XNYS:DVA DaVita HealthCare Partners Inc Quarterly Report 10-Q Filing - 3/31/2012

Effective Date 3/31/2012

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Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

For the Quarterly Period Ended

March 31, 2012

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

Commission File Number: 1-14106

 

 

DAVITA INC.

 

 

1551 Wewatta Street

Denver, CO 80202

Telephone number (303) 405-2100

 

Delaware   51-0354549
(State of incorporation)   (I.R.S. Employer Identification No.)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer   x    Accelerated filer   ¨
Non-accelerated filer   ¨  (Do not check if a smaller reporting company)    Smaller reporting company   ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

As of April 27, 2012, the number of shares of the Registrant’s common stock outstanding was approximately 94.0 million shares and the aggregate market value of the common stock outstanding held by non-affiliates based upon the closing price of these shares on the New York Stock Exchange was approximately $8.4 billion.

 

 

 


Table of Contents

DAVITA INC.

INDEX

 

            Page No.      
  PART I. FINANCIAL INFORMATION  

Item 1.

 

Condensed Consolidated Financial Statements:

 
 

Consolidated Statements of Income for the three months ended March 31, 2012 and March 31, 2011

    1   
 

Consolidated Statements of Comprehensive Income for the three months ended March 31, 2012 and March  31, 2011

    2   
 

Consolidated Balance Sheets as of March 31, 2012 and December 31, 2011

    3   
 

Consolidated Statements of Cash Flows for the three months ended March 31, 2012 and March 31, 2011

    4   
 

Consolidated Statements of Equity for the three months ended March 31, 2012 and for the year ended December 31, 2011

    5   
 

Notes to Condensed Consolidated Financial Statements

    6   

Item 2.

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

    27   

Item 3.

 

Quantitative and Qualitative Disclosures about Market Risk

    38   

Item 4.

 

Controls and Procedures

    39   
  PART II. OTHER INFORMATION  

Item 1.

 

Legal Proceedings

    41   

Item 1A.

 

Risk Factors

    41   

Item 2.

 

Unregistered Sales of Equity Securities and Use of Proceeds

    57   

Item 6.

 

Exhibits

    58   
  Signature     59   

 

Note: Items 3, 4 and 5 of Part II are omitted because they are not applicable.

 

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Table of Contents

DAVITA INC.

CONSOLIDATED STATEMENTS OF INCOME

(unaudited)

(dollars in thousands, except per share data)

 

    Three months ended March 31,  
              2012                          2011             

Patient service operating revenues

  $ 1,763,700      $ 1,497,434   

Less: Provision for uncollectible accounts related to patient service operating revenues

    (53,008     (41,071
 

 

 

   

 

 

 

Net patient service operating revenues

    1,710,692        1,456,363   

Other revenues

    155,943        105,950   
 

 

 

   

 

 

 

Total net operating revenues

    1,866,635        1,562,313   
 

 

 

   

 

 

 

Operating expenses and charges:

   

Patient care costs

    1,263,159        1,114,086   

General and administrative

    207,389        151,602   

Depreciation and amortization

    75,975        61,838   

Provision for uncollectible accounts

    2,024        972   

Equity investment income

    (2,632     (1,519
 

 

 

   

 

 

 

Total operating expenses and charges

    1,545,915        1,326,979   
 

 

 

   

 

 

 

Operating income

    320,720        235,334   

Debt expense

    (61,381     (58,595

Other income

    1,039        841   
 

 

 

   

 

 

 

Income from continuing operations before income taxes

    260,378        177,580   

Income tax expense

    95,495        62,959   
 

 

 

   

 

 

 

Income from continuing operations

    164,883        114,621   

Discontinued operations:

   

Income from operations of discontinued operations, net of tax

    —          131   
 

 

 

   

 

 

 

Net income.

    164,883        114,752   

Less: Net income attributable to noncontrolling interests

    (24,763     (20,250
 

 

 

   

 

 

 

Net income attributable to DaVita Inc.

  $ 140,120      $ 94,502   
 

 

 

   

 

 

 

Earnings per share:

   

Basic income from continuing operations per share attributable to DaVita Inc.

  $ 1.49      $ 0.98   
 

 

 

   

 

 

 

Basic net income per share attributable to DaVita Inc.

  $ 1.49      $ 0.98   
 

 

 

   

 

 

 

Diluted income from continuing operations per share attributable to DaVita Inc.

  $ 1.46      $ 0.96   
 

 

 

   

 

 

 

Diluted net income per share attributable to DaVita Inc.

  $ 1.46      $ 0.96   
 

 

 

   

 

 

 

Weighted average shares for earnings per share:

   

Basic

    93,769,092        96,263,802   
 

 

 

   

 

 

 

Diluted

    95,729,105        98,378,371   
 

 

 

   

 

 

 

Amounts attributable to DaVita Inc.:

   

Income from continuing operations

  $ 140,120      $ 94,371   

Discontinued operations

    —          131   
 

 

 

   

 

 

 

Net income

  $ 140,120      $ 94,502   
 

 

 

   

 

 

 

See notes to condensed consolidated financial statements.

