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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549
 FORM 10-Q (Mark One) x
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
 For the Quarterly Period Ended June 30, 2004 OR o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
 For the transition period from_________________to_______________ Commission File No. 0-27640 RENAL CARE GROUP, INC.  Delaware
(State or other jurisdiction of
incorporation or organization)
    
    62-1622383
(I.R.S. Employer Identification No.)
 2525 West End Avenue, Suite 600, Nashville, Tennessee 37203
(Address of principal executive offices) (Zip code) Registrants telephone number, including area code: (615) 345-5500 Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days). Yes x No o Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). Yes x No o Indicate the number of shares outstanding of each of the issuers classes
of common stock as of the latest practicable date. Class
    
    Outstanding at August 5, 2004Common Stock, $.01 par value
    
    67,070,176




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RENAL CARE GROUP, INC. INDEX  
 Page No.PART I  FINANCIAL INFORMATIONItem 1.
    
    Financial StatementsCondensed Consolidated Balance Sheets  December 31, 2003 and June 30, 2004 (unaudited)
    
    
    1Condensed Consolidated Income Statements  (unaudited) For the three months and six months ended June 30, 2003 and 2004
    
    
    2Condensed Consolidated Statements of Cash Flows  (unaudited) For the six months ended June 30, 2003 and 2004
    
    
    3Notes to Condensed Consolidated Financial Statements  (unaudited)
    
    
    4Item 2.
    
    Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    15Risk Factors
    
    
    20Item 3.
    
    Quantitative and Qualitative Disclosures About Market Risk
    
    
    28Item 4.
    
    Controls and Procedures
    
    
    28PART II  OTHER INFORMATIONItem 2.
    
    Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities
    
    
    29Item 4.
    
    Submission of Matters to a Vote of Security Holders
    
    
    29Item 6.
    
    Exhibits and Reports on Form 8-K
    
    
    30Signature
    
    
    31Exhibit
Index
    
    
    32EX-31.1  SECTION 302 CEO CERTIFICATIONEX-31.2  SECTION 302 CFO CERTIFICATIONEX-32.1  SECTION 906 CEO CERTIFICATIONEX-32.2  SECTION 906 CFO CERTIFICATION
  Note: Items 1, 3, and 5 of Part II are omitted because they are not applicable




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PART I  FINANCIAL INFORMATION 
 ITEM 1. FINANCIAL STATEMENTS RENAL CARE GROUP, INC. 
 Condensed Consolidated Balance Sheets
(in thousands, except per share data)
 December 31,
    
    June 30,2003
    
    2004(unaudited)ASSETSCurrent assets:Cash and cash equivalents
    
    $
    50,295
    
    
    $
    44,182Accounts receivable, net
    
    
    173,679
    
    
    
    231,629Inventories
    
    
    26,345
    
    
    
    24,161Prepaid expenses and other current assets
    
    
    28,050
    
    
    
    24,259Income tax receivable
    
    
    1,910
    
    
    
    10,643Deferred income taxes
    
    
    11,825
    
    
    
    21,958Total current assets
    
    
    292,104
    
    
    
    356,832Property, plant and equipment, net
    
    
    224,397
    
    
    
    289,427Intangible assets, net
    
    
    14,046
    
    
    
    30,700Goodwill
    
    
    286,578
    
    
    
    626,656Other assets
    
    
    2,748
    
    
    
    7,469Total assets
    
    $
    819,873
    
    
    $
    1,311,084LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable and accrued expenses
    
    $
    123,206
    
    
    $
    129,019Due to third-party payors
    
    
    46,049
    
    
    
    68,700Current portion of long-term debt
    
    
    182
    
    
    
    20,834Total current liabilities
    
    
    169,437
    
    
    
    218,553Long-term debt, net of current portion
    
    
    2,652
    
    
    
    490,635Deferred income taxes
    
    
    38,390
    
    
    
    35,841Other long-term liabilities
    
    
    5,898
    
    
    
    10,211Minority interest
    
    
    32,651
    
    
    
    43,200Total liabilities
    
    
    249,028
    
    
    
    798,440Commitments and contingenciesStockholders equity:Preferred stock, $0.01 par value, 10,000 shares authorized, none issued
    
    
    
    
    
    
    Common stock, $0.01 par value, 90,000 and 150,000 shares authorized,
80,465 and 81,572 shares issued at December 31, 2003 and June 30,
2004, respectively
    
    
    805
    
    
    
    816Treasury stock, 9,961 and 14,514 shares of common stock at December
31, 2003 and June 30, 2004, respectively
    
    
    (234,404
    )
    
    
    (372,249
    )Additional paid-in capital
    
    
    374,414
    
    
    
    394,777Retained earnings
    
    
    430,030
    
    
    
    489,300Total stockholders equity
    
    
    570,845
    
    
    
    512,644Total liabilities and stockholders equity
    
    $
    819,873
    
    
    $
    1,311,084
 See accompanying notes to condensed consolidated financial statements. 1




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RENAL CARE GROUP, INC. 
 Condensed Consolidated Income Statements
(in thousands, except per share data)
(unaudited)
 Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,2003
    
    2004
    
    2003
    
    2004Net revenue
    
    $
    247,061
    
    
    $
    340,854
    
    
    $
    489,204
    
    
    $
    618,882Operating costs and expenses:Patient care costs
    
    
    159,998
    
    
    
    229,849
    
    
    
    317,475
    
    
    
    409,221General and administrative expenses
    
    
    21,187
    
    
    
    27,341
    
    
    
    47,475
    
    
    
    50,017Provision for doubtful accounts
    
    
    6,468
    
    
    
    8,049
    
    
    
    12,880
    
    
    
    15,159Depreciation and amortization
    
    
    11,579
    
    
    
    14,900
    
    
    
    21,877
    
    
    
    27,063Total operating costs and expenses
    
    
    199,232
    
    
    
    280,139
    
    
    
    399,707
    
    
    
    501,460Income from operations
    
    
    47,829
    
    
    
    60,715
    
    
    
    89,497
    
    
    
    117,422Interest expense, net
    
    
    165
    
    
    
    5,765
    
    
    
    450
    
    
    
    6,730Income before minority interest and income taxes
    
    
    47,664
    
    
    
    54,950
    
    
    
    89,047
    
    
    
    110,692Minority interest
    
    
    6,029
    
    
    
    7,690
    
    
    
    12,337
    
    
    
    14,904Income before income taxes
    
    
    41,635
    
    
    
    47,260
    
    
    
    76,710
    
    
    
    95,788Provision for income taxes
    
    
    15,822
    
    
    
    18,077
    
    
    
    29,145
    
    
    
    36,518Net income
    
    $
    25,813
    
    
    $
    29,183
    
    
    $
    47,565
    
    
    $
    59,270Net income per share:Basic
    
    $
    0.35
    
    
    $
    0.44
    
    
    $
    0.66
    
    
    $
    0.87Diluted
    
    $
    0.34
    
    
    $
    0.42
    
    
    $
    0.64
    
    
    $
    0.84Weighted average shares outstanding:Basic
    
    
    72,806
    
    
    
    66,832
    
    
    
    72,539
    
    
    
    67,871Diluted
    
    
    74,897
    
    
    
    69,227
    
    
    
    74,522
    
    
    
    70,225
 See accompanying notes to condensed consolidated financial statements. 2




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RENAL CARE GROUP, INC. 
 Condensed Consolidated Statements of Cash Flows
(in thousands)
(unaudited)
 Six Months EndedJune 30,2003
    
    2004OPERATING ACTIVITIESNet income
    
    $
    47,565
    
    
    $
    59,270Adjustments to reconcile net income to net cash provided by operating activities:Depreciation and amortization
    
    
    21,877
    
    
    
    27,063Loss on disposal of property and equipment
    
    
    312
    
    
    
    564Income applicable to minority interest
    
    
    12,337
    
    
    
    14,904Distributions to minority shareholders
    
    
    (12,381
    )
    
    
    (9,906
    )Deferred income taxes
    
    
    
    
    
    
    7,889Changes in operating assets and liabilities, net of effects from acquisitions
    
    
    5,404
    

    
    
    (18,605
    )Net cash provided by operating activities
    
    
    75,114
    
    
    
    81,179INVESTING ACTIVITIESCash paid for acquisitions, net of cash acquired
    
    
    (5,492
    )
    
    
    (230,746
    )Purchases of property and equipment, net
    
    
    (34,517
    )
    
    
    (45,031
    )Change in other assets
    
    
    (780
    )
    
    
    (5,299
    )Net cash used in investing activities
    
    
    (40,789
    )
    
    
    (281,076
    )FINANCING ACTIVITIESProceeds from issuance of long-term debt
    
    
    
    
    
    
    325,000Payments on long-term debt
    
    
    
    
    
    
    (4,063
    )Net payments under line of credit and capital leases
    
    
    (7,240
    )
    
    
    (2,101
    )Net proceeds from issuance of common stock
    
    
    22,280
    
    
    
    12,793Repurchase of treasury shares
    
    
    (4,380
    )
    
    
    (137,845
    )Net cash provided by financing activities
    
    
    10,660
    
    
    
    193,784Increase (decrease) in cash and cash equivalents
    
    
    44,985
    
    
    
    (6,113
    )Cash and cash equivalents at beginning of period
    
    
    38,359
    
    
    
    50,295Cash and cash equivalents at end of period
    
    $
    83,344
    
    
    $
    44,182
 See accompanying notes to condensed consolidated financial statements. 3




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RENAL CARE GROUP, INC. 
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2004
(dollars in thousands, except per share data)
(unaudited)
 1. Basis of Presentation Overview Renal Care Group, Inc. (the Company) provides dialysis services to patients with chronic
kidney failure, also known as end-stage renal disease (ESRD). As of June 30,
2004, the Company provided dialysis and ancillary services to over 28,700 patients
through more than 395 owned outpatient dialysis centers in 31 states, in
addition to providing acute dialysis services at more than 200 hospitals. Renal Care Groups net revenue has been derived primarily from the
following sources:  
    
    outpatient hemodialysis services;
    
    ancillary services associated with dialysis, primarily the
administration of EPOGEN® (erythropoietin alfa, which we refer to as
EPO);
    
    home dialysis services;
    
    inpatient hemodialysis services provided to acute care hospitals and skilled nursing facilities;
    
    laboratory services; and
    
    management contracts with joint ventures, hospital-based dialysis programs and medical university dialysis programs. Most patients with end-stage renal disease receive three dialysis
treatments each week in an outpatient setting. Reimbursement for these
services is provided primarily by the Medicare ESRD program based on rates
established by the Centers for Medicare and Medicaid Services (CMS). For the
six months ended June 30, 2003 and 2004, approximately 55% and 53%,
respectively, of the Companys net revenue was derived from reimbursement under
the Medicare and Medicaid programs. Medicare reimbursement is subject to rate
and other legislative changes by Congress and periodic changes in regulations,
including changes that may reduce payments under the ESRD program. Neither
Congress nor CMS approved an increase in the composite rate for 2003 or 2004.
Congress has approved an increase of 1.6% in the Medicare ESRD composite rate
for 2005, as well as changes in the way we are paid for separately billable
drugs. The Medicare Modernization Act of 2003 provides that dialysis providers
will be reimbursed for separately billable drugs, including EPO, at
the drugs average acquisition cost and that the composite rate will be
increased by an amount equal to the providers lost profit on those separately
billable drugs. Congress stated that it intended these changes to be budget
neutral. On July 27, 2004 CMS issued proposed regulations to implement these
changes, which propose that we will be reimbursed for separately
billable drugs at a 3% discount from the average sale price and that
the composite rate be increased by 11.3%. These proposed regulations also include a case-mix adjustment and a
geographic adjustment to the composite rate as well as a related budget
neutrality adjustment. If the proposed regulations become effective,
management believes they will result in a net reduction of $0.03 per
share in diluted net income for 2005. The Medicare composite rate applies to a designated group of outpatient
dialysis services, including the dialysis treatment, supplies used for the
treatment, certain laboratory tests and medications, and most of the home
dialysis services we provide. Renal Care Group receives separate reimbursement
outside the composite rate for some other services, laboratory tests and drugs,
including specific drugs such as EPO and some physician-ordered tests provided
to dialysis patients. Congress and CMS have considered
expanding the drugs and services that are included in the composite rate. 4




