients receiving charitable premium support, legislative changes, rules or interpretations limiting such support or other reasons, the financial impact on our company could be materially greater than the annual financial impact described above of patients previously enrolled in ACA plans and could materially and adversely affect our results of operations. See "Item 1A. Risk Factors-Risks Related to Our Business-If the number of patients with commercial insurance declines, our operating results and cash flows would be adversely affected" and "-If there is a decline in financial assistance from charitable organizations to patients with commercial insurance, our operating results and cash flows would be adversely affected" in our 2019 Form 10-K. We believe that the operating environment will continue to be challenging due to the ongoing and uncertain impact of COVID-19 as described above and the government's response to it, adverse trends in our commercial payor mix, continuing pressure on commercial rates, pressure on Medicare Advantage rates due to the continued growth in this subset of the Medicare patient population, the uncertainty around the ACA and the ability of our patients overall to access charitable premium assistance from non-profit organizations such as the AKF resulting from actions by theU.S. President andCongress . In addition, the impact of many of the foregoing trends may be exacerbated by the impact of COVID-19. We believe that the pressure on commercial rates due to more restrictive health plan benefit design and our strategy of increasing our in-network payor relationships could continue to create additional challenges. In addition, certain members ofCongress have proposed measures that would expand government-sponsored coverage of healthcare expenses, including single payor proposals, which, if adopted, could materially and adversely affect our business, results of operations and financial condition. In addition, inJuly 2019 , theU.S. President signed an executive order to launch theAdvancing American Kidney Health initiative that, among other things, will further encourage dialysis in the home. We are unable to predict the full effect of the foregoing factors on our 44 -------------------------------------------------------------------------------- business, results of operations and cash flows. See also "Item 1A. Risk Factors-Risks Related to Our Business-If the rates paid by commercial payors continue to decline, our operating results and cash flow will be adversely affected" and "-The Advancing American Kidney Health initiative may adversely affect our business, results of operations, cash flows and revenues" in our 2019 Form 10-K. 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 Erythropoietin Stimulating Agents ("ESAs") and medical supplies. We currently obtain the ESAs Aranesp and Epogen from Amgen Inc. and the ESAs Mircera and Retacrit fromVifor International AG . Increased utilization of ESAs 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, any shortage of supplies 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. See also "Item 1A. Risk Factors-Risks Related to Our Business-Changes in the availability and cost of ESAs and other pharmaceuticals could adversely affect our operating results and financial condition as well as our ability to care for patients" and "-If our suppliers are unable to meet our needs, if there are material price increases or if we are unable to effectively access new technology, our operating results and financial condition could be adversely affected" in our 2019 Form 10-K. See also "Item 1A. Risk Factors-The ongoing COVID-19 pandemic and responses thereto have adversely affected, and we expect will continue to adversely affect, our business, results of operations and financial condition."
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 due to co-insurance, co-payments and deductibles, 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.
Impact of the IPO and Certain Legal Matters
We are an emerging growth company as defined in the Jumpstart Our Business Startups Act (the "JOBS Act") and may currently take advantage of exemptions available under the JOBS Act including exemption from the auditor attestation requirements under Section 404 of the Sarbanes-Oxley Act of 2002; reduced disclosure obligations regarding executive compensation in our periodic reports and proxy statements; exemption from the requirements of holding non-binding stockholder votes on executive compensation arrangements; and exemption from any rules requiring mandatory audit firm rotation and auditor discussion and analysis and, unless theSEC otherwise determines, any future audit rules that may be adopted by thePublic Company Accounting Oversight Board . We will be an emerging growth company until the earliest of (i)December 31, 2021 , (ii) the last day of the fiscal year in which we have annual gross revenue of$1 billion or more, (iii) the date on which we have, during the previous three-year period, issued more than$1 billion in non-convertible debt or (iv) the first day of the first fiscal year after we have more than$700 million in aggregate market value of outstanding common equity held by our non-affiliates as of the last day of our second fiscal quarter. When the available exemptions under the JOBS 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 and related matters. See "-Operating Expenses-Certain legal and other matters" and "Item 1. Legal Proceedings." OnApril 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, inU.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. 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. 45 -------------------------------------------------------------------------------- Any changes to the TRA liability will be recognized in our statement of operations as Change in fair value of income tax receivable agreement in future periods. See "Note 5 - Fair Value Measurements" of the notes to the unaudited condensed consolidated financial statements.
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 withU.S. generally accepted accounting principles ("GAAP"), while other financial information, such as Adjusted EBITDA and Adjusted EBITDA-NCI, is not prepared in accordance with GAAP. The following table presents certain operating data, which we monitor as key performance indicators, for the periods indicated. Three Months Ended Nine Months Ended
Operating Data and Non-GAAP Financial Data:
248 244 248 244
Number of de novo clinics opened (during
period) 1 1 6 5
Patients (as of end of period) 16,918 17,159 16,918 17,159
Number of treatments 626,021 625,684 1,873,021 1,831,893
Non-acquired treatment growth 0.1 % 5.8 % 2.1 % 4.9 %
Normalized non-acquired treatment growth(1) 3.2 % 5.7 % 3.7 % 5.6 %
Acquired treatment growth - % 2.3 % 0.1 % 2.1 %
Total treatment growth 0.1 % 8.1 % 2.2 % 7.1 %
Normalized total treatment growth(1) 3.2 % 7.9 % 3.8 % 7.7 %
Patient service operating revenues per
treatment $ 335 $ 338 $ 325 $ 337
Patient care costs per treatment $ 240 $ 247 $ 241 $ 249
General and administrative expenses per
treatment $ 37 $ 30 $ 38 $ 37
Adjusted EBITDA (including noncontrolling
interests)(2) $ 40,688 $ 38,705 $ 98,345 $ 95,537
Adjusted EBITDA-NCI(2) $ 25,210 $ 26,455 $ 63,923 $ 64,635
_____________________________
(1)We calculate normalized total treatment growth and normalized 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 divested
subsequent to the corresponding prior period and, for the three and nine months
ended September 30, 2020 , the number of missed treatments, which included
mortality, associated with COVID-19 positive patients, and expressing the
resulting number as a percentage. The calculation of normalized treatment growth
and normalized non-acquired treatment growth is further adjusted to equalize the
number of treatment days during the applicable period with the corresponding
prior period, to the extent there are differences due to the calendar. We
estimate that missed treatments associated with COVID-19 positive patients
resulted in an approximately 1.7% and 0.9% impact to our treatment growth for
the three and nine months ended September 30, 2020 , respectively.
(2)Includes approximately $1.7 million and $2.8 million , respectively, for the
three and nine months ended September 30, 2020 , attributable to the temporary
suspension under the CARES Act of the 2% Medicare sequestration reimbursement
reduction.
(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 patient-friendly features and convenience of location and clinic hours.
46
--------------------------------------------------------------------------------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, and general and administrative expenses on a per treatment basis to assess our operational efficiency.