 

1


Table of Contents

DAVITA INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(unaudited)

(dollars in thousands, except per share data)

 

    Three months ended March 31,  
              2012                          2011             

Net income

  $ 164,883      $ 114,752   
 

 

 

   

 

 

 

Other comprehensive income (loss), net of tax:

   

Unrealized losses on interest rate swap and cap agreements:

   

Unrealized losses on interest rate swap and cap agreements

    (2,261     (4,134

Less: Reclassifications of net swap and cap agreements realized losses into net income

    2,520        1,743   

Unrealized gains on investments:

   

Unrealized gains on investments

    1,146        268   

Less: Reclassification of net investment realized gains into net income

    (75     (57

Foreign currency translation adjustments

    (619     —     
 

 

 

   

 

 

 

Other comprehensive income (loss)

    711        (2,180
 

 

 

   

 

 

 

Total comprehensive income

    165,594        112,572   

Less: Comprehensive income attributable to the noncontrolling interest

    (24,763     (20,250
 

 

 

   

 

 

 

Comprehensive income attributable to DaVita Inc.

    140,831      $ 92,322   
 

 

 

   

 

 

 

See notes to condensed consolidated financial statements.

 

2


Table of Contents

DAVITA INC.

CONSOLIDATED BALANCE SHEETS

(unaudited)

(dollars in thousands, except per share data)

 

     March 31,
2012
    December 31,
2011
 
ASSETS     

Cash and cash equivalents

   $ 449,290      $ 393,752   

Short-term investments

     8,616        17,399   

Accounts receivable, less allowance of $289,238 and $250,343

     1,266,869        1,195,163   

Inventories

     72,285        75,731   

Other receivables

     216,493        269,832   

Other current assets

     47,492        49,349   

Deferred income taxes

     313,355        280,382   
  

 

 

   

 

 

 

Total current assets

     2,374,400        2,281,608   

Property and equipment, net

     1,490,572        1,432,651   

Amortizable intangibles, net

     160,617        159,491   

Equity investments

     26,956        27,325   

Long-term investments

     9,897        9,890   

Other long-term assets

     30,065        34,231   

Goodwill

     5,064,577        4,946,976   
  

 

 

   

 

 

 
   $ 9,157,084      $ 8,892,172   
  

 

 

   

 

 

 
LIABILITIES AND EQUITY     

Accounts payable

   $ 269,029      $ 289,653   

Other liabilities

     347,096        325,734   

Accrued compensation and benefits

     455,825        412,972   

Current portion of long-term debt

     89,646        87,345   

Income tax payable

     80,519        37,412   
  

 

 

   

 

 

 

Total current liabilities

     1,242,115        1,153,116   

Long-term debt

     4,401,865        4,417,624   

Other long-term liabilities

     139,656        132,006   

Alliance and product supply agreement, net

     18,655        19,987   

Deferred income taxes

     448,372        423,098   
  

 

 

   

 

 

 

Total liabilities

     6,250,663        6,145,831   

Commitments and contingencies

    

Noncontrolling interests subject to put provisions

     504,491        478,216   

Equity:

    

Preferred stock ($0.001 par value, 5,000,000 shares authorized; none issued)

    

Common stock ($0.001 par value, 450,000,000 shares authorized; 134,862,283 shares issued; 93,983,930 and 93,641,363 shares outstanding)

     135        135   

Additional paid-in capital

     575,364        596,300   

Retained earnings

     3,335,938        3,195,818   

Treasury stock, at cost (40,878,353 and 41,220,920 shares)

     (1,618,134     (1,631,694

Accumulated other comprehensive loss

     (18,773     (19,484
  

 

 

   

 

 

 

Total DaVita Inc. shareholders’ equity

     2,274,530        2,141,075   

Noncontrolling interests not subject to put provisions

     127,400        127,050   
  

 

 

   

 

 

 

Total equity

     2,401,930        2,268,125   
  

 

 

   

 

 

 
   $ 9,157,084      $ 8,892,172   
  

 

 

   

 

 

 

See notes to condensed consolidated financial statements.

 

3


Table of Contents

DAVITA INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)

(dollars in thousands)

 

     Three months ended
March 31,
 
     2012     2011  

Cash flows from operating activities:

    

Net income

   $ 164,883      $ 114,752   

Adjustments to reconcile net income to cash provided by operating activities:

    

Depreciation and amortization

     75,975        62,037   

Stock-based compensation expense

     12,550        9,716   

Tax benefits from stock award exercises

     10,890        13,868   

Excess tax benefits from stock award exercises

     (6,101     (7,196

Deferred income taxes

     (13,335     18,221   

Equity investment income, net

     483        1,420   

Loss on disposal of assets and other non-cash charges

     7,125        5,506   

Changes in operating assets and liabilities, other than from acquisitions and divestitures:

    

Accounts receivable

     (71,706     (20,461

Inventories

     4,851        7,429   

Other receivables and other current assets

     56,452        24,922   

Other long-term assets

     3,742        990   

Accounts payable

     (20,624     26,565   

Accrued compensation and benefits

     41,623        31,542   

Other current liabilities

     17,462        9,483   

Income taxes

     43,072        29,878   

Other long-term liabilities

     4,532        1,111   
  

 