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If a patient is younger than 65 years old and has private health
insurance, then that patients treatment is typically reimbursed at rates
significantly higher than Medicare during the first 30 months of care. After
that period, Medicare becomes the primary payor. Reimbursement for dialysis
services provided pursuant to a hospital contract is negotiated with the
individual hospital and is usually higher than the Medicare composite rate.
Because dialysis is a life-sustaining therapy to treat a chronic disease,
utilization is predictable and is not subject to seasonal fluctuations. Renal Care Group derives a significant portion of its net revenue and net
income from the administration of EPO. EPO is manufactured by a single
company, Amgen Inc. The Company administers EPO to most of its patients to
treat anemia, a medical complication frequently experienced by dialysis
patients. Net revenue from the administration of EPO was 24% and 27% of the
net revenue of the Company for the six months ended June 30, 2003 and 2004,
respectively. Interim Financial Statements Management believes the information contained in this quarterly report on
Form 10-Q reflects all adjustments necessary to make the results of operations
for the interim periods a fair representation of such operations. All of these
adjustments are of a normal recurring nature. Operating results for interim
periods are not necessarily indicative of results that may be expected for the
year as a whole. We suggest that you read these financial statements in
conjunction with our consolidated financial statements and the related notes
thereto included in our current report on Form 8-K, as filed with the SEC on
April 19, 2004. 2. Business Acquisitions 2004 Acquisitions During the first six months of 2004, we completed three acquisitions. The combined net
assets acquired and resulting net cash purchase price paid in these
acquisitions were $230,746. Our largest acquisition was the purchase of
National Nephrology Associates, Inc. (NNA) on April 2,
2004. The purchase price of NNA consisted of a net cash payment of approximately $163,000 and
an assumption of all outstanding debt, including its $160,000, 9% senior
subordinated notes. NNA provided dialysis services to approximately 5,600
patients and operated 87 outpatient dialysis facilities in 15 states, as well
as providing acute dialysis services to approximately 55 hospitals. Each of the
three transactions involved the acquisition of entities that provide care to
ESRD patients through owned dialysis facilities. The acquired businesses either
strengthened existing market share within a specific geographic area or
provided an entrance into a new market. We began recording the results
of operations for each of these acquired businesses at the effective date of
the transaction. The following table summarizes the preliminarily estimated fair values of
the assets acquired and liabilities assumed at the date of acquisition for the
three acquisitions completed during the first six months of 2004: Accounts receivable, net
    
    $
    45,410Inventory and other current assets
    
    
    23,382Property, plant and equipment, net
    
    
    48,818Intangible assets
    
    
    16,651Goodwill
    
    
    340,078Other assets
    
    
    10,397Total assets acquired
    
    
    484,736Total liabilities assumed
    
    
    253,990Net assets acquired
    
    $
    230,746
 Some
of the estimated fair values of assets and liabilities are
preliminary and may be adjusted based on managements final analysis. These include items such as deferred tax assets and liabilities,
a pending actuarial analysis of workers compensation and medical malpractice accruals, and obtaining
independent appraisals for certain assets. Intangible assets primarily
represent the value assigned to certain contracts such as non-competition
agreements and acute dialysis service agreements entered into in the
transactions. Related amounts will be amortized over the lives of the
contracts, which generally range from five to fifteen years. The
Company recorded estimated employee severance costs of $1,000 and estimated
contract termination costs of $1,500 associated with the NNA
acquisition. As of June 30, 2004 these amounts remain
outstanding pending the employee terminations and resolution of the
contractual matters. 5




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Pro Forma Data The following summary, prepared on a pro forma basis, combines our results
of operations with those of the businesses we acquired in 2003 and 2004. These
pro forma results reflect the acquisitions as if we consummated them as of the
beginning of the periods presented, giving effect to adjustments such as
amortization of intangibles, interest expense and related income taxes. Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,2003
    
    2004
    
    2003
    
    2004Pro forma net revenue
    
    $
    316,758
    
    
    $
    341,425
    
    

    $
    626,502
    
    
    $
    685,068Pro forma net income
    
    $
    26,958
    
    
    $
    29,261
    
    
    $
    50,668
    
    
    $
    60,876Pro forma net income per share:Basic
    
    $
    0.37
    
    
    $
    0.44
    
    
    $
    0.70
    
    
    $
    0.90Diluted
    
    $
    0.36
    
    
    $
    0.42
    
    
    $
    0.68
    
    
    $
    0.87
 The unaudited pro forma results of operations are not necessarily
indicative of what actually would have occurred if the acquisitions had been
completed as of the beginning of the periods presented. 3. Long Term Debt Long term debt consisted of the following as of December 31, 2003 and June 30,
2004: December 31,
    
    June 30,2003
    
    2004Term loan facility, bearing interest at 2.7% at June 30, 2004
    
    $
    
    
    
    $
    320,9389% senior subordinated notes
    
    
    
    
    
    
    159,700Other
    
    
    2,834
    
    
    
    5,884Total indebtedness, excluding fair value premium
    
    
    2,834
    
    
    
    486,522Add: 9% senior subordinated notes fair value premium
    
    
    
    
    
    
    24,947Total long-term debt
    
    
    2,834
    
    
    
    511,469Less: current portion
    
    
    182
    
    
    
    20,834$
    2,652
    
    
    $
    490,635
 Credit Agreements As of December 31, 2003, we had two credit agreements with a group of
banks totaling $150,000. On February 10, 2004, we entered into a new credit
agreement (the 2004 Agreement) with a group of banks totaling up to $700,000.
The 2004 Agreement replaced both of our prior facilities. The 2004 agreement
has a $150,000 revolving credit facility, a $325,000 term loan facility and a
$225,000 incremental term loan facility. Borrowings under the incremental term
loan facility are subject to obtaining commitments from the banks and finalizing
specific terms. The revolving credit facility and the $325,000 term loan
facility have a final maturity of February 10, 2009. Each of our wholly-owned
subsidiaries has guaranteed all of our obligations under the 2004 Agreement.
Further, our obligations under the 2004 Agreement, and our subsidiaries
obligations under their guarantees, are secured by a pledge of the equity
interests we hold in each of our subsidiaries. The 2004 Agreement includes
financial covenants that are customary based on the amount and duration of the
agreement. Borrowings under the revolving credit facility and $150,000 of the
committed term loan facility under the 2004 Agreement may be used for
acquisitions, repurchases of Company common stock, capital expenditures,
working capital and general corporate purposes. Borrowings under the 2004
Agreement bear interest at variable rates determined by the Companys leverage
ratio. Effective June 30, 2004, we entered into interest rate swap agreements
to hedge interest rate risk on $150,000 of our term loan (See Interest Rate
Swap below). The portion of our borrowings that is subject to
variable rates carries a degree of interest
rate risk. Specifically, the Company will face higher interest costs on this
debt if interest rates rise. 6




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9% Senior Subordinated Notes With our acquisition of NNA, we assumed all of NNAs outstanding debt
including its 9% senior subordinated notes (the Notes), due 2011. We recorded the Notes at
the face value of $160,000 plus an additional $25,600 representing the
difference between the fair value of the Notes and the face amount on
the date of acquisition.
Accordingly, the Notes were recorded at the estimated fair value of $185,600. As of June
30, 2004, the outstanding balance of the Notes was $184,647. The Notes bear interest at the rate of 9% per annum on the face amount.
The $24,947 fair value premium that is unamortized is being recognized over the life of the Notes using the effective
interest method and is recorded as a reduction to interest expense.  Accordingly, the effective interest rate
on the Notes as of June 30, 2004 was 6.4%.
Each of our wholly-owned subsidiaries has guaranteed all of our obligations
under these notes. The rights of the noteholders and our obligations under
these notes are set forth in an indenture that NNA entered into in October 2003
and we assumed in connection with the NNA acquisition. The indenture includes
customary financial covenants. Interest Rate Swap On June 3, 2004, we entered into interest rate swap agreements to hedge the interest rate risk on $150,000 of our term
loan. These interest rate swap agreements became effective on June 30, 2004.
Under these interest rate swap agreements we will exchange fixed and variable
rate interest payments based on a $150,000 notional principal amount through
March 30, 2007. The notional amount of $150,000 and interest payments of 3.5%
are fixed in the agreements, with the interest payments being subject
to adjustment based on our leverage ratio. The changes in cash flows under these agreements
are expected to offset the changes in interest rate payments attributable to
fluctuations in LIBOR. The hedge is structured to qualify for the shortcut
method; therefore, changes in the fair value of the agreement will be directly
recorded in comprehensive income. The interest payments under this agreement
are settled on a net basis each calendar quarter. The aggregate maturities of long-term debt, excluding the fair value premium,
at June 30, 2004 are as follows: 2004
    
    $
    14,0092005
    
    
    22,3442006
    
    
    30,4692007
    
    
    56,8752008
    
    
    156,406Thereafter
    
    
    206,419$
    486,522
 Guarantor Information Our wholly-owned subsidiaries have guaranteed the Notes as well as our
obligations under the 2004 Agreement. We conduct substantially all of our business through
subsidiaries. Presented below is condensed consolidating financial information
as of June 30, 2004 and December 31, 2003 and for the three months and six
months ended June 30, 2004 and 2003. The information segregates Renal Care
Group, Inc. (the parent company), the combined wholly-owned subsidiary
guarantors, the combined non-guarantor subsidiaries and consolidating
adjustments. All of the subsidiary guarantees are both full and unconditional,
and joint and several. 7




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Condensed Consolidating Balance Sheets Parent
    
    Guarantor
    
    Non-Guarantor
    
    Consolidating
    
    ConsolidatedCompany
    
    Subsidiaries
    
    Subsidiaries
    
    Adjustments
    
    TotalAs of December 31, 2003Cash and cash equivalents
    
    $
    20,157
    
    
    $
    2,646
    
    
    $
    27,492
    
    
    $
    
    
    
    $
    50,295Accounts receivable, net
    
    
    
    
    
    
    117,209
    
    
    
    56,470
    
    
    
    
    
    
    
    173,679Other current assets
    
    
    35,329
    
    
    
    21,467
    
    
    
    11,334
    
    
    
    
    
    
    
    68,130Total current assets
    
    
    55,486
    
    
    
    141,322
    
    
    
    95,296
    
    
    
    
    
    
    
    292,104Property, plant and
equipment, net
    
    
    27,841
    
    
    
    123,894
    
    
    
    69,924
    
    
    
    2,738
    
    
    
    224,397Goodwill
    
    
    1,483
    
    
    
    187,848
    
    
    
    96,947
    
    
    
    300
    
    
    
    286,578Other assets
    
    
    10,637
    
    
    
    25,926
    
    
    
    5,940
    
    
    
    (25,709
    )
    
    
    16,794Total assets
    
    $
    95,447
    
    
    $
    478,990
    
    
    $
    268,107
    
    
    $
    (22,671
    )
    
    $
    819,873Current liabilities
(including
intercompany assets
and liabilities)
    
    $
    (261,412
    )
    
    $
    315,138
    
    
    $
    126,004
    
    
    $
    (10,293
    )
    
    $
    169,437Long-term debt
    
    
    
    
    
    
    
    
    
    
    2,652
    
    
    
    
    
    
    
    2,652Long-term liabilities
    
    
    42,951
    
    
    
    1,243
    
    
    
    94
    
    
    
    
    
    
    
    44,288Minority interest
    
    
    
    
    
    
    30,091
    
    
    