Non-GAAP Financial Measures
This Form 10-Q makes reference to certain non-GAAP financial measures. These non-GAAP financial measures are not recognized measures under GAAP and do not have a standardized meaning prescribed by GAAP. When used, these measures are defined in such terms as to allow the reconciliation to the closest 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 GAAP measures by providing further understanding of our results of operations from management's perspective. Accordingly, they should not be considered in isolation nor as a substitute for analysis of our financial information reported under GAAP. We use non-GAAP financial 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 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 stock-based compensation and
associated payroll taxes, depreciation, amortization and impairment, interest
expense, net, income taxes and other non-income-based tax, change in fair value
of income tax receivable agreement, certain legal and other matters, severance,
executive retirement and related costs and gain or loss on sale or closure of
clinics. "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 a
further understanding of our results of operations from management's
perspective. We believe Adjusted EBITDA is helpful in highlighting trends
because Adjusted EBITDA excludes certain expenses that can differ significantly
from company to company depending on, among other things, long-term strategic
decisions regarding capital structure and investments, and the tax jurisdictions
in which companies operate, or that we believe do not reflect our core business
operations. 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 and differ from the calculation of
"Consolidated EBITDA" under our credit agreement. Adjusted EBITDA and Adjusted
EBITDA-NCI may not be indicative of historical operating results, and we do not
mean for these items to be predictive of future results of operations or cash
flows. Adjusted EBITDA and Adjusted EBITDA-NCI have limitations as analytical
tools, and they should not be considered 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 and associated payroll taxes;
•do not include depreciation, amortization and impairment-because construction
and operation of our dialysis clinics requires significant capital expenditures,
depreciation and amortization are a necessary element of our costs and our
ability to generate profits;
•do not include interest expense-as we have borrowed money for general corporate
and facility purposes, interest expense is a necessary element of our costs and
ability to generate profits and cash flows;
•do not include income tax expense or benefits and other non-income-based taxes;
•do not include change in fair value of income tax receivable agreement;
•do not include costs related to certain legal and other matters;
47
--------------------------------------------------------------------------------•do not include severance, executive retirement and related costs; and •do not reflect the gain or loss on sale or closure of clinics.
In addition, Adjusted EBITDA is not adjusted for the portion of earnings that we distribute to our joint venture partners.
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 Nine Months Ended September
30, 30,
(in thousands) 2020 2019 2020 2019
Net income $ 12,787 $ 17,027 $ 25,292 $ 17,022
Add:
Stock-based compensation and associated payroll taxes 1,534 986 5,934 3,277
Depreciation, amortization and impairment 9,259 10,220 26,760 30,585
Interest expense, net 9,501 12,242 30,235 32,533
Income tax expense (benefit) and other non-income-based tax(a)
(57) (11,195) (1,301) (9,542)
Change in fair value of income tax receivable
agreement(b) 42 30 (1,301) (1,348)
Certain legal and other matters(c) 6,420 9,634 9,548 23,306
Severance, executive retirement and related costs 909 25 2,470 480
(Gain) loss on sale or closure of clinics 293 (264) 708 (776)
Adjusted EBITDA (including noncontrolling interests) $ 40,688 $ 38,705 $ 98,345 $ 95,537
Less: Net income attributable to noncontrolling
interests (15,478) (12,250) (34,422) (30,902)
Adjusted EBITDA -NCI $ 25,210 $ 26,455 $ 63,923 $ 64,635 _____________________________
(a)Non-income-based tax includes franchise, gross receipts, and similar tax assessments. (b)See "Note 5 - Fair Value Measurements" of the notes to the unaudited condensed consolidated financial statements. (c)For the nine months endedSeptember 30, 2020 and 2019, includes$3.4 million and$21.4 million , respectively, relating to our restatement of certain of our prior financial statements and other financial information, as described in our Annual Report on Form 10-K for the fiscal year endedDecember 31, 2018 (the "Restatement"), the relatedSEC investigation and Audit Committee review and litigation relating to the foregoing and other expenses relating to matters that we believe do not reflect our core business operations. Also included above are$4.6 million of legal expenses related to the Merger. Components of Operations
Patient Service Operating Revenues
Patient service operating revenues. Patient service operating revenues, the major component of our revenues, are derived from dialysis treatments and related services. Sources of payment of revenues are principally from government-based programs, including Medicare, Medicaid, and state workers' compensation programs, commercial insurance payors and other sources such as theVA and hospitals, as well as patient self-pay. Patient service operating revenues are reported at the amounts that reflect the consideration to which we expect to be entitled in exchange for providing dialysis treatments and related services. Amounts may include variable consideration for discounts, price concessions and retroactive revenue adjustments due to new information obtained, such as actual payment receipt, as well as settlement of audits, reviews and investigations. Third-party payors, patients and other payors are generally billed at least monthly, typically in the month the dialysis treatment is performed. 48
-------------------------------------------------------------------------------- We maintain a usual and customary fee schedule for dialysis treatment and other related services. However, the transaction price is typically recorded at a discount to the fee schedule. The transaction prices for Medicare and Medicaid programs are based on predetermined net realizable rates per treatment that are established by statutes or regulations. The transaction prices for contracted payors are based on contracted rates. For other payors, we estimate the transaction price based on usual and customary rates for services provided, reduced by contractual and other adjustments that result from differences between the rates charged for services performed and expected reimbursements from third-party payors, discounts provided to uninsured patients in accordance with our policy and/or implicit price concessions. We determine our estimates of contractual allowances and discounts based on contractual agreements, regulatory compliance and historical collection experience. We determine our estimate of implicit price concessions based on our historical collection experience with each payor, and where no prior experience exists, we consider information from the patient's health plan. Amounts billed that have not yet been collected and that meet the conditions for an unconditional right to payment are presented as net accounts receivable. Contractual and other adjustments as well as discounts with third-party payors are considered variable consideration and are included in the determination of the estimated transaction price for providing patient care. In assessing the probability of these claim payments, we review previous payment history and record a reserve at the patient level that results in an estimate of expected revenue such that it is probable that a significant revenue reversal will not occur in future periods. Operating Expenses Patient care costs. Patient care costs are those costs directly associated with operating our dialysis clinics. Patient care costs principally include salaries, wages and benefits, stock-based compensation expense, pharmaceuticals, medical supplies, rent and utilities, laboratory testing, medical director fees and insurance costs and exclude depreciation, amortization and impairment. General and administrative expenses. General and administrative expenses generally consist of salaries, wages and benefits, and stock-based compensation expense to personnel at our corporate office for clinic and corporate administration, including accounting, billing and cash collection functions; costs of patient insurance education; costs of regulatory compliance and legal oversight; charitable contributions; and professional fees, and exclude depreciation, amortization and impairment. Depreciation, amortization and impairment. Depreciation, amortization and impairment 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. Impairment expense is attributable to our assets held for sale. See "Note 4 - Assets Held for Sale andGoodwill " of the notes to the unaudited condensed consolidated financial statements. Certain legal and other matters. Certain legal and other matters include legal fees and other expenses associated with matters that we believe do not reflect our core business operations, including, but not limited to, our handling of, and response to the following: •theSEC investigation and related Audit Committee review and Restatement process (2019-2020), •the securities and derivative litigation related to the foregoing (2019-2020), •our internal review and analysis of factual and legal issues relating to the aforementioned matters, •legal fees and other expenses relating to our previously announced execution of the Merger Agreement; and •other legal fees and other expenses relating to matters that we believe do not reflect our core business operations.