 

   

 

 

 

Net cash provided by operating activities

     331,874        329,783   
  

 

 

   

 

 

 

Cash flows from investing activities:

    

Additions of property and equipment, net

     (112,459     (67,530

Acquisitions

     (132,699     (81,523

Proceeds from asset sales

     825        2,812   

Purchase of investments available for sale

     (489     (298

Purchase of investments held-to-maturity

     (3,212     (15,161

Proceeds from sale of investments available for sale

     6,791        1,149   

Proceeds from maturities of investments held-to-maturity

     7,551        15,163   

Distributions received on equity investments

     2        —     
  

 

 

   

 

 

 

Net cash used in investing activities

     (233,690     (145,388
  

 

 

   

 

 

 

Cash flows from financing activities:

    

Borrowings

     8,634,603        10,983,125   

Payments on long-term debt

     (8,658,001     (11,000,635

Interest rate cap premiums and other deferred financing costs

     3        (13,399

Distributions to noncontrolling interests

     (26,405     (22,187

Stock award exercises and other share issuances, net

     1,663        3,410   

Excess tax benefits from stock award exercises

     6,101        7,196   

Contributions from noncontrolling interests

     3,651        3,959   

Proceeds from sales of additional noncontrolling interests

     100        785   

Purchases from noncontrolling interests

     (4,372     (756
  

 

 

   

 

 

 

Net cash used in financing activities

     (42,657     (38,502

Effect of exchange rate changes on cash and cash equivalents

     11        —     
  

 

 

   

 

 

 

Net increase in cash and cash equivalents

     55,538        145,893   

Cash and cash equivalents at beginning of period

     393,752        860,117   
  

 

 

   

 

 

 

Cash and cash equivalents at end of period

   $ 449,290      $ 1,006,010   
  

 

 

   

 

 

 

See notes to condensed consolidated financial statements.

 

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Table of Contents

DAVITA INC.

CONSOLIDATED STATEMENTS OF EQUITY

(unaudited)

(dollars and shares in thousands)

 

    Non-
controlling
interests
subject to
put
provisions
    DaVita Inc. Shareholders’ Equity     Non-
controlling
interests
not
subject to
put
provisions
 
      Common stock     Additional
paid-in
capital
    Retained
earnings
    Treasury stock     Accumulated
other
comprehensive
income (loss)
    Total    

Balance at December 31, 2010

  $ 383,052        134,862      $ 135      $ 620,546      $ 2,717,817        (38,861   $ (1,360,579   $ 503      $ 1,978,422      $ 58,712   

Comprehensive income:

                   

Net income

    59,135              478,001              478,001        36,259   

Other comprehensive loss

                  (19,987     (19,987  

Stock purchase shares issued

          4,268          175        6,554          10,822     

Stock unit shares issued

          (2,866       78        2,866          —       

Stock options and SSARs exercised

          (37,370       1,182        42,813          5,443     

Stock-based compensation expense

          48,718                48,718     

Excess tax benefits from stock awards exercised

          20,834                20,834     

Distributions to noncontrolling interests

    (61,343                     (39,310

Contributions from noncontrolling interests

    12,547                        8,463   

Sales and assumptions of additional noncontrolling interests

    49,343            (1,299             (1,299     55,566   

Purchases from noncontrolling interests

    (2,103         (9,486             (9,486     (2,100

Changes in fair value of noncontrolling interests

    63,762            (63,762             (63,762  

Expired put provision

    (26,177         16,717                16,717        9,460   

Purchase of treasury stock

              (3,795     (323,348       (323,348  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at December 31, 2011

  $ 478,216        134,862      $ 135      $ 596,300      $ 3,195,818        (41,221   $ (1,631,694   $ (19,484   $ 2,141,075      $ 127,050   

Comprehensive income:

                   

Net income

    15,775              140,120              140,120        8,988   

Other comprehensive income

                  711        711     

Stock unit shares issued

          (1,095       28        1,095         

Stock options and SSARs exercised

          (11,074       315        12,465          1,391     

Stock-based compensation expense

          12,550                12,550     

Excess tax benefits from stock awards exercised

          6,101                6,101     

Distributions to noncontrolling interests

    (15,394                     (11,011

Contributions from noncontrolling interests

    2,843                        808   

Sales and assumptions of additional noncontrolling interests

    —              5                5        1,565   

Purchases from noncontrolling interests

    (3,475         (897             (897  

Changes in fair value of noncontrolling interests

    26,526            (26,526             (26,526  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at March 31, 2012

  $ 504,491        134,862      $ 135      $ 575,364      $ 3,335,938        (40,878   $ (1,618,134   $ (18,773   $ 2,274,530      $ 127,400   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

See notes to condensed consolidated financial statements.

 

5


Table of Contents

DAVITA INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

(dollars and shares in thousands, except per share data)

Unless otherwise indicated in this Quarterly Report on Form 10-Q “the Company”, “we”, “us”, “our” and similar terms refer to DaVita Inc. and its consolidated subsidiaries.