    2,347
    
    
    
    213
    
    
    
    32,651Stockholders equity
    
    
    313,908
    
    
    
    132,518
    
    
    
    137,010
    
    
    
    (12,591
    )
    
    
    570,845Total liabilities
and stockholders equity
    
    $
    95,447
    
    
    $
    478,990
    
    
    $
    268,107
    
    
    $
    (22,671
    )
    
    $
    819,873
 Parent
    
    Guarantor
    
    Non-Guarantor
    
    Consolidating
    
    ConsolidatedCompany
    
    Subsidiaries
    
    Subsidiaries
    
    Adjustments
    
    TotalAs of June 30, 2004Cash and cash
equivalents
    
    $
    
    
    
    $
    9,473
    
    
    $
    38,178
    
    
    $
    (3,469
    )
    
    $
    44,182Accounts
receivable, net
    
    
    
    
    
    
    174,193
    
    
    
    56,933
    
    
    
    503
    
    
    
    231,629Other current assets
    
    
    50,018
    
    
    
    23,223
    
    
    
    8,810
    
    
    
    (1,030
    )
    
    
    81,021Total current assets
    
    
    50,018
    
    
    
    206,889
    
    
    
    103,921
    
    
    
    (3,996
    )
    
    
    356,832Property, plant and
equipment, net
    
    
    33,486
    
    
    
    169,666
    
    
    
    84,805
    
    
    
    1,470
    
    
    
    289,427Goodwill
    
    
    1,483
    
    
    
    497,123
    
    
    
    127,750
    
    
    
    300
    
    
    
    626,656Other assets
    
    
    26,692
    
    
    
    89,526
    
    
    
    5,788
    
    
    
    (83,837
    )
    
    
    38,169Total assets
    
    $
    111,679
    
    
    $
    963,204
    
    
    $
    322,264
    
    
    $
    (86,063
    )
    
    $
    1,311,084Current liabilities
(including
intercompany assets
and liabilities)
    
    $
    (653,702
    )
    
    $
    736,258
    
    
    $
    161,530
    
    
    $
    (25,533
    )
    
    $
    218,553Long-term debt
    
    
    487,301
    
    
    
    327
    
    
    
    3,007
    
    
    
    
    
    
    
    490,635Long-term liabilities
    
    
    43,340
    
    
    
    2,400
    
    
    
    312
    
    
    
    
    
    
    
    46,052Minority interest
    
    
    
    
    
    
    38,892
    
    
    
    4,095
    
    
    
    213
    
    
    
    43,200Stockholders equity
    
    
    234,740
    
    
    
    185,327
    
    
    
    153,320
    
    
    
    (60,743
    )
    
    
    512,644Total liabilities
and stockholders
equity
    
    $
    111,679
    
    
    $
    963,204
    
    
    $
    322,264
    
    
    $
    (86,063
    )
    
    $
    1,311,084
 8




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##### Table of Contents



Condensed Consolidating Income Statements Parent
    
    Guarantor
    
    Non-Guarantor
    
    Consolidating
    
    ConsolidatedCompany
    
    Subsidiaries
    
    Subsidiaries
    
    Adjustments
    
    TotalFor the three months ended
June 30, 2003Net revenue
    
    $
    89
    
    
    $
    170,386
    
    
    $
    77,640
    
    
    $
    (1,054
    )
    
    $
    247,061Total operating costs and
expenses
    
    
    9,995
    
    
    
    129,085
    
    
    
    61,206
    
    
    
    (1,054
    )
    
    
    199,232Income (loss) from
operations
    
    
    (9,906
    )
    
    
    41,301
    
    
    
    16,434
    
    
    
    
    
    
    
    47,829Interest expense, net
    
    
    165
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    165Minority interest
    
    
    
    
    
    
    5,325
    
    
    
    704
    
    
    
    
    
    
    
    6,029Provision (benefit) for
income taxes
    
    
    (3,827
    )
    
    
    13,672
    
    
    
    5,977
    
    
    
    
    
    
    
    15,822Net income (loss)
    
    $
    (6,244
    )
    
    $
    22,304
    
    
    $
    9,753
    
    
    $
    
    
    
    $
    25,813
 Parent
    
    Guarantor
    
    Non-Guarantor
    
    Consolidating
    
    ConsolidatedCompany
    
    Subsidiaries
    
    Subsidiaries
    
    Adjustments
    
    TotalFor the three months ended
June 30, 2004Net revenue
    
    $
    747
    
    
    $
    241,216
    
    
    $
    100,123
    
    
    $
    (1,232
    )
    
    $
    340,854Total operating costs and
expenses
    
    
    15,845
    
    
    
    188,368
    
    
    
    77,158
    
    
    
    (1,232
    )
    
    
    280,139Income (loss) from
operations
    
    
    (15,098
    )
    
    
    52,848
    
    
    
    22,965
    
    
    
    
    
    
    
    60,715Interest expense, net
    
    
    5,765
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    5,765Minority interest
    
    
    
    
    
    
    7,434
    
    
    
    256
    
    
    
    
    
    
    
    7,690Provision (benefit) for
income taxes
    
    
    (7,980
    )
    
    
    17,371
    
    
    
    8,686
    
    
    
    
    
    
    
    18,077Net income (loss)
    
    $
    (12,883
    )
    
    $
    28,043
    
    
    $
    14,023
    
    
    $
    
    
    
    $
    29,183
 9




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##### Table of Contents



Condensed Consolidating Income Statements Parent
    
    Guarantor
    
    Non-Guarantor
    
    Consolidating
    
    ConsolidatedCompany
    
    Subsidiaries
    
    Subsidiaries
    
    Adjustments
    
    TotalFor the six months ended
June 30, 2003Net revenue
    
    $
    89
    
    
    $
    339,961
    
    
    $
    151,208
    
    
    $
    (2,054
    )
    
    $
    489,204Total operating costs and
expenses
    
    
    24,308
    
    
    
    257,531
    
    
    
    119,922
    
    
    
    (2,054
    )
    
    
    399,707Income (loss) from
operations
    
    
    (24,219
    )
    
    
    82,430
    
    
    
    31,286
    
    
    
    
    
    
    
    89,497Interest expense, net
    
    
    450
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    450Minority interest
    
    
    
    
    
    
    10,905
    
    
    
    1,432
    
    
    
    
    
    
    
    12,337Provision (benefit) for
income taxes
    
    
    (9,372
    )
    
    
    27,175
    
    
    
    11,342
    
    
    
    
    
    
    
    29,145Net income (loss)
    
    $
    (15,297
    )
    
    $
    44,350
    
    
    $
    18,512
    
    
    $
    
    
    
    $
    47,565
 Parent
    
    Guarantor
    
    Non-Guarantor
    
    Consolidating
    
    ConsolidatedCompany
    
    Subsidiaries
    
    Subsidiaries
    
    Adjustments
    
    TotalFor the six months ended
June 30, 2004Net revenue
    
    $
    934
    
    
    $
    428,870
    
    
    $
    191,509
    
    
    $
    (2,431
    )
    
    $
    618,882Total operating costs and
expenses
    
    
    26,151
    
    
    
    329,491
    
    
    
    148,249
    
    
    
    (2,431
    )
    
    
    501,460Income (loss) from
operations
    
    
    (25,217
    )
    
    
    99,379
    
    
    
    43,260
    
    
    
    
    
    
    
    117,422Interest expense, net
    
    
    6,730
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    6,730Minority interest
    
    
    
    
    
    
    14,020
    
    
    
    884
    
    
    
    
    
    
    
    14,904Provision (benefit) for
income taxes
    
    
    (12,192
    )
    
    
    32,550
    
    
    
    16,160
    
    
    
    
    
    
    
    36,518Net income (loss)
    
    $
    (19,755
    )
    
    $
    52,809
    
    
    $
    26,216
    
    
    $
    
    
    
    $
    59,270
 10




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##### Table of Contents



Condensed Consolidating Statements of Cash Flows Parent
    
    Guarantor
    
    Non-Guarantor
    
    Consolidating
    
    ConsolidatedCompany
    
    Subsidiaries
    
    Subsidiaries
    
    Adjustments
    
    TotalFor the six months ended
June 30, 2003Cash flows from operating
activities:Net income (loss)
    
    $
    (15,297
    )
    
    $
    44,350
    
    
    $
    18,512
    
    
    $
    
    
    
    $
    47,565Changes in
operating and
intercompany assets
and liabilities and
non-cash items
included in net income
    
    
    59,497
    
    
    
    (24,757
    )
    
    
    (6,103
    )
    
    
    (1,088
    )
    
    
    27,549Net cash provided by (used in)
operating activities
    
    
    44,200
    
    
    
    19,593
    
    
    
    12,409
    
    
    
    (1,088
    )
    
    
    75,114Net cash (used in)
provided by investing activities
    
    
    (5,039
    )
    
    
    (22,077
    )
    
    
    (15,077
    )
    
    
    1,404
    
    
    
    (40,789
    )Net cash provided by financing
activities
    
    
    10,660
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    10,660Increase (decrease) in cash and
cash equivalents
    
    
    49,821
    
    
    
    (2,484
    )
    
    
    (2,668
    )
    
    
    316
    
    
    
    44,985Cash and cash equivalents, at
beginning of period
    
    
    
    
    
    
    2,484
    
    
    
    36,191
    
    
    
    (316
    )
    
    
    38,359Cash and cash equivalents, at end
of period
    
    $
    49,821
    
    
    $
    
    
    
    $
    33,523
    
    
    $
    
    
    
    $
    83,344Parent
    
    Guarantor
    
    Non-Guarantor
    
    Consolidating
    
    ConsolidatedCompany
    
    Subsidiaries
    
    Subsidiaries
    
    Adjustments
    
    TotalFor the six months ended
June 30, 2004Cash flows from operating
activities:Net income (loss)
    

    $
    (19,755
    )
    
    $
    52,809
    
    
    $
    26,216
    
    
    $
    
    
    
    $
    59,270Changes in operating and
intercompany assets
and liabilities and
non-cash items
included in net income
    
    
    (82,613
    )
    
    
    43,692
    
    
    
    17,415
    
    
    
    43,415
    
    
    
    21,909Net cash provided by (used in)
operating activities
    
    
    (102,368
    )
    
    
    96,501
    
    
    
    43,631
    
    
    
    43,415
    
    
    
    81,179Net cash
(used in) provided by investing activities
    
    
    (170,723
    )
    
    
    (89,375
    )
    
    
    (22,246
    )
    
    
    1,268
    
    
    
    (281,076
    )Net cash provided by (used in)
financing activities
    
    
    252,934
    
    
    
    (299
    )
    
    
    (10,699
    )
    
    
    (48,152
    )
    
    
    193,784(Decrease) increase in cash and
cash equivalents
    
    
    (20,157
    )
    
    
    6,827
    
    
    
    10,686
    
    
    
    (3,469
    )
    
    
    (6,113
    )Cash and cash equivalents, at
beginning of period
    
    
    20,157
    
    
    
    2,646
    
    
    
    27,492
    
    
    
    
    
    
    
    50,295Cash and cash equivalents, at end
of period
    
    $
    
    
    
    $
    9,473
    
    
    $
    38,178
    
    
    $
    (3,469
    )
    
    $
    44,182
 11




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##### Table of Contents



4. Net Income per Share The following table sets forth the computation of basic and diluted net
income per share (shares in thousands): Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,2003
    
    2004
    
    2003
    
    2004Numerator:Numerator for basic and
diluted net income per share
 net income
    
    $
    25,813
    
    
    $
    29,183
    
    
    $
    47,565
    
    
    $
    59,270Denominator:Denominator for basic net
income per share  weighted-average shares
    
    
    72,806
    
    
    
    66,832
    
    
    
    72,539
    
    
    
    67,871Effect of dilutive securities:Stock options
    
    
    2,091
    
    
    
    2,395
    
    
    
    1,983
    
    
    