See "Item 1. Legal Proceedings" and "Note 16 - Certain Legal and Other Matters" of the notes to the unaudited consolidated financial statements.
Operating Income
Operating income is equal to our 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.
49--------------------------------------------------------------------------------
Interest, Change in Fair Value of Income Tax Receivable and Income 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.
Change in fair value of income tax receivable agreement. Change in fair value of income tax receivable agreement is the non-cash gain or loss associated with the change in the fair value of the TRA during the period indicated. Income tax (benefit) expense. Income tax (benefit) expense is recorded on 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 are 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 noncontrolling 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 our company, is classified within the line item Net income attributable to noncontrolling interests. See also "Part II. Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations-Critical Accounting Policies and Estimates-Noncontrolling Interests" in our 2019 Form 10-K and "Note 8 - Noncontrolling Interests Subject to Put Provisions" of the notes to the unaudited condensed consolidated financial statements.
Results of Operations
Three Months Ended
The following table summarizes our results of operations for the periods
indicated:
Three Months Ended September 30, Increase (Decrease)
Percentage
(in thousands) 2020 2019 Amount Change
Patient service operating revenues $ 209,689 $ 211,429 $ (1,740) (0.8) %
Operating expenses:
Patient care costs 150,357 154,588 (4,231) (2.7) %
General and administrative 23,379 18,783 4,596 24.5 %
Depreciation, amortization and impairment 9,259 10,220 (961) (9.4) %
Certain legal and other matters 6,420 9,634 (3,214) (33.4) %
Total operating expenses 189,415 193,225 (3,810) (2.0) %
Operating income 20,274 18,204 2,070 11.4 %
Other income - CARES Act 1,920 - 1,920 NM
Interest expense, net (9,501) (12,242) 2,741 (22.4) %
Change in fair value of income tax receivable
agreement (42) (30) (12) (40.0) %
Income before income taxes 12,651 5,932 6,719 113.3 %
Income tax expense (136) (11,095) 10,959 98.8 %
Net income 12,787 17,027 (4,240) (24.9) %
Less: Net income attributable to noncontrolling
interests (15,478) (12,250) (3,228) 26.4 %
Net income (loss) attributable to American Renal
Associates Holdings, Inc. $ (2,691) $ 4,777 $ (7,468) 156.3 %
50--------------------------------------------------------------------------------
_____________________
NM - Not Meaningful
Patient Service Operating Revenues
Patient service operating revenues. Patient service operating revenues for the three months endedSeptember 30, 2020 were$209.7 million , a decrease of$1.7 million , or 0.8%, from$211.4 million for the three months endedSeptember 30, 2019 . The three months endedSeptember 30, 2019 included favorable resolutions of certain commercial out-of-network claims. During the three months endedSeptember 30, 2020 , the decrease was also due to lower contributions from calcimimetics reflecting lower reimbursement rates from Medicare and adverse changes in commercial treatment reimbursement rates, which reflect a larger base of in-network commercial payor relationships, partially offset by an increase of 0.1% in the number of dialysis treatments, driven primarily by de novo clinic openings, and a recognition of$1.7 million from the temporary suspension under the CARES Act of the 2% Medicare sequestration reimbursement reduction, which became effectiveMay 1, 2020 . We estimate that treatments missed due to COVID-19 resulted in$2.8 million of reduced patient service operating revenues, net of direct patient care costs, during the quarter,$1.9 million of which were offset by grants under the CARES Act, which is reflected as Other income - CARES Act on the condensed consolidated statements of operations for the three months endedSeptember 30, 2020 . As a percentage of revenue by payor type, government-based payors accounted for 73% of our revenues for each of the three months endedSeptember 30, 2020 and 2019. Patient service operating revenues per treatment for the three months endedSeptember 30, 2020 and 2019 were$335 and$338 , respectively, primarily due to the suspension of the sequestration reimbursement reduction. Non-acquired treatment growth was 0.1%. Normalized total treatment growth was 3.2% and normalized non-acquired treatment growth was 3.2% for the three months endedSeptember 30, 2020 . Missed treatments due to COVID-19 resulted in an estimated 1.7% impact to treatment growth during the period. Patient service operating revenues relating to start-up clinics for the three months endedSeptember 30, 2020 were$3.3 million , compared to$2.6 million for the three months endedSeptember 30, 2019 , an increase of$0.7 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." Operating Expenses Patient care costs. Patient care costs for the three months endedSeptember 30, 2020 were$150.4 million , a decrease of$4.2 million , or 2.7%, from$154.6 million for the three months endedSeptember 30, 2019 , which was primarily due to reduced ancillary costs, including ESAs and calcimimetics, partially offset by the 0.1% increase in the number of treatments. We estimate that we incurred$5.6 million of COVID-19 related patient care expenses during the period, primarily attributable to higher personnel costs due to hazard pay, overtime and additional staffing expense, as well as higher supply costs for personal protective equipment and infection control materials. During the three months endedSeptember 30, 2020 , we applied CARES Act grant funds of approximately$5.0 million to offset additional expenses. Our patient care costs per treatment for the three months endedSeptember 30, 2020 were$240 , compared to$247 for the three months endedSeptember 30, 2019 . As a percentage of patient service operating revenues, patient care costs were 71.7% for the three months endedSeptember 30, 2020 , compared to 73.1% for the three months endedSeptember 30, 2019 . General and administrative expenses. General and administrative expenses for the three months endedSeptember 30, 2020 were$23.4 million , an increase of$4.6 million , or 24.5%, from$18.8 million for the three months endedSeptember 30, 2019 . During 2020, we incurred higher amounts amount for accounting fees, temporary labor and stock compensation. In addition, 2020 included executive retirement expenses and executive search fees. During 2019, we recorded a reduction of executive compensation expense in 2019 arising from the Restatement. General and administrative expenses per treatment were$37 for the three months endedSeptember 30, 2020 , compared to$30 for the three months endedSeptember 30, 2019 .