1. Condensed consolidated interim financial statements

The condensed consolidated interim financial statements included in this report are prepared by the Company without audit. In the opinion of management, all adjustments consisting only of normal recurring items necessary for a fair presentation of the results of operations are reflected in these consolidated interim financial statements. All significant intercompany accounts and transactions have been eliminated. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. The most significant estimates and assumptions underlying these financial statements and accompanying notes generally involve revenues recognition and provisions for uncollectible accounts, impairments and valuation adjustments, fair value estimates, accounting for income taxes, variable compensation accruals, purchase accounting valuation estimates and stock-based compensation. The results of operations for the three months ended March 31, 2012 are not necessarily indicative of the operating results for the full year. The consolidated interim financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011. Prior year balances and amounts have been classified to conform to the current year presentation. The Company has evaluated subsequent events through the date these condensed consolidated financial statements were issued and has included all necessary disclosures.

 

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Table of Contents

DAVITA INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (continued)

(unaudited)

(dollars and shares in thousands, except per share data)

 

2. Earnings per share

Basic net income per share is calculated by dividing net income attributable to DaVita Inc., net of the decrease in noncontrolling interest redemption rights in excess of fair value, by the weighted average number of common shares and vested stock units outstanding. Diluted net income per share includes the dilutive effect of outstanding stock-settled stock appreciation rights, stock options and unvested stock units (under the treasury stock method).

The reconciliations of the numerators and denominators used to calculate basic and diluted earnings per share are as follows:

 

     Three months ended
March 31,
 
     2012      2011  

Basic:

     

Income from continuing operations attributable to DaVita Inc.

   $ 140,120       $ 94,371   

Decrease in noncontrolling interest redemption rights in excess of fair value

     —           27   
  

 

 

    

 

 

 

Income from continuing operations for basic earnings per share calculation

   $ 140,120       $ 94,398   

Discontinued operations attributable to DaVita Inc.

     —           131   
  

 

 

    

 

 

 

Net income attributable to DaVita Inc. for basic earnings per share calculation

   $ 140,120       $ 94,529   
  

 

 

    

 

 

 

Weighted average shares outstanding during the period

     93,766         96,258   

Vested stock units

     3         6   
  

 

 

    

 

 

 

Weighted average shares for basic earnings per share calculation

     93,769         96,264   
  

 

 

    

 

 

 

Basic income from continuing operations per share attributable to DaVita Inc.

   $ 1.49       $ 0.98   
  

 

 

    

 

 

 

Basic net income per share attributable to DaVita Inc.

   $ 1.49       $ 0.98   
  

 

 

    

 

 

 

Diluted:

     

Income from continuing operations attributable to DaVita Inc.

   $ 140,120       $ 94,371   

Decrease in noncontrolling interest redemption rights in excess of fair value

     —           27   
  

 

 

    

 

 

 

Income from continuing operations for diluted earnings per share calculation

   $ 140,120       $ 94,398   

Discontinued operations attributable to DaVita Inc.

     —           131   
  

 

 

    

 

 

 

Net income attributable to DaVita Inc. for diluted earnings per share calculation

   $ 140,120       $ 94,529   
  

 

 

    

 

 

 

Weighted average shares outstanding during the period

     93,766         96,258   

Vested stock units

     3         6   

Assumed incremental shares from stock plans

     1,960         2,114   
  

 

 

    

 

 

 

Weighted average shares for diluted earnings per share calculation

     95,729         98,378   
  

 

 

    

 

 

 

Diluted income from continuing operations per share attributable to DaVita Inc.

   $ 1.46       $ 0.96   
  

 

 

    

 

 

 

Diluted net income per share attributable to DaVita Inc.

   $ 1.46       $ 0.96   
  

 

 

    

 

 

 

Anti-dilutive stock-settled awards excluded from calculation (1)

     2,309         558   
  

 

 

    

 

 

 

 

(1) 

Shares associated with stock-settled stock appreciation rights and stock options that are excluded from the diluted denominator calculation because they are anti-dilutive under the treasury stock method.

 

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DAVITA INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (continued)

(unaudited)

(dollars and shares in thousands, except per share data)

 

3. Stock-based compensation and other common stock transactions

Stock-based compensation recognized in a period represents the amortization during that period of the estimated grant-date fair value of current and prior stock-based awards over their vesting terms, adjusted for expected forfeitures. Shares issued upon exercise of stock awards are generally issued from shares in treasury. The Company has used the Black-Scholes-Merton valuation model for estimating the grant-date fair value of stock-settled stock appreciation rights granted in all periods. During the three months ended March 31, 2012, the Company granted 100 stock-settled stock appreciation rights with an aggregate grant-date fair value of $1,916 and a weighted-average expected life of approximately 3.5 years, and also granted 8 stock units with an aggregate grant-date fair value of $672 and a weighted-average expected life of approximately 2.0 years.