    2,354Denominator for diluted net
income per share  adjusted
weighted-average shares and
assumed conversions
    
    
    74,897
    
    
    
    69,227
    
    
    
    74,522
    
    
    
    70,225Net income per share:Basic
    
    $
    0.35
    
    
    $
    0.44
    
    
    $
    0.66
    
    
    $
    0.87Diluted
    
    $
    0.34
    
    
    $
    0.42
    
    
    $
    0.64
    
    
    $
    0.84
 5. Stockholders Equity Stock-based Compensation We account for stock-based compensation to employees and directors using
the intrinsic value method in accordance with the provisions of Accounting
Principles Board Opinion No. 25, Accounting for Stock Issued to Employees,and
related Interpretations. Accordingly, we recognize no compensation expense when
we grant fixed options to employees and directors, because the exercise price
of the stock options equals or exceeds the market price of the underlying stock
on the dates of grant. Option grants to medical directors and non-vested stock
grants are expensed over their vesting periods. The following table presents the pro forma effect on net income and net
income per share as if we had applied the fair value based method and
recognition provisions of Statement of Financial Accounting Standards No. 12




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##### Table of Contents



123, Accounting for Stock-Based Compensation,(SFAS No. 123) to
stock-based compensation to employees and directors: Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,2003
    
    2004
    
    2003
    
    2004Net income, as reported
    
    $
    25,813
    
    
    $
    29,183
    
    

    $
    47,565
    
    
    $
    59,270Add: stock-based
compensation expense,
net of related tax
effects, included in
the determination of
net income as reported
    
    
    283
    
    
    
    26
    
    
    
    344
    
    
    
    57Less: stock-based
compensation expense,
net of related tax
effects, determined by
the fair value-based
method
    
    
    (2,276
    )
    
    
    (2,155
    )
    
    
    (4,763
    )
    
    
    (4,542
    )Pro forma net income
    
    $
    23,820
    
    
    $
    27,054
    
    
    $
    43,146
    
    
    $
    54,785Net income per share:Basic, as reported
    
    $
    0.35
    
    
    $
    0.44
    
    
    $
    0.66
    
    
    $
    0.87Basic, pro forma
    
    $
    0.33
    
    
    $
    0.40
    
    
    $
    0.59
    
    
    $
    0.81Diluted, as reported
    
    $
    0.34
    
    
    $
    0.42
    
    
    $
    0.64
    
    
    $
    0.84Diluted, pro forma
    
    $
    0.32
    
    
    $
    0.39
    
    
    $
    0.58
    
    
    $
    0.78
 The effects of applying SFAS No. 123 for providing pro forma disclosures
are not likely to be representative of the effects on reported net income for
future periods. Stock Split On April 27, 2004, we announced a three-for-two stock split in the form of
a stock dividend distributed to shareholders of record as of May 7, 2004. On
May 24, 2004 we issued one share for every two shares held by shareholders as
of the record date. The par value of our common stock remained unchanged at
$0.01. Authorized Shares On June 9, 2004, our shareholders approved an amendment to the certificate
of incorporation increasing the number of authorized shares of common stock
from 90,000 to 150,000. 6. Contingencies On August 30, 2000, 19 patients were hospitalized and one patient died
shortly after becoming ill while receiving treatment at one of our dialysis
centers in Youngstown, Ohio. One of the 19 hospitalized patients also died some
time later. In March 2001, one of the affected patients sued the Company in
Mahoning County, Ohio for injuries related to the August 30, 2000 incident.
Additional suits were filed. As of June 30, 2004, we had settled all but four
of these suits. The suits allege negligence, medical malpractice and product
liability. Additional defendants were named in each of the suits. Additional
defendants in some of the suits include the water system vendors who installed
and maintained the water system in the dialysis center. We have denied the
allegations and have filed cross-claims against the water system vendors. We
intend to pursue these cross-claims vigorously. Management believes that Renal
Care Groups insurance should be adequate to cover these illnesses and does not
anticipate a material adverse effect on our consolidated financial position or
results of operations. We are involved in other litigation and regulatory investigations arising
in the ordinary course of business. In the opinion of management, after
consultation with legal counsel, management believes these matters will be
resolved without material adverse effect on Renal Care Groups consolidated
financial position or results of operations. Laws and regulations governing the Medicare and Medicaid programs are
complex and subject to interpretation. We believe that we are in compliance
with all applicable laws and regulations governing the Medicare and Medicaid
programs. We are not aware of any pending or threatened investigations
involving allegations of potential noncompliance with applicable laws or
regulations. While no regulatory inquiries have been made, compliance with such
laws and regulations can be subject to future government review and
interpretation, and 13




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##### Table of Contents



non-compliance or alleged non-compliance could result in significant regulatory
action including fines, penalties, and exclusion from the Medicare and Medicaid
programs. We generally engage practicing board-certified or board-eligible
nephrologists to serve as medical directors for our centers. Medical directors
are responsible for the administration and monitoring of patient care policies,
including patient education, administration of dialysis treatment, development
programs and assessment of all patients in our dialysis centers. We pay medical
director fees that are consistent with the fair market value of the required
supervisory services. Our medical director agreements typically have a term of
seven years with a three-year renewal option. 7. Defined Benefit Plan Effective January 29, 2003, we implemented a retirement benefit plan for
our former Chairman, Chief Executive Officer and President. He died March 20,
2003. The plan provides that we will make 120 monthly payments of $54 each to
our former Chairmans beneficiary, beginning in April 2003. As a result, in the
first quarter of 2003, we recorded a $5,350 charge included in general and
administrative expenses representing the pre-tax net present value of these
payments. As of June 30, 2004, we have accrued liabilities totaling $4,792
related to this defined benefit plan. 14




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##### Table of Contents



ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Results of Operations Three Months Ended June 30, 2003 Compared to Three Months Ended June 30, 2004 Net Revenue.Net revenue increased from $247.1 million for the three
months ended June 30, 2003 to $340.9 million for the three months ended June
30, 2004, an increase of $93.8 million or 38.0%. This increase resulted
primarily from a 35.3% increase in the number of treatments performed by Renal
Care Group from 809,413 in the 2003 period to 1,095,250 in the 2004 period.
This growth in treatments is the result of our acquisition of NNA and other
dialysis facilities along with a 3.7% increase in same-market treatments for
the 2004 period over the 2003 period. In addition, average net revenue per
dialysis treatment increased 2.3% from $304 in 2003 to $311 in 2004. The
increase in net revenue per treatment from 2003 is largely due to an increase
in the utilization of certain ancillary drugs along with the impact of our
annual price increase implemented in the fourth quarter of 2003. This increase
was partially offset by lower revenue per treatment realized by the former NNA
operations. As we transition NNAs patients into our laboratory, we expect revenue per
treatment to remain steady or improve in the remainder of 2004. Excluding any potential changes
in ancillary drug utilization, we expect net revenue to remain between $310 and
$315 per treatment for the remainder of 2004. Patient Care Costs.Patient care costs consist of costs directly related
to the care of patients, including direct labor, drugs and other medical
supplies, and operational costs of facilities. Patient care costs increased
from $160.0 million for the three months ended June 30, 2003 to $229.8 million
for the three months ended June 30, 2004, an increase of 43.7%. This increase
was due principally to the increase in the number of treatments performed
during the period, which resulted in corresponding increases in the use of
labor, drugs and supplies. Patient care costs as a percentage of net revenue
increased from 64.8% in the 2003 period to 67.4% in the 2004 period. This
increase is due to generally higher salary and benefit costs and routine supply
costs experienced in the former NNA facilities. Patient care costs per
treatment increased 6.1% from $198 in the 2003 period to $210 in the 2004
period. This increase was due to an increase in the utilization of certain
ancillary drugs as well as the higher cost structure in the former NNA
facilities. General and Administrative Expenses.General and administrative expenses
include corporate office costs and other costs not directly related to the care
of patients, including facility administration, accounting, billing and
information systems. General and administrative expenses increased from $21.2
million for the three months ended June 30, 2003 to $27.3 million for the three
months ended June 30, 2004, an increase of 29.0%. The increase in general and
administrative expenses over the second quarter of 2003 is due to increased
costs associated with the acquisitions that we closed in the first half of
2004. General and administrative expenses as a percentage of net revenue
decreased from 8.6% in 2003 to 8.0% in 2004 as we leveraged our corporate
functions over a larger base of revenue as a result of our acquisitions in
2004. Provision for Doubtful Accounts.We determine the provision for doubtful
accounts as a function of payor mix, billing practices and other factors. We
reserve for doubtful accounts in the period when we recognize the revenue.
Management establishes these reserves based on its estimate of the net
collectibility of accounts receivable while considering a variety of factors.
These factors include, but are not limited to, analysis of revenues generated
from payor sources, subsequent collection testing and regular reviews of
detailed accounts receivable agings. We make adjustments to the allowance for
doubtful accounts as necessary based on the results of managements ongoing
reviews of the net collectibility of accounts receivable. The provision for
doubtful accounts increased from $6.5 million for the three months ended June
30, 2003 to $8.0 million for the three months ended June 30, 2004, an increase
of $1.6 million, or 24.4%. This increase was principally the result of
increases in our net revenue. The provision for doubtful accounts as a
percentage of net revenue decreased from 2.6% in the 2003 period to 2.4% in the
2004 period. The decrease in the provision for doubtful accounts as a
percentage of net revenue was due to improvements in the Companys historical
collection results. Depreciation and Amortization.Depreciation and amortization increased
from $11.6 million for the three months ended June 30, 2003 to $14.9 million
for the three months ended June 30, 2004, an increase of 28.7%. This 15




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increase was due to increases in plant and equipment and separately
identifiable intangible assets associated with our recent acquisitions, start-up of dialysis facilities, normal replacement costs of dialysis
facilities and equipment, and purchases of information systems.
Depreciation and amortization as a percentage of net revenue decreased from
4.7% in 2003 to 4.4% in 2004 principally as a result of NNAs practice of
leasing dialysis equipment under operating leases, which resulted in lower
depreciation and amortization and higher patient care costs. Income from Operations.Income from operations increased from $47.8
million for the three months ended June 30, 2003 to $60.7 million for the three
months ended June 30, 2004, an increase of 26.9%. Income from operations as a
percentage of net revenue decreased from 19.4% in the 2003 period to 17.8% in
the 2004 period principally as a result of the acquisition of NNA, which had
generally lower margins than the Company as a result of its lower revenue per
treatment and higher patient care costs and other factors discussed above. Interest Expense, Net.Interest expense increased from $165,000 for the
three months ended June 30, 2003 to $5.8 million for the three months ended
June 30, 2004. This increase was due to higher average borrowings outstanding
during the quarter, as a result of additional borrowings associated with the
completion of our program to repurchase $250.0 million in common stock between
November 2003 and March 2004, our recent acquisitions and the assumption of
NNAs $160.0 million 9% senior subordinated notes. Minority Interest.Minority interest represents the proportionate equity
interest of other owners in consolidated entities that we do not wholly own.
The financial results of those entities are included in the Companys
consolidated results. Minority interest as a percentage of net revenue
decreased from 2.4% in the 2003 period to 2.3% in the 2004 period. The
decrease in minority interest expense as a percentage of revenue occurred as
our recent acquisitions diluted the percentage of our facilities that operate
as joint ventures. As of June 30, 2004, we were the majority and controlling
owner in 64 joint ventures. Provision for Income Taxes.Income tax expense increased from $15.8
million for the three months ended June 30, 2003 to $18.1 million for the three
months ended June 30, 2004, an increase of $2.3 million or 14.3%. The increase
is a result of higher pre-tax earnings described above. Our effective tax rate
increased from 38.0% for the 2003 period to 38.3% for the 2004 period. The
increase reflects a higher overall effective rate associated with the
operations acquired from NNA. Net Income.Net income increased from $25.8 million for the three months
ended June 30, 2003 to $29.2 million for the three months ended June 30, 2004,
an increase of $3.4 million or 13.1%. The increase is a result of the items
discussed above. Six Months Ended June 30, 2003 Compared to Six Months Ended June 30, 2004 Net Revenue.Net revenue increased from $489.2 million for the six months
ended June 30, 2003 to $618.9 million for the six months ended June 30, 2004,
an increase of $129.7 million or 26.5%. This increase resulted primarily from
a 22.7% increase in the number of treatments performed by Renal Care Group from
1,593,254 in the 2003 period to 1,955,499 in the 2004 period. This growth in
treatments is the result of our acquisition of NNA and other dialysis
facilities along with a 3.6% increase in same-market treatments for the 2004
period over the 2003 period. In addition, average net revenue per dialysis
treatment increased 3.3% from $306 in 2003 to $316 in 2004. The increase in
net revenue per treatment is largely due to an increase in the utilization of
certain ancillary drugs, the impact of our annual price increase implemented in
the fourth quarter of 2003 and the favorable resolution of several contractual
issues with payors during the first quarter 2004. This increase was partially
offset by lower revenue per treatment realized by the former NNA operations. Patient Care Costs.Patient care costs consist of costs directly related
to the care of patients, including direct labor, drugs and other medical
supplies, and operational costs of facilities. Patient care costs increased
from $317.5 million for the six months ended June 30, 2003 to $409.2 million
for the six months ended June 30, 2004, an increase of 28.9%. This increase was
due principally to the increase in the number of treatments performed during
the period, which was reflected in corresponding increases in the use of labor,
drugs and supplies. Patient care costs as a percentage of net revenue increased
from 64.9% in 2003 to 66.1% in 2004. This increase is due to generally higher
salary and benefit costs and routine supply costs experienced in the former NNA
facilities. Patient care costs 16