As a percentage of patient service operating revenues, general and
administrative expenses were 11.1% for the three months ended
Depreciation, amortization and impairment. Depreciation, amortization and impairment expense for the three months endedSeptember 30, 2020 was$9.3 million , compared to$10.2 million for the three months endedSeptember 30, 2019 . The decrease in the quarter is primarily related to reduced capital expenditures over the past two years, and the fact that certain clinics had been held for sale and were not depreciated. In addition, as a percentage of patient service operating revenues, depreciation, amortization and impairment expense was 4.4% for the three months endedSeptember 30, 2020 , compared to 4.8% for the three months endedSeptember 30, 2019 . 51 -------------------------------------------------------------------------------- Certain legal and other matters. Certain legal and other matter costs for the three months endedSeptember 30, 2020 were$6.4 million , compared to$9.6 million for the three months endedSeptember 30, 2019 . The three months endedSeptember 30, 2020 andSeptember 30, 2019 include$0.8 million and$8.3 million , respectively, of expenses relating to the Restatement and relatedSEC investigation and Audit Committee review discussed in our Form 10-K for the fiscal year endedDecember 31, 2018 . See "-Components of Operations-Certain legal and other matters." In addition, during the three months endedSeptember 30, 2020 , we incurred approximately$4.6 million of expenses associated with the Merger.
Operating Income
Operating income for the three months ended
As a percentage of patient service operating revenues, operating income was 9.7% for the three months endedSeptember 30, 2020 , compared to 8.6% for the three months endedSeptember 30, 2019 , reflecting the factors described above.
Interest, Change in Fair Value of Income Tax Receivable Agreement, and Income Taxes
Interest expense, net. Interest expense, net for the three months endedSeptember 30, 2020 was$9.5 million , and for the three months endedSeptember 30, 2019 was$12.2 million , a decrease of 22.4%. The decrease is primarily attributable to lower interest rates under the amended 2017 Credit Agreement described in "Liquidity and Capital Resources" below partially offset by the impact of higher borrowings. Change in fair value of income tax receivable agreement. Change in fair value of income tax receivable agreement for the three months endedSeptember 30, 2019 was -$(0.3) million and was not material for the three months endedSeptember 30, 2020 . Income tax (benefit) expense. The income tax (benefit) expense for the three months endedSeptember 30, 2020 and 2019 represented an effective tax rate of (1.1)% and (187.0)%, respectively. The variation from the statutory federal rate of 21% on our share of pre-tax income during the three months endedSeptember 30, 2020 and 2019, respectively, is primarily due to the tax impact of the noncontrolling interest in the clinics as a result of the joint venture model, the valuation allowance and the change in fair value of the TRA liability, which is not deductible for income tax purposes and also other non-deductible expenses. Additionally, as a result of the CARES Act, three months endedSeptember 30, 2020 , we determined we would be able to carry our forecasted 2019 net operating losses of$6.1 million back to tax years when the statutory tax rate was 35% resulting in an income tax benefit of$0.9 million , which is included in income tax benefit in the condensed consolidated statements of operations as well as release of$0.2 million of valuation allowance three months endedSeptember 30, 2020 . We have and will continue to incorporate and evaluate the impact the CARES Act has on our overall tax provision. See "Note 11 - Income Taxes" of the notes to the unaudited condensed consolidated financial statements for additional information.
Net Income Attributable to Noncontrolling Interests
Net income attributable to noncontrolling interests for the three months endedSeptember 30, 2020 was$15.5 million , representing an increase of$3.2 million , or 26.4%, from$12.3 million for the three months endedSeptember 30, 2019 . The increase was primarily due to increased profitability in our joint ventures due to the factors described above. 52
--------------------------------------------------------------------------------
Nine Months Ended
The following table summarizes our results of operations for the periods
indicated:
Nine Months Ended September 30, Increase (Decrease)
Percentage
(in thousands) 2020 2019 Amount Change
Patient service operating revenues $ 608,021 $ 616,443 $ (8,422) (1.4) %
Operating expenses:
Patient care costs 451,462 455,785 (4,323) (0.9) %
General and administrative 70,950 68,309 2,641 3.9 %
Depreciation, amortization and impairment 26,760 30,585 (3,825) (12.5) %
Certain legal and other matters 9,548 23,306 (13,758) (59.0) %
Total operating expenses 558,720 577,985 (19,265) (3.3) %
Operating income 49,301 38,458 10,843 28.2 %
Other income - CARES Act 3,393 - 3,393 NM
Interest expense, net (30,235) (32,533) 2,298 7.1 %
Change in fair value of income tax receivable
agreement 1,301 1,348 (47) (3.5) %
Income before income taxes 23,760 7,273 16,487 226.7 %
Income tax benefit (expense) (1,532) (9,749) 8,217 84.3 %
Net income (loss) 25,292 17,022 8,270 48.6 %
Less: Net income attributable to noncontrolling
interests (34,422) (30,902) (3,520) (11.4) %
Net loss attributable to American Renal
Associates Holdings, Inc. $ (9,130) $ (13,880) $ 4,750 34.2 %
Patient Service Operating Revenues
Patient service operating revenues. Patient service operating revenues for the nine months endedSeptember 30, 2020 were$608.0 million , a decrease of$8.4 million , or 1.4% from$616.4 million . The nine months endedSeptember 30, 2019 included favorable resolutions of certain commercial out-of-network claims. During the nine months endedSeptember 30, 2020 , the decrease was also due to lower contributions from calcimimetics reflecting lower reimbursement rates from Medicare and adverse changes in commercial treatment reimbursement rates resulting from the increase in our in-network commercial payor relationships, partially offset by an increase of 2.2% in the number of dialysis treatments driven primarily by de novo clinic openings, and a recognition of$2.8 million from the temporary suspension under the CARES Act of the 2% Medicare sequestration reimbursement reduction, which became effectiveMay 1, 2020 . We estimate that COVID-19 related volume disruptions resulted in$4.4 million of reduced patient service operating revenues, net of direct patient care costs, during the period, of which$3.4 million were offset by grants under the CARES Act and is reflected in Other income. As a percentage of revenue by payor type, government-based payors accounted for 73% of our revenues for the nine months endedSeptember 30, 2020 and 2019. Patient service operating revenues per treatment for the nine months endedSeptember 30, 2020 was$325 , compared with$337 for the nine months endedSeptember 30, 2019 , a decrease of 3.6%. Non-acquired treatment growth was 2.1%, and acquired treatment growth was 0.1%. Normalized total treatment growth was 3.8% and normalized non-acquired treatment growth was 3.7% for the nine months endedSeptember 30, 2020 . Missed treatments due to COVID-19 resulted in an estimated 0.9% impact to treatment growth during the period. Patient service operating revenues relating to start-up clinics for the nine months endedSeptember 30, 2020 were$7.5 million , compared to$6.9 million for the nine months endedSeptember 30, 2019 , an increase of$0.6 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."