For the three months ended March 31, 2012 and 2011, the Company recognized $12,550 and $9,716, respectively, in stock-based compensation expense for stock appreciation rights, stock units and discounted employee stock plan purchases, which are primarily included in general and administrative expenses. The estimated tax benefits recorded for stock-based compensation through March 31, 2012 and 2011 was $4,723 and $3,673, respectively. As of March 31, 2012, there was $82,358 of total estimated unrecognized compensation cost related to nonvested stock-based compensation arrangements under the Company’s equity compensation and stock purchase plans. The Company expects to recognize this cost over a weighted average remaining period of 1.4 years.

During the three months ended March 31, 2012 and 2011, the Company received $1,391 and $2,244, respectively, in cash proceeds from stock option exercises and $10,890 and $13,868, respectively, in actual tax benefits upon the exercise of stock awards.

4. Long-term debt

Long-term debt was comprised of the following:

 

     March 31,
2012
    December 31,
2011
 

Senior Secured Credit Facilities:

    

Term Loan A

   $ 937,500      $ 950,000   

Term Loan A-2

     199,000        199,500   

Term Loan B

     1,728,125        1,732,500   

Senior notes

     1,550,000        1,550,000   

Acquisition obligations and other notes payable

     32,209        37,447   

Capital lease obligations

     52,104        43,364   
  

 

 

   

 

 

 

Total debt principal outstanding

     4,498,938        4,512,811   

Discount on long-term debt

     (7,427     (7,842
  

 

 

   

 

 

 
     4,491,511        4,504,969   

Less current portion

     (89,646     (87,345
  

 

 

   

 

 

 
   $     4,401,865      $     4,417,624   
  

 

 

   

 

 

 

 

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Table of Contents

DAVITA INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (continued)

(unaudited)

(dollars and shares in thousands, except per share data)

 

Scheduled maturities of long-term debt at March 31, 2012 were as follows:

 

2012 (remainder of the year)

     58,189   

2013

     126,747   

2014

     178,987   

2015

     678,555   

2016

     1,861,859   

2017

     6,098   

Thereafter

     1,588,503   

During the first three months of 2012, the Company made mandatory principal payments under its Senior Secured Credit Facilities totaling $12,500 on the Term Loan A, $500 on the Term Loan A-2 and $4,375 on the Term Loan B.

The Company has entered into several interest rate swap agreements as a means of hedging its exposure to and volatility from variable-based interest rate changes as part of its overall risk management strategy. These agreements are not held for trading or speculative purposes and have the economic effect of converting the LIBOR variable component of the Company’s interest rate to a fixed rate. These swap agreements are designated as cash flow hedges, and as a result, hedge-effective gains or losses resulting from changes in the fair values of these swaps are reported in other comprehensive income until such time as each specific swap tranche is realized, at which time the amounts are reclassified into net income. Net amounts paid or received for each specific swap tranche that have settled have been reflected as adjustments to debt expense. In addition, the Company has entered into several interest rate cap agreements that have the economic effect of capping the Company’s maximum exposure to LIBOR variable interest rate changes on specific portions of the Company’s Term Loan B debt, as described below. These cap agreements are also designated as cash flow hedges and as a result changes in the fair values of these cap agreements are reported in other comprehensive income. The amortization of the original cap premium is recognized as a component of debt expense on a straight line basis over the term on the cap agreements. The swap and cap agreements do not contain credit-risk contingent features.

As of March 31, 2012, the Company maintained a total of nine interest rate swap agreements with amortizing notional amounts totaling $937,500. These agreements had the economic effect of modifying the LIBOR variable component of the Company’s interest rate on an equivalent amount of the Company’s Term Loan A to fixed rates ranging from 1.59% to 1.64%, resulting in an overall weighted average effective interest rate of 4.11%, including the Term Loan A margin of 2.50%. The swap agreements expire by September 30, 2014 and require monthly interest payments. The Company estimates that approximately $11,900 of existing unrealized pre-tax losses in other comprehensive income at March 31, 2012 will be reclassified into income over the next twelve months.

As of March 31, 2012, the Company maintained five interest rate cap agreements with notional amounts totaling $1,250,000. These agreements have the economic effect of capping the LIBOR variable component of the Company’s interest rate at a maximum of 4.00% on an equivalent amount of the Company’s Term Loan B debt. The cap agreements expire on September 30, 2014.

 

9


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DAVITA INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (continued)

(unaudited)

(dollars and shares in thousands, except per share data)

 

The following table summarizes the Company’s derivative instruments as of March 31, 2012 and December 31, 2011:

 

     March 31, 2012      December 31, 2011  

Derivatives designated as hedging
instruments

   Balance sheet
location
   Fair value      Balance sheet
location
   Fair value  

Interest rate swap agreements

   Other long-
term liabilities
   $     23,196       Other long-
term liabilities
   $     23,145   
     

 

 

       

 

 

 

Interest rate cap agreements

   Other long-
term assets
   $ 958       Other long-
term assets
   $ 1,381   
     

 

 

       

 

 

 

The following table summarizes the effects of the Company’s interest rate swap and cap agreements for the three months ended March 31, 2012 and 2011:

 