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per treatment increased 5.0% from $199 in 2003 to $209 in 2004. This
increase was due to an increase in the utilization of certain ancillary drugs
as well as the higher cost structure in the former NNA facilities. General and Administrative Expenses.General and administrative expenses
include corporate office costs and other costs not directly related to the care
of patients, including facility administration, accounting, billing and
information systems. General and administrative expenses increased from $47.5
million for the six months ended June 30, 2003 to $50.0 million for the six
months ended June 30, 2004, an increase of 5.4%. The increase in general and
administrative expenses over the 2003 period is due to costs associated with
acquisitions that closed in the first half of 2004. This increase was
partially offset by a $5.4 million charge related to a supplemental retirement
benefit plan for the Companys former chairman, chief executive and president
that we recorded in the first quarter of 2003. General and administrative
expenses as a percentage of net revenue decreased from 9.7% in 2003 to 8.1% in
2004. This decrease was the result of leveraging our corporate functions over
a larger base of revenue as well as the absence of the retirement charge in the
2004 period. Provision for Doubtful Accounts.We determine the provision for doubtful
accounts as a function of payor mix, billing practices and other factors. We
reserve for doubtful accounts in the period in which the revenue is recognized.
Management establishes these reserves based on its estimates of the net
collectibility of accounts receivable while considering a variety of factors.
These factors include, but are not limited to, analysis of revenues generated
from payor sources, subsequent collection testing and regular reviews of
detailed accounts receivable agings. We make adjustments to the allowance for
doubtful accounts as necessary based on the results of managements ongoing
reviews of the net collectibility of accounts receivable. The provision for
doubtful accounts increased from $12.9 million for the six months ended June
30, 2003 to $15.2 million for the six months ended June 30, 2004, an increase
of $2.3 million, or 17.7%. The provision for doubtful accounts as a percentage
of net revenue decreased slightly from 2.6% in 2003 to 2.4% in 2004. The
decrease in the provision for doubtful accounts as a percentage of net revenue
was due to improvements in the Companys historical collection results. Depreciation and Amortization.Depreciation and amortization increased
from $21.9 million for the six months ended June 30, 2003 to $27.1 million for
the six months ended June 30, 2004, an increase of $5.2 million, or 23.7%. This
net increase was due to increases in plant and equipment and separately
identifiable assets associated with our recent acquisitions, start-up of
dialysis facilities, normal replacement costs of dialysis facilities and
equipment, and purchases of information systems. Depreciation and
amortization as a percentage of net revenue decreased from 4.5% in 2003 to 4.4%
in 2004. Income from Operations.Income from operations increased from $89.5
million for the six months ended June 30, 2003 to $117.4 million for the six
months ended June 30, 2004, an increase of $27.9 million, or 31.2%. Income from
operations as a percentage of net revenue increased from 18.3% in the 2003
period to 19.0% in the 2004 period as a result of the factors discussed above. Interest Expense, Net.Interest expense increased from $450,000 for the
six months ended June 30, 2003 to $6.7 million for the six months ended June
30, 2004. The increase was the result of higher average borrowings in 2004, as
a result of additional borrowings associated with the completion of our program
to repurchase $250.0 million in common stock between November 2003 and March
2004, our recent acquisitions and the assumption of NNAs $160.0 million 9%
senior subordinated notes. Minority Interest.Minority interest represents the proportionate equity
interest of other owners in consolidated entities that we do not wholly own.
The financial results of those entities are included in the Companys
consolidated results. Minority interest as a percentage of net revenue
decreased from 2.5% in the 2003 period to 2.4% in the 2004 period. The
decrease in minority interest expense as a percentage of revenue occurred as
our recent acquisitions diluted the percentage of our facilities that operate
as joint ventures. As of June 30, 2004, we were the majority and controlling
owner in 64 joint ventures. Provision for Income Taxes.Income tax expense increased from $29.1
million for the six months ended June 30, 2003 to $36.5 million for the six
months ended June 30, 2004, an increase of $7.4 million or 25.3%. The increase
is a result of higher pre-tax earnings described above. The Companys effective
tax rate increased from 38.0% for the 2003 period to 38.1% for the 2004 period.
The increase reflects a higher overall effective rate associated with the
operations acquired from NNA. 17




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Net Income.Net income increased from $47.6 million for the six months
ended June 30, 2003 to $59.3 million for the six months ended June 30, 2004, an
increase of $11.7 million or 24.6%. The increase is a result of the items
discussed above. Liquidity and Capital Resources We require capital primarily to acquire and develop dialysis centers, to
purchase property and equipment for existing centers, to repurchase shares of
our common stock and to finance working capital needs. At June 30, 2004, our
working capital was $138.3 million, cash and cash equivalents were $44.2
million, and our current ratio was approximately 1.6 to 1.0. Net cash provided by operating activities was $81.2 million for the six
months ended June 30, 2004. Cash provided by operating activities consists of
net income before depreciation and amortization expense and income applicable
to minority interest, adjusted for changes in components of working capital.
Net cash used in investing activities was $281.1 million for the six months
ended June 30, 2004. Net cash used in investing activities consisted primarily
of $230.7 million of cash paid for acquisitions, net of cash acquired, as well
as $45.0 million of purchases of property and equipment. Net cash provided by
financing activities was $193.8 million for the six months ended June 30, 2004.
Net cash provided by financing activities primarily reflects proceeds from the
issuance of long-term debt of $325.0 million, net proceeds of $12.8 million
from the issuance of common stock, offset by $137.8 million in repurchases of
our common stock. As of December 31, 2003, we had two credit agreements with a group of
banks totaling $150.0 million. On February 10, 2004, we entered into a new
credit agreement (the 2004 Agreement) with a group of banks totaling up to
$700.0 million. The 2004 Agreement replaced both of our prior facilities. The
2004 agreement has a $150.0 million revolving credit facility, a $325.0 million
term loan facility and a $225.0 million incremental term loan facility.
Borrowings under the incremental term loan facility are subject to obtaining
commitments from the banks and finalizing specific terms. The revolving credit
facility and the $325.0 million term loan facility have a final maturity of
February 10, 2009. Each of our wholly-owned subsidiaries has guaranteed all of
our obligations under the 2004 Agreement. Further, our obligations under the
2004 Agreement, and our subsidiaries obligations under their guarantees, are
secured by a pledge of the equity interests we hold in each of our
subsidiaries. The 2004 Agreement includes financial covenants that are
customary based on the amount and duration of the agreement. Borrowings under the $150.0 million revolving credit facility may be used
for acquisitions, repurchases of our stock, capital expenditures, working
capital and general corporate purposes. As of June 30, 2004, we can borrow up
to $150.0 million under the revolving credit facility but cannot borrow any
additional amounts under the $325.0 million term loan facility which was fully
funded at closing of the 2004 Agreement. At June 30, 2004, our outstanding
indebtedness was $511.5 million, including a remaining balance of $320.9
million under the term loan facility, $184.6 million of senior subordinated
notes assumed in the NNA transaction and $5.9 million of other indebtedness,
primarily capital leases. The
senior subordinated notes we assumed in the NNA transaction bear interest at the rate of 9% per annum on
the face amount that was $160.0 million at the date of
acquisition. As of June 30, 2004 these notes have a remaining
face value of $159.7 million and are recorded at their fair
value of $184.6 million. These notes do not provide for scheduled
principal amortization and are scheduled to mature on November 1, 2011. Each
of our wholly-owned subsidiaries has guaranteed all of our obligations under
these notes. The rights of the noteholders and our obligations under these
notes are set forth in an indenture that NNA entered into in October 2003 and
we assumed in connection with the NNA acquisition. The indenture includes
customary financial covenants. Borrowings under the 2004 Agreement bear interest at variable rates
determined by our leverage ratio. These variable rate debt instruments carry a
degree of interest rate risk and we will face higher interest costs on this
debt if interest rates rise. On June 3, 2004, we entered into interest rate swap agreements to hedge
the interest rate risk on $150.0 million of our term loan. These interest rate
swap agreements became effective on June 30, 2004. Under these 18




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interest rate swap agreements we will exchange fixed and variable rate
interest payments based on a $150.0 million notional principal amount through
March 30, 2007. The notional amount of $150.0 million and
the interest rate of
3.5% plus an additional spread based on the Companys leverage
ratio are fixed in the agreements. The changes in cash flows under these
agreements are expected to offset the changes in interest rate payments
attributable to fluctuations in LIBOR. The hedge is structured to qualify for
the shortcut method; therefore, changes in the fair value of the agreement will
be directly recorded in comprehensive income. The interest payments under this
agreement are settled on a net basis each calendar quarter. As a result of our indebtedness, we will incur substantial interest
expense in and after 2004. Based on our outstanding indebtedness of $486.5 million,
excluding the unamortized fair value premium of $24.9 million on the Notes, the
aggregate maturities of our borrowings are as follows: 2004 - $14.0 million;
2005 - $22.3 million; 2006 - $30.5 million; 2007 - $56.9 million; 2008 - $156.4
million; and thereafter - $206.4 million. A significant component of our growth strategy is the acquisition and
development of dialysis facilities. There can be no assurance that we will be
able to identify suitable acquisition candidates or to close acquisitions on
acceptable terms. Management believes that existing cash and funds from
operations, together with funds available under our credit facility, will be
sufficient to meet our acquisition, expansion, capital expenditure and working
capital needs for the foreseeable future. However, in order to finance certain
large strategic acquisition opportunities, we may need to incur additional
short and long-term bank indebtedness or to issue equity or debt securities.
The availability and terms of any future financing will depend on market and
other conditions. There can be no assurance that we will be able to secure
additional financing, if required, on acceptable terms. We plan to make capital expenditures of between $85.0 million and $95.0
million in 2004, primarily for equipment replacement, expansion of existing
dialysis facilities and construction of de novo facilities. We expect that
these capital expenditures will be funded with cash provided by operating
activities and our existing credit facilities. Management believes that capital
resources available to us will be sufficient to meet the needs of our business,
both on a short- and long-term basis. Management, from time to time, determines the appropriateness of
repurchasing common stock in accordance with a repurchase plan initially
authorized by the Board of Directors in October 2000. In 2001, we began
repurchasing shares of our common stock by purchasing 150,000 shares of common
stock for approximately $3.1 million. In 2002, we repurchased 4.3 million
shares of our common stock for approximately $90.9 million. In October 2003, we
announced that the Board of Directors had approved an increase in the
repurchase plan to allow the purchase of up to a total of $450.0 million in
common stock, and we announced that we intended to repurchase $250.0 million in
common stock between November 1, 2003 and March 31, 2004. During 2003, we
repurchased 5.5 million shares of common stock for $140.5 million. In the first
half of 2004, we repurchased 4.6 million shares for $137.8 million. Through
June 30, 2004, we had repurchased an aggregate of 14.5 million shares under the
plan, for a total of approximately $372.2 million. Critical Accounting Policies The Securities and Exchange Commission (SEC) issued a financial reporting
release, FR-60, Cautionary Advice Regarding Disclosure About Critical
Accounting Policies. In accordance with that release, management has
identified accounting policies that it considers critical to the business of
Renal Care Group. Those policies include net revenue and contractual
provisions, provision for doubtful accounts, self-insurance accruals, and
impairment of long-lived assets and long-lived assets to be disposed of. These
policies were identified as critical based on their importance to the
consolidated financial statements as well as on the degrees of subjectivity and
complexity involved in these policies. There have been no changes in Renal Care
Groups critical accounting policies or in the application of those policies
from those described in the annual report on Form 10-K, as filed with the SEC
on March 4, 2004 and in the current report on Form 8-K, as filed with the SEC
on April 19, 2004. 19