Operating Expenses
Patient care costs. Patient care costs for the nine months endedSeptember 30, 2020 were$451.5 million , a decrease of$4.3 million from$455.8 million for the nine months endedSeptember 30, 2019 , which was primarily due to reduced ancillary costs, including ESAs and calcimimetics, partially offset by the 2.2% increase in the number of treatments. We estimate that we incurred$13.9 million of COVID-19 related patient care expenses during the period, primarily attributable to higher personnel 53 -------------------------------------------------------------------------------- costs due to hazard pay, overtime and additional staffing expense, as well as higher supply costs for personal protective equipment and infection control materials of which$13.1 million were offset by grants under the CARES Act. Patient care costs per treatment for the nine months endedSeptember 30, 2020 were$241 , compared to$249 for the nine months endedSeptember 30, 2019 . As a percentage of patient service operating revenues, patient care costs were 74.3% for the nine months endedSeptember 30, 2020 , compared to 73.9% for the nine months endedSeptember 30, 2019 . General and administrative expenses. General and administrative expenses for the nine months endedSeptember 30, 2020 were$71.0 million , an increase of approximately$2.7 million , or 3.9%, from$68.3 million for the nine months endedSeptember 30, 2019 . During 2020, we incurred higher amounts for accounting fees, temporary labor and stock compensation offset by lower corporate headcount. In addition, 2020 included executive retirement expenses and executive search fees and did not include charitable contributions. During 2019, we recorded a reduction of executive compensation expense in 2019 arising from the Restatement. General and administrative expenses per treatment for the nine months endedSeptember 30, 2020 were$38 , compared to$37 for the nine months endedSeptember 30, 2019 .
As a percentage of patient service operating revenues, general and
administrative expenses were 11.7% for the nine months ended
Depreciation, amortization and impairment. Depreciation, amortization and impairment expense for the nine months endedSeptember 30, 2020 was$26.8 million , compared to$30.6 million for the nine months endedSeptember 30, 2019 . The decrease in 2020 is primarily related to reduced capital expenditures over the past two years, and the fact that certain clinics had been held for sale and were not depreciated. In addition, the nine months endedSeptember 30, 2020 included a reduction to the valuation allowance of$0.5 million related to assets held for sale. As a percentage of patient service operating revenues, depreciation, amortization and impairment expense was 4.4% for the nine months endedSeptember 30, 2020 , compared to 5.0% for the nine months endedSeptember 30, 2019 . Certain legal and other matters. Certain legal and other matter costs for the nine months endedSeptember 30, 2020 were$9.5 million , compared to$23.3 million for the nine months endedSeptember 30, 2019 . The nine months endedSeptember 30, 2020 and 2019 include$3.4 million and$9.4 million , respectively, of expenses relating to theSEC investigation and related Audit Committee examination and Restatement process discussed in our 2018 Form 10-K. See "-Components of Operations-Certain legal and other matters." In addition, we incurred approximately$4.6 million of expenses associated with the Merger.
Operating Income
Operating income for the nine months endedSeptember 30, 2020 was$49.3 million , an increase of$10.8 million , or 28.2%, from$38.5 million for the nine months endedSeptember 30, 2019 , which was primarily due to the factors described above. For the nine months endedSeptember 30, 2020 and 2019, start-up clinics reduced operating income by$5.5 million and$6.5 million , respectively.
As a percentage of patient service operating revenues, operating income was 8.1%
for the nine months ended
Interest and Taxes
Interest expense, net. Interest expense, net for the nine months endedSeptember 30, 2020 was$30.2 million , and for the nine months endedSeptember 30, 2019 was$32.5 million , a decrease of 7.1%. The decrease is primarily attributable to lower interest rates under the amended 2017 Credit Agreement described in "Liquidity and Capital Resources" below partially offset by the impact of higher borrowings. Change in fair value of income tax receivable agreement. Change in fair value of income tax receivable agreement for the nine months endedSeptember 30, 2020 and 2019 was$1.3 million and$1.3 million , respectively. Income tax (benefit) expense. The income tax (benefit) expense for the nine months endedSeptember 30, 2020 and 2019 represented an effective tax rate of (6.5)% and (134.0)%, respectively. The variation from the statutory federal rate of 21% on our share of pre-tax income during the nine months endedSeptember 30, 2020 and 2019 is primarily due to the tax impact of the noncontrolling interest in the clinics as a result of the joint venture model, the valuation allowance and the change in fair value of the TRA liability, which is not deductible for income tax purposes and also other non-deductible 54 -------------------------------------------------------------------------------- expenses. Additionally, as a result of the CARES Act, during the nine months endedSeptember 30, 2020 , we determined we will be able to carry our forecasted 2019 net operating losses of$22.4 million back to tax years when the statutory tax rate was 35%, resulting in an income tax benefit of$3.1 which is included in income tax benefit in the condensed consolidated statements of operations. As a result of the CARES Act, we have released$3.4 million of valuation allowance during the nine months endedSeptember 30, 2020 . We have and will continue to incorporate and evaluate the impacts the CARES Act has on our overall tax provision. See "Note 11 - Income Taxes" of the notes to the unaudited condensed consolidated financial statements for additional information.
Net Income Attributable to Noncontrolling Interests
Net income attributable to noncontrolling interests for the nine months endedSeptember 30, 2020 was$34.4 million , representing an increase of$3.5 million , or 11.4%, from$30.9 million for the nine months endedSeptember 30, 2019 . The increase was primarily due to increased profitability in our joint ventures due to the factors described above.