    Amount of gains
(losses)  recognized in
OCI on interest rate swap
and cap agreements
    Location of
gains (losses)
reclassified
from
accumulated
OCI into income
  Amount of gains
(losses) reclassified
from accumulated
OCI into  income
 
    Three months ended
March 31,
      Three months ended
March 31,
 

Derivatives designated as cash flow hedges

        2012                 2011                   2012                 2011        

Interest rate swap agreements

  $ (3,276   $ (3,200   Debt expense   $ (3,225   $ (2,254

Interest rate cap agreements

    (424     (3,564   Debt expense     (897     (598

Tax benefit

    1,439        2,630          1,602        1,109   
 

 

 

   

 

 

     

 

 

   

 

 

 

Total

  $ (2,261   $ (4,134     $ (2,520   $ (1,743
 

 

 

   

 

 

     

 

 

   

 

 

 

As of March 31, 2012, interest rates on the Company’s Term Loan A-2 and Term Loan B debt are set at their interest rate floors. Interest rates on the Company’s senior notes and Term Loan A are fixed and economically fixed, respectively, while rates on $1,250,000 of the Company’s Term Loan B is subject to interest rate caps.

As a result of the swap and cap agreements, the Company’s overall weighted average effective interest rate on the Senior Secured Credit Facilities was 4.63%, based upon the current margins in effect of 2.50% for the Term loan A, 3.50% for the Term Loan A-2 and 3.00% for the Term Loan B, as of March 31, 2012.

The Company’s overall weighted average effective interest rate during the first quarter of 2012 was 5.27% and as of March 31, 2012 was 5.28%.

As of March 31, 2012, the Company had undrawn revolving credit facilities totaling $350,000 of which approximately $52,297 was committed for outstanding letters of credit.

5. Contingencies

The majority of the Company’s revenues are from government programs and may be subject to adjustment as a result of: (1) examination by government agencies or contractors, for which the resolution of any matters raised may take extended periods of time to finalize; (2) differing interpretations of government regulations by different Medicare contractors or regulatory authorities; (3) differing opinions regarding a patient’s medical diagnosis or the medical necessity of services provided; and (4) retroactive applications or interpretations of

 

10


Table of Contents

DAVITA INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (continued)

(unaudited)

(dollars and shares in thousands, except per share data)

 

governmental requirements. In addition, the Company’s revenues from commercial payors may be subject to adjustment as a result of potential claims for refunds, as a result of government actions or as a result of other claims by commercial payors.

Inquiries by the Federal Government and Certain Related Civil Proceedings

2005 U.S. Attorney Investigation: In March 2005, the Company received a subpoena from the U.S. Attorney’s Office for the Eastern District of Missouri in St. Louis. The subpoena required production of a wide range of documents relating to the Company’s operations, including documents related to, among other things, pharmaceutical and other services provided to patients, relationships with pharmaceutical companies, and financial relationships with physicians and joint ventures. The subpoena covers the period from December 1, 1996 through March 2005. In October 2005, the Company received a follow-up request for additional documents related to specific medical director and joint venture arrangements. In February 2006, the Company received an additional subpoena for documents, including certain patient records relating to the administration and billing of Epogen®, or EPO. In May 2007, the Company received a request for documents related to durable medical equipment and supply companies owned and operated by the Company. The Company cooperated with the inquiry and has produced the requested records. The subpoenas were issued in connection with a joint civil and criminal investigation. It is possible that criminal proceedings may be initiated against the Company in connection with this investigation. The Company has not received a communication from the St. Louis U.S. Attorney’s Office on this matter in over two years.

Woodard Private Civil Suit: In February 2007, the Company received a request for information from the Office of Inspector General, U.S. Department of Health and Human Services, or OIG, for records relating to EPO claims submitted to Medicare. In August 2007, the Company received a subpoena from the OIG seeking similar documents. The requested documents relate to services provided from 2001 to 2004 by a number of the Company’s centers. The request and subpoena were sent from the OIG’s offices in Houston and Dallas, Texas. The Company cooperated with the inquiry and has produced all previously requested records to date. The Company was contacted by the U.S. Attorney’s Office for the Eastern District of Texas, which stated that this was a civil investigation related to EPO claims. On July 6, 2009, the United States District Court for the Eastern District of Texas lifted the seal on the civil qui tam complaint related to these previous requests for information. The Company was subsequently served with a complaint by the relator, Ivey Woodard, purportedly on behalf of the federal government, under the qui tam provisions of the federal False Claims Act. The government did not intervene and is not actively pursuing this matter. The relator is pursuing the claims independently and the parties are engaged in active litigation. The complaint contains allegations relating to the Company’s EPO practices for the period from 1992 through 2010 and seeks monetary damages and civil penalties as well as costs and expenses. The court has ruled that claims earlier than 1996 are beyond the statute of limitations. The Company believes that there is some overlap between the subject of this complaint and the review of EPO utilization in the 2005 U.S. Attorney investigation described above. The Company is vigorously defending this matter and intends to continue to do so. The Company can make no assurances as to the time or resources that will be needed to devote to this litigation or its final outcome.