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RISK FACTORS You should carefully consider the risks described below before investing
in Renal Care Group. The risks and uncertainties described beloware notthe
only ones facing Renal Care Group. Other risks and uncertainties that we have
not predicted or assessed may also adversely affect us. If any of the following risks occurs, our earnings, financial condition or
business could be materially harmed, and the trading price of our common stock
could decline, resulting in the loss of all or part of your investment. If Congress or CMS changes the Medicare or Medicaid programs for dialysis, then
our revenue and earnings could decrease. If the government changes the Medicare, Medicaid or
similar government programs or the rates those programs pay for our services,
then our revenue and earnings may decline. We estimate that approximately 50%
of our net revenue for 2002, 49% of our net revenue for 2003, and 49% of our
net revenue for the six months ended June 30, 2004 consisted of reimbursements
from Medicare, including reimbursement for the administration of EPO. We also
estimate that approximately 7% of our net revenue for 2002, 6% of our net
revenue for 2003 and 4% of our net revenue for the six months ended June 30,
2004 consisted of reimbursements from Medicaid or comparable state programs.
Any of the following actions in connection with government programs could cause
our revenue and earnings to decline:  
    
    a reduction of the amount paid to us under government programs;
    
    an increase in the costs associated with performing our services that are subject to
inflation, such as labor and supply costs, without a corresponding increase in reimbursement
rates;
    
    the inclusion of some or all ancillary services, for which we are now reimbursed separately,
in the flat composite rate for a dialysis treatment; or
    
    changes in laws, or the interpretations of laws, which could cause us to modify our operations. Specifically, Congress and CMS have proposed expanding the drugs and
services that are included in the flat composite rate. CMS has indicated that
it believes such a mechanism would be fairer and easier to administer. In
addition, Congress mandated a change in the way we will be paid beginning in
2005 for some of the drugs, including EPO, that we bill for outside of the flat
composite rate. This change will result in lower reimbursement for these drugs
and a higher composite rate. Congress stated that these changes are not
intended to reduce overall reimbursement to dialysis providers.
CMS recently issued proposed regulations to implement these
changes. These proposed regulations provide that we will be
reimbursed for separately billable drugs at a 3% discount from the
average sale price and that the composite rate will be increased by
11.3%. These proposed regulations also include a case-mix adjustment
and a geographic adjustment to the composite rate as well as a
buget-neutrality adjustment. If these regulations become
effective as proposed, management believes they will result in a net reduction of
$0.03 per share in diluted net income in 2005. If states lower Medicaid reimbursement, then we would be less profitable. The Medicaid programs in some of the states in which we operate have
formerly reimbursed us, or currently reimburse us, at rates higher than those
paid by Medicare. Some of these programs, like Washingtons, Wisconsins, and
New Mexicos have approved reductions in reimbursement. Other programs have
proposed reductions or have announced that they are considering reductions. In
addition, a number of the states where we operate are experiencing budget
shortfalls, and some of these states may consider reducing Medicaid
reimbursement or changing their Medicaid programs to cut costs. We are unable
to predict whether and, if so, when any reductions in Medicaid reimbursement,
other than those already approved, might occur and what their precise effect
will be. If reimbursement for EPO decreases, then we could be less profitable. If government or private payors decrease reimbursement rates for EPO, for
which we are currently reimbursed separately outside of the flat composite
rate, then our revenue and earnings will decline. Revenues from the
administration of EPO were approximately 23% of our net revenue for 2002, 24%
of our net revenue for 2003 and 27% of our net revenue for the six months ended
June 30, 2004. Most of our payments for EPO come from government programs. For
the six months ended June 30, 2004, Medicare and Medicaid reimbursement
represented approximately 53% of the total revenue we derived from EPO. A
reduction in the reimbursement rate for EPO or the 20




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inclusion of EPO in the list of items covered by the flat composite rate
could materially and adversely affect our revenue and earnings. As
discussed above, Congress has mandated a change in the way we will be
reimbursed for EPO, and CMS has proposed regulations to implement the
change. This change and others in the proposed regulations could, as
discussed above, adversely affect our net income in 2005. If Amgen raises the price for EPO or if EPO becomes in short supply, then we
could be less profitable. EPO is produced by a single manufacturer, Amgen, Inc., and there are no
substitute products currently marketed to dialysis providers in the United
States. In April 2002, Amgen announced a 3.9% increase in the price of EPO.
This price increase adversely affected our earnings in 2003 and changes in the
rebate structure under our current contract with Amgen may adversely affect our
earnings in 2004. If Amgen imposes additional EPO price increases or if Amgen
or other factors interrupt the supply of EPO, then our revenue and earnings
will decline. If Amgen markets Aranesp® for ESRD patients, then we could be less profitable. Amgen has developed and obtained FDA approval for a new drug to treat
anemia that is marketed as Aranesp® (darbepoetin alfa). Aranesp® is a longer
acting form of bio-engineered protein that, like EPO, can be used to treat
anemia. EPO is usually administered in conjunction with each dialysis
treatment. Aranesp® can remain effective for between two and three weeks. If
Amgen markets Aranesp® for the treatment of dialysis patients, then our
earnings could be materially and adversely affected by either of the following
factors:  
    
    our margins realized from the administration of Aranesp® could be
lower than the margins realized on the administration of EPO; or
    
    physicians could decide to administer Aranesp® in their offices, and
we would not recognize revenue or profit from the administration of
EPO or Aranesp®. If payments by private insurers, hospitals or managed care organizations
decrease, then our revenue and earnings could decrease. If private insurers, managed care organizations or hospitals reduce their
rates or if we experience a significant shift in our revenue mix toward
additional Medicare or Medicaid reimbursement, then our revenue and earnings
will decline. We estimate that approximately 43% of our net revenue for 2002,
45% of our net revenue for 2003, and 47% of our net revenue for the six months
ended June 30, 2004 was derived from sources other than Medicare and Medicaid.
In general, payments we receive from private insurers and hospitals for our
services are at rates significantly higher than the Medicare or Medicaid rates.
Payments we receive from managed care organizations are also at rates higher
than Medicare and Medicaid rates but lower than those paid by private insurers.
In addition, we have been able to implement annual price increases for private
insurers and managed care organizations that we have not been able to implement
for federal programs. Management believes that health insurance pricing is
cyclical and that we may be at or near the top of the cycle. As a result,
management believes that our ability to maintain or raise rates to private
insurers and managed care companies will likely be more limited over the next
several years than it has been in the recent past. We have recently experienced
reductions in reimbursement from two commercial insurers, and management
believes that the reductions in reimbursement by these two commercial insurers
along with pricing pressure from other commercial insurers and managed care
organizations will likely adversely impact our revenue per treatment and
earnings per share in 2004. Any of the following events could have a material
adverse effect on our revenue and earnings:  
    
    any number of economic or demographic factors could cause private
insurers, hospitals or managed care companies to reduce the rates they
pay us or to refuse to pay price increases or work to reduce the rate
of our price increases;
    
    a portion of our business that is currently reimbursed by private
insurers or hospitals may become reimbursed by managed care
organizations, which generally have lower rates for our services;
    
    a portion of our business that is currently reimbursed by private
insurers at rates based on our billed charges may become reimbursed
under a contract at lower rates; or
    
    the scope of coverage by Medicare or Medicaid under the flat composite
rate could expand and, as a result, reduce the extent of our services
being reimbursed at the higher private-insurance rates. 21




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If local physicians stop sending patients to our centers or were prohibited
from doing so for regulatory reasons, then our revenue and earnings would
decline. Our dialysis centers depend on local nephrologists sending patients to the
centers. Typically, one or a few physicians patients make up all or a
significant portion of the patient base at each of our dialysis centers, and
the loss of the patient base of one or more of these physicians could have a
material adverse effect on the operations of that center. The loss of the
patient base of a significant number of local physicians could cause our
revenue and earnings to decline. In many instances, the primary referral
sources for our centers are physicians who also serve as medical directors of
our centers and may be shareholders. If the medical director relationship or
stock ownership were found to violate applicable federal or state law,
including fraud and abuse laws and laws prohibiting self-referrals, then the
physicians acting as medical directors or owning our stock could be forced to
stop referring patients to our centers. A number of our medical director agreements will expire over the next
three years, unless they are renewed or renegotiated. We did not renew or
renegotiate a small number of our medical director agreements that expired in
2003, and we may not be able to renew or renegotiate expiring medical director
agreements successfully, or we may not be able to enforce the non-competition
provisions of some of our medical director or other agreements. Any of these
factors could result in a loss of patients, since dialysis patients are
typically treated at a center where their physician or a member of his or her
practice group serves as medical director. We believe that our future success
will depend in part on our ability to attract and retain qualified physicians
to serve as medical directors of our dialysis centers. If our business is alleged or found to violate heath care or other applicable
laws, our revenue and earnings could decrease. We are subject to extensive federal, state and local regulation. The laws
that apply to our operations include, but are not limited to, the following:  
    
    fraud and abuse prohibitions under state and federal health care laws;
    
    prohibitions and limitations on patient referrals;
    
    billing and reimbursement rules, including false claims prohibitions
under health care reimbursement laws;
    
    rules regarding the collection, use, storage and disclosure of patient
health information, including the federal Health Insurance Portability
and Accountability Act of 1996, which we refer to as HIPAA, and state law
equivalents of HIPAA;
    
    facility licensure;
    
    health and safety requirements;
    
    environmental compliance; and
    
    medical and toxic waste disposal. Much of the regulation of our business, particularly in the areas of fraud
and abuse and patient referral, is complex and open to differing
interpretations. Due to the broad application of the statutory provisions and
the absence in many instances of regulations or court decisions addressing the
specific arrangements by which we conduct our business, including our
arrangements with medical directors, physician stockholders and physician joint
venture partners, governmental agencies could challenge some of our practices
under these laws. New regulations governing electronic transactions and the collection, use,
storage, and disclosure of health information impose significant administrative
and financial obligations on our business. If, after the required compliance
date, we are found to have violated these regulations, we could be subject to:  
    
    criminal or civil penalties, including significant fines; 22




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
    
    claims by people who believe their health information has been
improperly used or disclosed; and
    