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 to fund purchases of equity held by our nephrologist partners. A significant portion of our cash flows is used to make distributions to the noncontrolling equity interests held by our nephrologist partners in our JV 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. For the nine months endedSeptember 30, 2020 , in addition to our typical requirements for operating capital and capital expenditures, we incurred approximately$4.9 million in professional accounting, consulting, legal fees and additional interest as a result of theSEC investigation, private litigation and in-process remediation of material weaknesses in our internal control over financial reporting. In addition, we incurred approximately$4.6 million of expenses associated with the Merger. We expect the merger related fees to be paid at the time the merger is completed. We believe that we will continue to incur fees for these services during 2020 in amounts in excess of our ordinary course legal and other professional expenses. In light of the uncertainty in the global economy and financial capital markets resulting from the COVID-19 pandemic, inMarch 2020 , we drew down all of the$30.5 million that was available under our 2017 Revolving Credit Facility (as defined below) as a precautionary measure to strengthen our liquidity. During the three and nine months endedSeptember 30, 2020 , we repaid$19 million of these borrowings. In addition, as part of its response to the COVID-19 pandemic, the federal government has expanded existing or introduced new programs to provide additional sources of liquidity to healthcare providers. Programs that benefit us include: •CMS Provider Relief Fund Grants. The CARES Act includes$100 billion in funds to be provided to hospitals and other healthcare providers to support healthcare-related expenses or lost revenue attributable to COVID-19 and to ensure uninsured individuals are able to obtain testing and treatment for COVID-19. OnApril 10, 2020 , CMS began distribution of$30 billion of the funds to providers based on the provider's share of total Medicare fee-for-service reimbursements in 2019. As part of this distribution, our facilities received approximately$27 million in the aggregate duringApril 2020 . As ofSeptember 30, 2020 , we had utilized$16.8 million of these funds, and expect to use some or all of the funds during future periods through the second quarter of 2021. Our ability to utilize and retain some or all of the remaining provider relief grant funds will depend on the magnitude, timing and nature of the impact of COVID-19. •Social Security Payroll Match. The CARES Act provides for the deferral of the social security payroll tax match of 6.2% through the end of 2020. For the third quarter, we recognized$3.9 million as a result of this provision, all of which is included in our consolidated cash as ofSeptember 30, 2020 . We expect this provision of the CARES Act to allow us to delay funding an additional approximately$4.0 million of social security payroll taxes during the remainder of the current year. Half of the amount ultimately deferred (approximately$3.5 to$4.5 million ) will be payable inDecember 2021 and the remaining inDecember 2022 . While this expense will continue to be reflected in our Condensed Consolidated Statement of Operations and accrued on our Condensed Consolidated Balance Sheet during 2020, the deferral of the payment will provide us additional liquidity during the deferral period. 55 -------------------------------------------------------------------------------- •Tax Benefit. The CARES Act also permits the acceleration of tax depreciation in previous income tax returns, which we estimate will result in cash tax benefits of approximately$8.0 million during the current year. •Medicare Advance Payment Programs. InMarch 2020 , in an action unrelated to the CARES Act, CMS expanded its existing Accelerated and Advance Payment Program to a broader group of Medicare providers and suppliers for the duration of the COVID-19 public health emergency. Payments under this program are intended to provide necessary funds when there is a disruption in Medicare claims submission and/or claims processing. Our facilities can request up to 100% of the Medicare fee-for-service payment amount for a three-month period. CMS has instructed its Medicare Administrative Contractors to review and issue advance payments within seven calendar days of receiving an advance payment request. CMS approved our requests for substantially all of the clinics. Medicare advance payments will be reduced by 25% to recoup the funds advanced for eleven months beginningApril 2021 . If the advance payments have not been fully recouped byMarch 2022 , the payments will be reduced by 50% until all advance payments have been recouped. InApril 2020 , our facilities applied for and received an aggregate of$83 million in advanced payments under this program. Through the third quarter, we used$19 million of these advanced payments to reduce clinic-level debt, and the remaining funds are included in our consolidated cash as ofSeptember 30, 2020 to provide us with additional liquidity during the current year.
See also "Item 1A. Risk Factors-The ongoing COVID-19 pandemic and responses thereto have adversely affected and we expect will continue to adversely affect, our business, results of operations and financial condition."
We believe our cash balance and cash flows from operations 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. In connection with the Merger, we agreed to limit our drawdowns under our 2017 Revolving Credit Facility through the date of the closing of the proposed merger to$2 million plus any fees incurred and limit total additional borrowings to$4 million . Cash Flows The following table shows a summary of our cash flows for the periods indicated: Nine Months Ended September 30, (dollars in thousands) 2020 2019 Net cash provided by operating activities$ 170,435 $ 35,103 Net cash provided by (used in) investing activities 1,358 (18,195) Net cash (used in) provided by financing activities (69,766) (12,018) Net increase in cash and restricted cash$ 102,027 $ 4,890 Cash Flows from Operations Net cash provided by operating activities for the nine months endedSeptember 30, 2020 was$170.4 million compared to net cash used in operating activities of$35.1 million for the same period in 2019, an increase of$135.3 million , primarily attributable to an increase in net income and the timing of working capital fluctuations, particularly those in the accounts receivable and accrued expenses and other liabilities which increased as ofSeptember 30, 2020 largely due to the$83 million of advance payments received under the Accelerated and Advance Payment Program as described above. 56
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Cash Flows from Investing Activities
Net cash provided by investing activities for the nine months ended
Cash Flows from Financing Activities
Net cash used in financing activities for the nine months endedSeptember 30, 2020 was$69.8 million compared to$12.0 million net cash provided by financing activities during the same period in 2019, an increase of$57.8 million largely due to the$15.1 million net payments on long-term debt in the nine months endedSeptember 30, 2020 compared to net long-term debt proceeds of$32.4 million for the same period in 2019. In addition, during the nine months endedSeptember 30, 2020 , we purchased certain noncontrolling interests totaling$17.4 million compared to$8.5 million during the same period in 2019.
Capital Expenditures
For the nine months endedSeptember 30, 2020 and 2019, we made capital expenditures of$16.3 million and$17.9 million , respectively, of which$12.1 million and$14.0 million were development capital expenditures, respectively, primarily incurred in connection with de novo clinic development and clinic expansions, and$4.2 million and$3.9 million , respectively, were other capital expenditures, primarily consisting of capital improvements at our existing clinics, including renovations and equipment replacement. Of the capital expenditures during the nine months endedSeptember 30, 2020 , there were$0.5 million of capital expenditures recorded in accrued expenses and accounts payable on the accompanying condensed consolidated balance sheet. For 2020, we expect to spend approximately 2% to 2.5% of total annual patient service operating revenues for development capital expenditures and 0.5% to 1% of total annual patient service operating revenues on other capital expenditures.
Debt Facilities