Vainer Private Civil Suit: In December 2008, The Company received a subpoena for documents from the OIG relating to the pharmaceutical products Zemplar, Hectorol, Venofer, Ferrlecit and EPO, as well as other related matters. The subpoena covers the period from January 2003 to December 2008. The Company was in contact with the U.S. Attorney’s Office for the Northern District of Georgia and the U.S. Department of Justice in Washington, DC, since November 2008 relating to this matter, and were advised that this was a civil inquiry. On June 17, 2009, the Company learned that the allegations underlying this inquiry were made as part of a civil

 

11


Table of Contents

DAVITA INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (continued)

(unaudited)

(dollars and shares in thousands, except per share data)

 

complaint filed by individuals and brought pursuant to the qui tam provisions of the federal False Claims Act. On April 1, 2011, the United States District Court for the Northern District of Georgia ordered the case to be unsealed. At that time, the Department of Justice and U.S. Attorney’s Office filed a notice of declination stating that the United States would not be intervening and not pursuing the relators’ allegation in litigation. On July 25, 2011, the relators, Daniel Barbir and Dr. Alon Vainer, filed their amended complaint in the United States District Court for the Northern District of Georgia, purportedly on behalf of the federal government. The allegations in the complaint relate to the Company’s drug administration practices for Vitamin D and iron agents for a period from 2003 through 2010. The complaint seeks monetary damages and civil penalties as well as costs and expenses. The Company is vigorously defending this matter and intends to continue to do so. The Company can make no assurances as to the time or resources that will be needed to devote to this litigation or its final outcome.

2010 U.S. Attorney Physician Relationship Investigation: In May 2010, the Company received a subpoena from the OIG’s office in Dallas, Texas. The subpoena covers the period from January 1, 2005 to May 2010, and seeks production of a wide range of documents relating to the Company’s operations, including documents related to, among other things, financial relationships with physicians and joint ventures. The Company met with representatives of the government to discuss the scope of the subpoena and the production of responsive documents. The Company has been advised that this is a civil investigation. The Company is cooperating with the inquiry. The Company can make no assurances as to the time or resources that will be needed to devote to this litigation or its final outcome.

2011 U.S. Attorney Physician Relationship Investigation: In August 2011, the Company announced it had learned that the U.S. Attorney’s Office for the District of Colorado would be looking into certain activities of the Company in connection with information being provided to a grand jury. The Company announced further that it understood that this investigation was at a very preliminary stage, and while its precise scope was unclear, it appeared to overlap, at least in part, with the 2010 U.S. Attorney Physician Relationship Investigation described above. Subsequent to the Company’s announcement of this 2011 U.S. Attorney Physician Relationship Investigation, it received a subpoena for documents which substantially overlaps with the subpoena in the 2010 U.S. Attorney Physician Relationship Investigation described above and covers the period from January 2006 to September 2011. The Company is cooperating with the government and is producing the requested records. Certain current and former members of the Board and executives received subpoenas in November 2011 and thereafter to testify before the grand jury, and other Company representatives may also receive subpoenas for testimony related to this matter. The Company can make no assurances as to the time or resources that will be needed to devote to this litigation or its final outcome.

2011 U.S. Attorney Medicaid Investigation: In October 2011, the Company announced that it would be receiving a request for documents, which could include an administrative subpoena from the Office of Inspector General for the U.S. Department of Health and Human Services. Subsequent to the Company’s announcement of this 2011 U.S. Attorney Medicaid Investigation, the Company received a request for documents in connection with the inquiry by the United States Attorney’s Office for the Eastern District of New York. The request relates to payments for infusion drugs covered by Medicaid composite payments for dialysis. The Company believes this inquiry is civil in nature. The Company does not know the time period or scope. The Company understands that certain other providers that operate dialysis clinics in New York may be receiving or have received a similar request for documents. The Company intends to cooperate with the government to provide responsive documents.

Except for the private civil complaints filed by the relators as described above, to the Company’s knowledge, no proceedings have been initiated against the Company at this time in connection with any of the

 

12


Table of Contents

inquiries by the federal government. Although the Company cannot predict whether or when proceedings might be initiated or when these matters may be resolved, it is not unusual for inquiries such as these to continue for a considerable period of time through the various phases of document and witness requests and on-going discussions with regulators. Responding to the subpoenas or inquiries and defending the Company in the relator proceedings will continue to require management’s attention and significant legal expense. Any negative findings in the inquiries or relator proceedings could result in substantial financial penalties or awards against the Company, exclusion from future participation in the Medicare and Medicaid programs and, to the extent criminal proceedings may be initiated against the Company, possible criminal penalties. At this time, the Company cannot predict the ultimate outcome of these inquiries, or the potential outcome of the relators’ claims, or the potential range of damages, if any.

Other

The Company has received several notices of claims from commercial payors and other third parties related to historical billing practices and claims against DVA Renal Healthcare (formerly known as Gambro Healthcare), a subsidiary of the Company, related to historical Gambro Healthcare billing practices and other matters covered by its 2004 settlement agreement with the Department of Justice and certain agencies of the U.S. government. The Company has received no further indication that any of these claims are active, and some of them may be barred by applicable statutes of limitations. To the extent any of these claims might proceed, the Company intends to defend against them vigorously; however, the Company may not be successful and these claims may lead to litigation and any such litigation may be resolved unfavorably. At this time, the Company cannot predict the ultimate outcome of this matter or the potential range of damages, if any.