    administrative penalties by payors. Government investigations of health care providers, including dialysis
providers, have continued to increase. We have been the subject of
investigations in the past, and the government may investigate our business in
the future. One of our competitors, DaVita, Inc., has announced that it is the
subject of an investigation by the U.S. Attorney for the Eastern District of
Pennsylvania. Another competitor, Gambro Healthcare, Inc., has announced that
it is the subject of an investigation by the U.S. Attorneys Office in St.
Louis, Missouri, and Gambro recently announced that it had reached an agreement
in principle to settle matters related to that investigation and to pay
approximately $355.0 million in connection with the settlement. If any of our
operations are found to violate applicable laws, then we may be subject to
severe sanctions, or we could be required to alter or discontinue the
challenged conduct or both. If we are required to alter our practices, we may
not be able to do so successfully. If any of these events occurs, our revenue
and earnings could decline. If our joint ventures are found to violate the law, our business could be
damaged. A number of the dialysis centers we operate are owned by joint ventures in
which we own a controlling interest and one or more physicians or physician
practice groups maintain a minority interest. The physician owners may also
provide medical director services to those centers or other centers we own and
operate. Because our relationships with physicians are governed by the
Anti-Kickback Statute, we have sought to satisfy as many safe harbor
requirements as possible in structuring these joint venture arrangements.
However, our joint venture arrangements do not satisfy all elements of a safe
harbor. Also, we believe we have structured the physician relationships in
these joint ventures in a way that meets applicable exceptions under the Stark
Law or that otherwise complies with the Stark Law. If the joint ventures were
found to be in violation of the Anti-Kickback Statute or the Stark Law, we
could be required to restructure them or refuse to accept referrals for
designated health services from the physicians with whom the joint venture
centers have a relationship. We also could be required to repay to Medicare
amounts received by the joint ventures pursuant to prohibited referrals, and we
could be subject to monetary penalties. If the joint venture centers are
subject to any of these penalties, our business could be damaged. Changes in the health care delivery, financing or reimbursement systems could
adversely affect our business. The health care industry in the United States may be entering a period of
change and uncertainty. Health care organizations, public or private, may
dramatically change the way they operate and pay for services. Our business is
designed to function within the current health care financing and reimbursement
system. During the past several years, the health care industry has been
subject to increasing levels of government regulation of, among other things,
reimbursement rates and relationships with referring physicians. In addition,
proposals to reform the health care system have been considered by Congress. In
light of the continued increases in the cost of health care and the current
economic weakness, there may be new proposals to change the health care system
and control costs. These proposals, if enacted, could further increase the
governments oversight role and involvement in health care, lower reimbursement
rates and otherwise change the operating environment for health care companies.
We cannot predict the likelihood of those events or what impact they may have
on our business. The dialysis business is highly competitive. If we do not compete effectively
in our markets, then we could lose market share and our rate of growth could
slow. The dialysis industry is largely consolidated, and the consolidation trend
continues as large providers acquire smaller providers. There is a small number
of large dialysis companies that compete for the acquisition of outpatient
dialysis centers and the development of relationships with referring
physicians. Two of our major competitors are part of larger companies that also
manufacture dialysis equipment, which allows them to benefit from lower
equipment costs. Several of our competitors, including these equipment
manufacturers, are larger than we are and have greater financial resources and
more established operations. We may also face competition from new entrants
into the market, including centers established by former medical directors or
other referring physicians. We cannot assure you that we will be able to
compete effectively with any of our competitors. 23




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If we are unable to make acquisitions in the future, then our rate of growth
will slow. Much of our historical growth has come from acquisitions. Although we
intend to continue to pursue growth through the acquisition of dialysis
centers, we may be unable to identify and complete suitable acquisitions at
prices we are willing to pay, or we may be unable to obtain the necessary
financing. Further, due to the increased size of our business, the amount that
acquired businesses contribute to our revenue and profits will continue to be
smaller on a percentage basis. Also, as a result of consolidation in the
dialysis industry, we believe the four largest providers of outpatient dialysis
services now own approximately 66% of the outpatient dialysis facilities in the
United States. We compete with these other companies to identify and complete
suitable acquisitions. We believe this competition has intensified in light of
the smaller pool of available acquisition candidates and other market forces.
As a result, we believe it will be more difficult for us to acquire suitable
companies on favorable terms. Further, the businesses we acquire may not
perform well enough to justify our investment. If we are unable to make
additional acquisitions on suitable terms, then we may not meet our growth
expectations. If we complete future acquisitions, we may dilute existing stockholders by
issuing more of our common stock or we may incur expenses related to debt and
goodwill, which could reduce our earnings. We may issue equity securities in future acquisitions that could be
dilutive to our shareholders. We also may incur additional debt in future
acquisitions. Interest expense on debt incurred to fund our acquisitions may
significantly reduce our profitability. While goodwill and other intangible
assets with indefinite lives are not amortized to expense under generally
accepted accounting principles, we are required to review all of these assets
at regular intervals for impairment and to charge an appropriate amount to
expense when we identify impairment. If we identify impairment and are required
to write off a significant portion of our intangible assets at one time, then
there could be a material adverse impact on our stock price. We may not have sufficient cash flow from our business to pay our substantial
debt. As of June 30, 2004, we had total consolidated debt of approximately
$511.5 million, including a $24.9 million fair value premium on the 9% senior
subordinated notes, and cash of approximately $44.2 million. Also, subject to
limitations, including those included in our credit facility and those
contained included in the indenture for the 9% senior subordinated notes we
assumed in the NNA acquisition, we are not and will not be prohibited from
incurring additional debt. Due to the large amount of our consolidated debt, we may not generate
enough cash from our operations to meet these obligations or to fund other
liquidity needs. Our ability to generate cash in the future is, to some
extent, subject to risks and uncertainties that are beyond our control. If we
are unable to meet our debt obligations, we may need to refinance all or a
portion of our indebtedness, sell assets or raise funds in the capital markets.
However, we can not assure you that, if we are unable to pay our debt, we will
be able to refinance it, obtain additional equity capital or sell assets, in
each case on commercially reasonable terms, or at all, or otherwise to fund our
liquidity needs. If for any reason we are unable to meet our debt obligations, we would be
in default under the terms of the agreements governing our outstanding debt.
If such a default were to occur, the lenders under our credit facility could
elect to declare all amounts outstanding under the credit facility immediately
due and payable, and the lenders would not be obligated to continue to advance
funds under our credit facility. In addition, if such a default were to occur,
the 9% senior subordinated notes would become immediately due and payable. If
the amounts outstanding under these debt agreements are accelerated, we cannot
assure you that our assets will be sufficient to repay the money we owe to
banks and other debt holders. If a change of control occurs, we may have to spend a substantial amount of
cash or incur additional indebtedness to satisfy our obligation to repurchase
the notes we assumed in the NNA acquisition from holders who choose to tender
their notes pursuant to certain procedures in the indenture. Upon specified change of control events the holders of the 9% senior
subordinated notes we assumed in the NNA acquisition have the right to require
us to repurchase all or any part (equal to $1,000 or an integral multiple
thereof) of the notes they hold at an offer price in cash equal to 101% of the
aggregate principal amount of the notes plus accrued and unpaid interest
thereon, if any, to the date of purchase. When a change of control occurs, we
may 24




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not be able to pay the purchase price for all of the notes tendered for
repurchase. Our failure to purchase tendered notes would constitute an event
of default under the indenture governing the 9% senior subordinated notes,
which in turn would constitute a default under our credit facility. In
addition, the terms of our credit facility restrict our ability to purchase the
9% senior subordinated notes. Future credit agreements or other agreements
relating to debt may contain similar or more restrictive provisions. We may
not be able to secure the consent of our lenders to repurchase the 9% senior
subordinated notes or refinance the borrowings that prohibit us from
repurchasing the notes. If we do not obtain a consent or repay the borrowings,
we could not repurchase the notes. Alternatively, even if we are able to pay the purchase price for the notes
tendered for repurchase, we may have to use a substantial amount of cash to do
so, which will deplete our funds to meet our other cash obligations or cause us
to incur additional indebtedness to repurchase the notes. These repurchase requirements may also delay or make it harder for others
to obtain control of Renal Care Group. The large amount and terms of our outstanding debt may prevent us from taking
actions we would otherwise consider in our best interest. The indenture governing our 9% senior subordinated notes and our credit
facility contain numerous financial and operating covenants that limit our
ability to engage in activities such as:  
    
    incurring additional debt;
    
    acquiring and developing new dialysis centers;
    
    making investments;
    
    creating liens;
    
    creating restrictions on the ability of our subsidiaries to pay dividends or other amounts to us;
    
    disposing of assets;
    
    paying dividends on our capital stock;
    
    repurchasing our capital stock;
    
    engaging in transactions with our affiliates; or
    
    consolidating, merging or selling all or substantially all of our assets. Our credit facility also requires us to comply with financial covenants
including a net worth test, a leverage ratio test and a fixed charge coverage
ratio test. Our ability to comply with these covenants may be affected by
events beyond our control, including those described in this Risk Factors
section. A breach of any of the covenants contained in our credit facility or
our inability to comply with the required financial covenants could result in
an event of default, which would allow the lenders under our credit facility to
declare all borrowings outstanding to be due and payable, which would, in turn,
trigger an event of default under the indenture governing our 9% senior
subordinated notes. In addition, our lenders could require us to apply all of
our available cash to repay our borrowings or they could prevent us from making
debt service payments on our 9% senior subordinated notes. If the amounts
outstanding under our credit facility or these notes are accelerated, we cannot
assure you that our assets would be sufficient to repay in full the money we
owe the banks and our other debt holders. The large amount of our outstanding debt and the limitations our credit
facility impose on us could have adverse consequences, including:  
    
    we will have to use much of our cash flow for scheduled debt
service rather than for operations, future business opportunities or
other purposes, such as funding working capital and capital
expenditures;
    
    we may not be able to increase our borrowings under our credit
facility or obtain other debt financing 25




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for future working capital, capital expenditures, acquisitions or
other corporate purposes;
    
    we could be less able to take advantage of significant business
opportunities, including acquisitions or divestitures;
    
    it may be difficult for us to satisfy our obligations under our 9% senior subordinated notes;
    
    our vulnerability to general adverse economic and industry conditions could be increased; and
    
    we could be at a competitive disadvantage to competitors with less debt. If we fail to integrate acquired companies, then we will be less profitable. We have grown significantly by acquisitions of other dialysis providers
since our formation. We recently acquired NNA, Midwest Kidney Centers, and a
dialysis program in Des Moines, Iowa, and we intend to pursue acquisitions of
more dialysis businesses in the future. We are unable to predict the number and
size of any future acquisitions. We face significant challenges in integrating
an acquired companys management and other personnel, clinical operations, and
financial and operating systems with ours, often without the benefit of
continued services from key personnel of the acquired company. We face these
challenges particularly in larger acquisitions like the acquisition of NNA. We
may be unable to integrate the businesses we acquire successfully or to achieve
anticipated benefits from an acquisition in a timely manner, which could lead
to substantial costs and delays or other operational, technical or financial
problems, including diverting managements attention from our existing
business. Any of these results could damage our profitability and our prospects
for future growth. If acquired businesses have unknown liabilities, then we could be exposed to
liabilities that could harm our business and profitability. Businesses we acquire may have unknown or contingent liabilities,
including liabilities for failure to comply with health care laws. Although we
generally attempt to identify practices that may give rise to unknown or
contingent liabilities and conform them to our standards after the acquisition,
private plaintiffs or governmental agencies may still assert claims. Even
though we generally seek to obtain indemnification from the sellers of
businesses we buy, unknown and contingent liabilities may not be covered by
indemnification or may exceed contractual limits or the financial capacity of
the indemnifying party. If our costs of insurance and claims increase, then our earnings could
decrease. We currently maintain programs of general and professional liability
insurance and directors and officers insurance with significant deductible or
self-insured retention amounts on each claim. In addition, we generally
self-insure our employee health plan and workers compensation program, while
maintaining excess insurance for some very large claims. We have accepted
higher deductibles and self-insurance exposure in each of the last several
years to offset part of the increases in premiums for the programs. These
deductibles and premiums increased substantially in 2002 and 2003. The rate of
increase in deductibles and premiums has moderated somewhat in 2004, but there
have been increases, and there may be larger increases in the future. Our
earnings could be materially and adversely affected by any of the following:  
    
    further increases in premiums, deductibles and self-insurance retentions;
    
    increases in the number of liability claims against us or the cost of
settling or trying cases related to those claims; and
    
    an inability to obtain one or more types of insurance on acceptable terms. If our board of directors does not approve an acquisition or change in control,
then our shareholders may not realize the full value of their stock. Our certificate of incorporation and bylaws contain a number of provisions
that may delay, deter or inhibit a future acquisition or change in control that
is not first approved by our board of directors. This could occur even if our
shareholders receive an attractive offer for their shares or if a substantial
number or even a majority of our shareholders believe the takeover is in their
best interest. These provisions are intended to encourage any person 26