As ofSeptember 30, 2020 , we had outstanding$584.9 million in aggregate principal amount of indebtedness, with an additional$32.0 million of borrowing capacity available under our 2017 Revolving Credit Facility (and no outstanding letters of credit). Our outstanding indebtedness included$422.4 million of term B loans under our 2017 Credit Agreement,$68.0 million of borrowings under our 2017 Revolving Credit Facility. Our outstanding indebtedness also included our third-party clinic-level debt, which includes term loans and lines of credit, totaling$87.0 million as ofSeptember 30, 2020 with maturities ranging fromOctober 2020 toDecember 2028 and interest rates ranging from 2.96% to 6.55%, and$7.5 million of finance lease obligations. See "Note 9 - Debt" of the notes to the condensed consolidated financial statements for further information about our debt. OnJune 22, 2017 ,ARH and American Renal Holdings Intermediate Company, LLC ("ARHIC") entered into a new credit agreement to refinance the credit facilities under ARH's then existing prior first lien credit agreement. The credit agreement was amended onApril 26, 2019 (as amended, the "2017 Credit Agreement") as discussed below. The 2017 Credit Agreement provides for (i) a$100 million senior secured revolving credit facility (the "2017 Revolving Credit Facility") and (ii) a$440 million senior secured term B loan facility (the "2017 Term B Loan Facility" and, together with the 2017 Revolving Credit Facility, the "2017 Facilities"). In addition, the 2017 Credit Agreement includes a feature under which maximum borrowings under the 2017 Facilities may be increased by an amount in the aggregate equal to the sum of (i) the greater of$125 million and 100% of Consolidated EBITDA (as defined in the 2017 Credit Agreement) plus (ii) an amount such that certain leverage ratios will not be exceeded after giving pro forma effect to the increase. OnJune 22, 2017 , ARH borrowed the full amount of the 2017 Term B Loan Facility and used such borrowings to repay outstanding balances under the then existing prior first lien credit agreement and the payment of customary fees and expenses incurred in connection with the foregoing. OnApril 26, 2019 , ARH entered into an amendment (the "Amendment") to the 2017 Credit Agreement, waiving certain actual or potential defaults and amending certain covenants and other provisions. Among other things, the waiver addressed actual or potential defaults that may have resulted from our failure to (i) satisfy the maximum consolidated net leverage ratio when required, and (ii) deliver when required certain prior period financial information prepared in accordance with GAAP. In connection with the Amendment, we paid fees of$6.0 million including a consent fee of$5.2 million during the quarter endedJune 30, 2019 and agreed to increase the interest rate on borrowings under the 2017 Credit Agreement. 57 -------------------------------------------------------------------------------- The 2017 Revolving Credit Facility is scheduled to mature inJune 2022 and the 2017 Term B Loan Facility is scheduled to mature inJune 2024 . The principal amount of the term B loans under the 2017 Term B Loan Facility ("term B loan") amortize in equal quarterly installments in an aggregate annual amount of (i) 1.00% of the original principal amount of such term B loans throughDecember 31, 2019 and (ii) 2.00% thereafter. The maturity dates under the 2017 Revolving Credit Facility and the 2017 Term Loan Facility are subject to extension with lender consent according to the terms of the 2017 Credit Agreement. The 2017 Credit Agreement includes provisions requiring ARH to offer to prepay term B loans in an amount equal to (i) the net cash proceeds above certain thresholds received from (a) asset sales and (b) casualty events resulting in the receipt of insurance proceeds, subject to customary provisions for the reinvestment of such proceeds, (ii) the net cash proceeds from the incurrence of debt not otherwise permitted under the 2017 Credit Agreement, and (iii) a percentage of consolidated excess cash flow retained in the business from the preceding fiscal year minus voluntary prepayments. For the period fromApril 26, 2019 untilSeptember 4, 2019 , the date of filing of our Form 10-Q for the fiscal quarter endedMarch 31, 2019 (the "Covenant Reversion Date"), the loans under the 2017 Term B Loan Facility bore interest at a rate equal to, at ARH's option, either (a) an alternate base rate equal to the higher of (1) the prime rate in effect on such day, (2) the federal funds effective rate plus 0.5% or (3) the Eurodollar rate applicable for a one-month interest period plus 1.0% (collectively, the "ABR Rate"), plus an applicable margin of 4.50% (increased from 2.25% prior to the Amendment), or (b) LIBOR, adjusted for changes in Eurodollar reserves ("Eurodollar Rate"), plus an applicable margin of 5.50% (increased from 3.25% prior to the Amendment). From and after the Covenant Reversion Date, the applicable margin on term B loans is 4.00% for ABR Rate loans and 5.00% for Eurodollar rate loans. As ofSeptember 30, 2020 , the interest payable quarterly was 5.15%. For the period fromApril 26, 2019 until the Covenant Reversion Date, outstanding loans under the 2017 Revolving Credit Facility bore interest at a rate equal to, at ARH's option, either (a) the ABR Rate, plus an applicable margin of 4.25%, or (b) the Eurodollar Rate, plus an applicable margin of 5.25%. From and after the Covenant Reversion Date, any outstanding loans under the 2017 Revolving Credit Facility bear interest at a rate equal to, at ARH's option, either the ABR Rate or the Eurodollar Rate, plus, in each case, an applicable margin priced off a grid based upon the consolidated net leverage ratio of ARH and its restricted subsidiaries, which margin is 1.75% higher than the applicable margin prior to the Amendment. There were$68.0 million of borrowings outstanding under the 2017 Revolving Credit Facility as ofSeptember 30, 2020 , which had an interest rate of 5.05%. Prior to the Amendment, the commitment fee applicable to undrawn revolving commitments under the 2017 Revolving Credit Facility was priced off a grid based upon the consolidated net leverage ratio of ARH and its restricted subsidiaries. For the period fromApril 26, 2019 until the Covenant Reversion Date, the commitment fee applicable to undrawn revolving commitments under the 2017 Revolving Credit Facility was 0.50% without regard to the consolidated net leverage ratio. The 2017 Credit Agreement contains customary events of default, the occurrence of which would permit the lenders to accelerate payment of the full amounts outstanding. Additionally, the 2017 Credit Agreement contains customary representations and warranties, affirmative covenants and negative covenants, including restrictive financial and operating covenants. The 2017 Credit Agreement includes a springing maximum consolidated net leverage ratio financial covenant of 6.00:1.00 for the benefit of the lenders under the 2017 Revolving Credit Facility (the "Revolver Financial Covenant") and, following the Amendment, a maximum consolidated net leverage ratio maintenance financial covenant of 7.00:1.00 for the benefit of the lenders under both the 2017 Revolving Credit Facility and the 2017 Term B Loan Facility. As ofSeptember 30, 2020 , we were in compliance with the consolidated net leverage ratio covenant in the 2017 Credit Agreement. As ofSeptember 30, 2020 , we did not meet the covenants for certain loans totaling$1.9 million and therefore reclassified the$0.6 million noncurrent portion of such loans to the Current portion of long-term debt on the accompanying condensed consolidated balance sheet. The obligations of ARH under the 2017 Credit Agreement are guaranteed by ARHIC and all of its existing and future wholly owned domestic subsidiaries (collectively, the "Guarantors") and secured by a pledge of all of ARH's capital stock and substantially all of the assets of ARH and the Guarantors, including their respective interests in their joint ventures. Our clinic-level debt includes third-party term loans and lines of credit. The loan documents for these clinic-level loans generally include representations and warranties, affirmative covenants and negative covenants, including restrictive financial and operating covenants. We have in the past and may in the future be required to seek waivers or amendments to the loan documents for one or more of our clinics as a result of clinic performance issues or otherwise. We recently entered into agreements with certain of our third-party clinic lenders waiving defaults arising from certain financial covenants at the clinic level. Pursuant to these agreements, as ofSeptember 30, 2020 , we are obliged to prepay up to an aggregate of approximately$8 million during 2020 and up to an aggregate of approximately$10 million during the second quarter of 2021 of the outstanding clinic-level debt, depending on the satisfaction of certain financial covenants for these clinic loans. Of these amounts, we are responsible for up to approximately$4 million and approximately$5 million , respectively, and our physician partners are responsible for the remainder. 58 --------------------------------------------------------------------------------
Contractual Obligations and Commitments
The following is a summary of contractual obligations and commitments as ofSeptember 30, 2020 (excluding put obligations relating to our joint ventures, dividend equivalent payments due to our pre-IPO option holders, obligations under our income tax receivable agreement, and obligations related to our United litigation settlement, which are described separately below): Scheduled payments under contractual obligations Less than 1 More than 5 (in thousands) Total year 1-3 years 3-5 years years 2017 Credit Agreement loans(1)$ 490,400 $ 8,800 $ 117,600 $ 364,000 $ - Operating leases(2) 181,859 31,785 78,974 33,092 38,008 Purchase obligations(3) 173,000 74,500 94,000 4,500 - Interest payments(4) 108,163 44,075 47,378 16,508 202 Third-party clinic-level debt 87,007 26,909 39,003 18,521 2,574 Finance leases(5) 13,356 1,174 3,712 2,737 5,733 Total$ 1,053,785 $ 187,243 $ 380,667 $ 439,358 $ 46,517
_____________________________
(1)Includes the 2017 Term B Loan Facility with total borrowings of$422.4 million , which bears interest at a variable rate, with principal payments of$2.2 million and interest payments due quarterly, and the 2017 Revolving Credit Facility, which also bears interest at a variable rate, with total borrowings outstanding of$68.0 million . (2)Net of estimated sublease proceeds of approximately$8 million through 2033. The above includes$1.0 million related to lease obligations that have not yet commenced. (3)Reflects amounts payable pursuant to minimum purchase commitments under our agreements with certain suppliers. In the event of a shortfall, we are required to pay in cash a portion or all of the amount of such shortfall or may, under certain circumstances, be subject to a price increase or other fee. (4)Represents interest payments on debt obligations, including the 2017 Term B Loan Facility under the 2017 Credit Agreement described above. To project interest payments on floating rate debt, we have used the rate as ofSeptember 30, 2020 which is described above. (5)Includes$1.0 million related to lease obligations that have not yet commenced.