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interested in acquiring us to negotiate with and obtain approval from our
board of directors before pursuing a transaction. Provisions that could delay,
deter or inhibit a future acquisition or change in control include the
following:  
    
    a staggered board of directors that would require two annual meetings to replace
a majority of the board of directors;
    
    restrictions on calling special meetings at which an acquisition or change in
control might be brought to a vote of the shareholders;
    
    blank check preferred stock that may be issued by our board of directors without
shareholder approval and that may be substantially dilutive or contain
preferences or rights objectionable to an acquiror; and
    
    a poison pill that would substantially dilute the interest sought by an acquiror. These provisions could also discourage bids for our common stock at a
premium and cause the market price of our common stock to decline. Our stock price is volatile and as a result, the value of your investment may
go down for reasons unrelated to the performance of our business. Our common stock is traded on the New York Stock Exchange. The market
price of our common stock has been volatile, ranging from a low closing price
of $27.55 per share to a high closing price of $34.29 per share during the six
months ended June 30, 2004. The market price for our common stock could
fluctuate substantially based on a variety of factors, including the following:  
    
    future announcements concerning us, our competitors or the health care market;
    
    the threat of litigation or government investigation;
    
    changes in government regulations; and
    
    changes in earnings estimates by analysts. Furthermore, stock prices for many companies fluctuate widely for reasons
that may be unrelated to their operating results. These fluctuations, coupled
with changes in demand or reimbursement levels for our services and general
economic, political and market conditions, could cause the market price of our
common stock to decline. Forward-Looking Statements Some of the information in this quarterly report on Form 10-Q represents
forward-looking statements that involve substantial risks and uncertainties.
You can identify these statements by forward-looking words such as may,
will, expect, anticipate, believe, intend, estimate and continue
or similar words. You should read statements that contain these words carefully
for the following reasons:  
    
    the statements discuss our future expectations;
    
    the statements contain projections of our future earnings or of our financial condition; and
    
    the statements state other forward-looking information. We believe it is important to communicate our expectations to our
investors. There may, however, be events in the future that we are not able to
predict accurately or over which we have no control. The risk factors listed
above, as well as any cautionary language in or incorporated by reference into
this quarterly report on Form 10-Q, provide examples of risks, uncertainties
and events that may cause our actual results to differ materially from the
expectations we describe in our forward-looking statements. The SEC allows us
to incorporate by reference the information we file with them, which means we
can disclose important information to you by referring you to those documents.
Before 27




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you invest in our common stock, you should be aware that the occurrence of any
of the events described in the above risk factors, elsewhere in or incorporated
by reference into this quarterly report on Form 10-Q and other events that we
have not predicted or assessed could have a material adverse effect on our
earnings, financial condition and business. If the events described above or
other unpredicted events occur, then the trading price of our common stock
could decline and you may lose all or part of your investment. 
 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The following discusses our exposure to market risk related to changes in
interest rates. Cash balances We maintain all cash in United States dollars in highly liquid,
interest-bearing, investment grade instruments with maturities of less than
three months, which we consider cash equivalents; therefore, the Company has no
market risk sensitive instruments. Outstanding debt As of June 30, 2004, we had outstanding debt of $511.5 million, including
a $24.9 million fair value premium on the 9% senior subordinated notes. This
debt consisted of $320.9 million outstanding under the term facility in our
2004 credit agreement, $184.6 million of indebtedness relating to the 9% senior
subordinated notes due 2011 and approximately $5.9 million outstanding under
various capital leases and notes payable. Borrowings of $170.9 million under
the term loan bear interest at variable rates based on LIBOR rates or the prime
rate that are determined by our leverage ratio. The remaining $150.0 million
under the term loan are fixed at a rate of 3.5% plus an additional
spread based on the Companys leverage ratio under interest rate
swap agreements that became effective on June 30, 2004. Our weighted average
borrowing rate under the term loan as of June 30, 2004, was 2.7%. We expect
this rate to rise in the future as the swap agreements take effect in the third
quarter of 2004 and if interest rates rise on the portion that bears interest at
floating rates. Outstanding senior subordinated notes bear nominal interest at
9% on the outstanding $159.7 million face amount of the notes.
The unamortized $24.9 million fair value premium is being
recognized over the
life of the notes using the effective interest method and is recorded
as a reduction to interest expense. Accordingly, the effective
interest rate on the notes as of June 30, 2004 was 6.4%. At June 30, 2004,
the fair value of our indebtedness under the credit facility and senior
subordinated notes approximated carrying value. At the June 30, 2004 borrowing
levels and excluding the impact of our interest rate swap agreements, if there
had been a 1% increase in the variable interest rates, then our pre-tax income
would have decreased by approximately $787,000 for the three months ended June 30,
2004. 
 ITEM 4. CONTROLS AND PROCEDURES Evaluation of Disclosure Controls and Procedures (a) Our chief executive officer and chief financial officer evaluated our
disclosure controls and procedures as of the end of the period covered by this
report. Based on that evaluation, the chief executive officer and chief
financial officer have concluded that as of the end of the period covered by
this report Renal Care Group maintains disclosure controls and procedures that
provide reasonable assurance that information required to be disclosed in our
reports under the Exchange Act is recorded, processed, summarized and reported
within the periods specified in the SECs rules and forms. (b) There have been no changes in our internal control over financial
reporting during the period covered by this report that have materially
affected, or are reasonably likely materially to affect, our internal control
over financial reporting. 28




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PART II  OTHER INFORMATION 
 ITEM 2. CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY SECURITIES During the quarter ended June 30, 2004, we purchased shares of our common
stock as part of a publicly announced program as follows: Number ofSharesPurchased as
    
    ApproximatePart of
    
    Dollar Value ofPublicly
    
    Shares that MayTotal Number
    
    Average Price
    
    Announced
    
    Yet Be Purchasedof Shares
    
    Paid per
    
    Plans or
    
    Under the Plans orPeriod
    
    Purchased
    
    Share
    
    Programs
    
    ProgramsApril 1, 2004 to
April 30, 2004
    
    
    72,000
    
    
    $
    30.65
    
    
    
    72,000
    
    
    $
    77,750,722May 1, 2004 to
May 31, 2004
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    77,750,722June 1, 2004 to
June 30, 2004
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    77,750,722Total
    
    
    72,000
    
    
    $
    30.65
    
    
    
    72,000
 The Registrants share repurchase program was originally announced on October
2, 2000, and was amended by announcements on July 9, 2002, November 18, 2002,
August 12, 2003 and October 28, 2003. The program permits repurchases of up to
$450.0 million of common stock. The program expires December 31, 2004. No
share repurchase plan or program expired during the period covered by this
quarterly report. The Companys certificate of incorporation was amended to increase the number
of authorized shares of common stock from 90,000,000 to 150,000,000. 
 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS On June 9, 2004, the Company held its annual meeting of shareholders in
Nashville, Tennessee for the following purposes and with the following results:  1.
    
    To elect Joseph C. Hutts, Harry R. Jacobson, M.D. and Thomas A. Lowery,
M.D. as Class II Directors, each to serve for a term of three years and
until his successor is elected: FOR
    
    ABSTAINElection of Joseph C. Hutts
    
    
    30,920,029
    
    
    
    2,007,007Election of Harry R. Jacobson, M.D
    
    
    30,660,310
    
    
    
    2,266,726Election of Thomas A. Lowery, M.D.
    
    
    31,831,868
    
    
    
    1,095,168
 Directors whose terms continued following the meeting but who were not subject
to election at the meeting are: Gary A. Brukardt, Peter J. Grua, William P.
Johnston, William V. Lapham, Stephen D. McMurray, M.D. and C. Thomas Smith. 29




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2.
    
    To approve the Renal Care Group, Inc. 2004 Stock and Incentive
Compensation Plan (the 2004 Incentive Plan): FOR
    
    AGAINST
    
    ABSTAIN16,805,820
    
    
    12,183,672
    
    
    
    63,391
  3.
    
    To approve an amendment to the Renal Care Group, Inc. 1996 Stock Option
Plan for Outside Directors (the Directors Plan) to allow the grant of
options to directors who are medical directors and the Chairman or Vice
Chairman of the board of directors, if such director is not also an
employee of the company: FOR
    
    AGAINST
    
    ABSTAIN24,277,424
    
    
    4,710,600
    
    
    
    64,859
  4.
    
    To approve an amendment to our Certificate of Incorporation to increase
the number of authorized shares of $0.01 par value common stock from
90,000,000 shares to 150,000,000 shares: FOR
    
    AGAINST
    
    ABSTAIN29,601,143
    
    
    3,273,371
    
    
    
    52,522
 
 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a)
    
    
    Exhibits:31.1
    
    
    Certification pursuant to Rule 13a-14(a)/15d-14(a), as adopted
pursuant to Section 302 of the Sarbanes-Oxley Act of 200231.2
    
    
    Certification pursuant to Rule 13a-14(a)/15d-14(a), as adopted
pursuant to Section 302 of the Sarbanes-Oxley Act of 200232.1*
    
    
    Certification pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 200232.2*
    
    
    Certification pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002* In accordance with Release No. 34-47551, this exhibit is
furnished to the SEC as an accompanying document. It is not
deemed to be filed for purposes of Section 18 of the
Securities Exchange Act of 1934 or otherwise subject to the
liabilities of that Section, and it shall not be deemed
incorporated by reference into any filing under the Securities
Act of 1933.(b)
    
    
    Reports on Form 8-KForm 8-K filed April 16, 2004Form 8-K filed April 19, 2004Form 8-K/A filed April 19, 2004Form 8-K filed April 28, 2004Form 8-K filed April 30, 2004Form 8-K/A filed May 7, 2004Form 8-K filed June 9, 2004Form 8-K/A filed June 9, 2004
 30




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SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized. RENAL CARE GROUP, INC. (Registrant)August 9, 2004
    BY:   /s/ David M. DillDavid M. DillExecutive Vice President,

Chief Financial Officer (Principal Financial Officer

and Principal Accounting Officer) 31




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RENAL CARE GROUP, INC. 
 EXHIBIT INDEX Number andDescription of Exhibit31.1
    
    Certification pursuant to Rule
13a-14(a)/15d-14(a), as adopted
pursuant to Section 302 of the
Sarbanes-Oxley Act of 200231.2
    
    Certification pursuant to Rule
13a-14(a)/15d-14(a), as adopted
pursuant to Section 302 of the
Sarbanes-Oxley Act of 200232.1*
    
    Certification pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley
Act of 200232.2*
    
    Certification pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley
Act of 2002
 * In accordance with Release No. 34-47551, this exhibit is furnished to the SEC
as an accompanying document. It is not deemed to be filed for purposes of
Section 18 of the Securities Exchange Act of 1934 or otherwise subject to the
liabilities of that Section, and it shall not be deemed incorporated by
reference into any filing under the Securities Act of 1933. 32