Put Obligations
We are party to agreements which contain put provisions that require us to
purchase a portion or all of the noncontrolling interests held by third parties
in certain of our consolidated subsidiaries. These put provisions are
exercisable at the third-party owners' discretion either within specified
periods ("time-based puts") or, in certain cases, upon the occurrence of
specific events ("event-based puts"), including the sale of all or substantially
all of our assets, closure of the clinic, change of control, departure of key
executives, third-party members' death, disability, bankruptcy, retirement, or
if third-party members are dissolved and other events, which could accelerate
time-based vesting. Some of these puts accelerated as a result of the IPO, of
which some were exercised during the nine months ended September 30, 2020 . If
the put obligations are exercised by a nephrologist partner, we are required to
purchase, at the estimated fair value calculated as set forth in the applicable
joint venture agreements, a previously agreed upon percentage of such
nephrologist partner's ownership interest. See "Note 8 - Noncontrolling
Interests Subject to Put Provisions" in the notes to the unaudited condensed
consolidated financial statements for discussion of these put provisions. The
table below summarizes our potential obligations as of September 30, 2020 .
Noncontrolling interests subject to put provisions
(dollars in thousands) September 30, 2020
Time-based puts $ 107,364
Event-based puts 5,146
Total Obligation $ 112,510
59-------------------------------------------------------------------------------- As ofSeptember 30, 2020 ,$67.6 million of time-based put obligations were exercisable by our nephrologist partners, including those accelerated as a result of physician IPO put rights. The following is a summary of the estimated potential cash payments in each of the specified years under all time-based puts existing as ofSeptember 30, 2020 and reflects the payments that would be made, assuming (a) all vested puts as ofSeptember 30, 2020 were exercised onOctober 1, 2020 and paid according to the applicable agreement and (b) all puts exercisable thereafter were exercised as soon as they vest and are paid accordingly. (dollars in thousands) Amount Year Exercisable 2020$ 70,690 2021 12,584 2022 12,825 2023 7,557 2024 2,015 Thereafter 1,693 Total$ 107,364 The estimated fair values of the interests subject to these put provisions can fluctuate, and the implicit multiple of earnings at which these obligations may be settled will vary depending upon clinic performance, market conditions and access to the credit and capital markets.
Dividend Equivalent Payments
OnApril 26, 2016 , we 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 future dividend equivalent payment, which were paid on vested options and become due upon vesting for unvested options. Additionally, in connection with the cash dividend, we have made payments to date equal to$1.30 per share, or$5.4 million in the aggregate, to option holders, and, in the case of some performance and market options, as ofSeptember 30, 2020 a future payment will be due upon vesting totaling$1.2 million .
Income Tax Receivable Agreement
OnApril 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, inU.S. federal, state and local income tax that we actually realize as a result of any deductions (including net operating losses resulting from such deductions) attributable to the exercise of (or any payment, including any dividend equivalent right or payment, in respect of) any compensatory stock option issued by us that was outstanding (whether vested or unvested) as of the day before the date of our IPO prospectus (such stock options, "Relevant Stock Options" and such deductions, "Option Deductions"). We plan to fund the payments under the TRA with cash flows from operations and, to the extent necessary, the proceeds of borrowings under our 2017 Revolving Credit Facility. 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. The amount of cash savings for 2019 is estimated to be$10.6 million as ofSeptember 30, 2020 .
United Settlement
OnJuly 2, 2018 , ARA OpCo and ARM executed a binding Settlement Term Sheet with plaintiff United to resolve all ongoing litigation, and onAugust 1, 2018 , the parties entered into a final settlement agreement (the "Settlement Agreement") on substantially the terms provided in the Settlement Term Sheet. The Settlement Agreement included a release of all claims that were asserted or that could have been asserted against us or against the nephrologists or other healthcare providerswho have entered into joint venture arrangements or medical directorships with us (the "Joint Venture Providers") and the joint venture entities without any admission of liability or wrongdoing. Pursuant to the Settlement Agreement, we will make total settlement payments of$32.0 million , inclusive of administrative fees and fees for plaintiffs' counsel, in five installments, with an initial present value of$29.6 million , which is included in "Certain legal and other matters" in the Consolidated Statement of 60 -------------------------------------------------------------------------------- Operations for the year endedDecember 31, 2018 . We paid the first installment in the amount of$10.0 million onAugust 1, 2018 , the second installment in the amount of$8.0 million onAugust 1, 2019 and the third installment in the amount of$7.0 million onAugust 1, 2020 , and the fourth installment in the amount of$3.5 million onAugust 1, 2021 and the final installment of$3.5 million onAugust 1, 2022 . As ofSeptember 30, 2020 ,$3.1 million is classified as Accrued expenses and other current liabilities and$2.8 million is classified in Other long-term liabilities. We also agreed to share certain information with United and to follow certain procedures with respect to patients covered by United. Subject to the mutual releases provided in the Settlement Agreement, United also agreed to renew, reinstate, and/or not to terminate the network agreements for any Joint Venture Providers whose network agreements United terminated or chose not to renew fromAugust 1, 2017 through the date of the Settlement Agreement. The Settlement Agreement included customary terms and conditions. In connection with the Settlement Agreement, we also entered into a three-year national network agreement with United onAugust 1, 2018 that provides for specified reimbursement rates for patients covered by Medicare Advantage, Medicaid HMO and commercial insurance products over the term of the agreement. The in-network agreement went into effect onSeptember 1, 2018 . 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 - Basis of Presentation, Organization and Recent Events" of the notes to the condensed consolidated financial statements.
Critical Accounting Policies and Estimates
For a description of our critical accounting policies and use of estimates, refer to "Part II. Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations-Critical Accounting Policies and Estimates" in our 2019 Form 10-K.
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