A wage and hour claim, which has been styled as a class action, is pending against the Company in the Superior Court of California. The Company was served with the complaint in this lawsuit in April 2008, and it has been amended since that time. The lawsuit, as amended, alleges that the Company failed to provide meal periods, failed to pay compensation in lieu of providing rest or meal periods, failed to pay overtime, and failed to comply with certain other California Labor Code requirements. In September 2011, the court denied the plaintiffs’ motion for class certification. Plaintiffs have appealed that decision. The Company intends to continue to vigorously defend against these claims. Any potential settlement of these claims is not anticipated to be material to the Company’s consolidated financial statements.

In October 2007, the Company was contacted by the Attorney General’s Office for the State of Nevada. The Attorney General’s Office informed the Company that it was conducting a civil and criminal investigation of the Company’s operations in Nevada and that the investigation related to the billing of pharmaceuticals, including EPO. In February 2008, the Attorney General’s Office informed the Company that the civil and criminal investigation had been discontinued. The Attorney General’s Office further advised the Company that Nevada Medicaid intended to conduct audits of end stage renal disease (ESRD) dialysis providers in Nevada and such audits would relate to the issues that were the subjects of the investigation. To the Company’s knowledge, no court proceedings have been initiated against the Company at this time. Any negative audit findings could result in a substantial repayment by the Company. At this time, the Company cannot predict the ultimate outcome of this matter or the potential range of damages, if any.

In June 2004, DVA Renal Healthcare was served with a complaint filed in the Superior Court of California by one of its former employees who worked for its California acute services program. The complaint, which is styled as a class action, alleges, among other things, that DVA Renal Healthcare failed to provide overtime wages, defined rest periods and meal periods, or compensation in lieu of such provisions and failed to comply with certain other California Labor Code requirements. The parties reached an agreement last year to fully resolve this matter for an amount that did not materially impact the Company’s financial results. That settlement has now received final approval from the court.

In addition to the foregoing, the Company is subject to claims and suits, including from time to time, contractual disputes and professional and general liability claims, as well as audits and investigations by various government entities, in the ordinary course of business. The Company believes that the ultimate resolution of any such pending proceedings, whether the underlying claims are covered by insurance or not, will not have a material adverse effect on its financial condition, results of operations or cash flows.

 

13


Table of Contents

DAVITA INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (continued)

(unaudited)

(dollars and shares in thousands, except per share data)

 

6. Investments in debt and equity securities

Based on the Company’s intentions and strategy involving investments in debt and equity securities, the Company classifies certain debt securities as held-to-maturity and records them at amortized cost. Equity securities that have readily determinable fair values and certain other debt securities classified as available for sale are recorded at fair value.

The Company’s investments consist of the following:

 

     March 31, 2012      December 31, 2011  
     Held to
maturity
     Available
for sale
     Total      Held to
maturity
     Available
for sale
     Total  

Certificates of deposit, money market funds and U.S. treasury notes due within one year

   $   7,416       $ —         $ 7,416       $ 11,754       $ —         $ 11,754   

Investments in mutual funds

     —           11,097         11,097         —           15,535         15,535   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
   $ 7,416       $   11,097       $   18,513       $   11,754       $   15,535       $   27,289   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Short-term investments

   $ 7,416       $ 1,200       $ 8,616       $ 11,754       $ 5,645       $ 17,399   

Long-term investments

     —           9,897         9,897         —           9,890         9,890   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
   $ 7,416       $ 11,097       $ 18,513       $ 11,754       $ 15,535       $ 27,289   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

The cost of the certificates of deposit and money market funds at March 31, 2012 and in addition, U.S. treasury notes at December 31, 2011, approximates their fair value. As of March 31, 2012 and December 31, 2011, the available for sale investments include $1,500 and $(255) of gross pre-tax gains (loss), respectively. During the three months ended March 31, 2012, the Company recorded gross pre-tax unrealized gains of $1,877, or $1,146 after tax, in other comprehensive income associated with changes in the fair value of these investments. During the three months ended March 31, 2012, the Company sold investments in mutual funds and its shares of NxStage common stock for net proceeds of $6,791, and recognized a pre-tax gain of $123, or $75 after tax, that was previously recorded in other comprehensive income. During the three months ended March 31, 2011, the Company sold investments in mutual funds for net proceeds of $1,149, and recognized a pre-tax loss of $93, or $57 after tax, that was previously recorded in other comprehensive income.

As of March 31, 2012, investments totaling approximately $2,900 classified as held to maturity are investments used to maintain certain capital requirements of the special needs plans of VillageHealth, which is a wholly-owned subsidiary of the Company. As of December 31, 2009, the Company discontinued the VillageHealth special needs plans and is still in process of paying out all incurred claims. During the first quarter of 2012, the Company received a total of $4,339 in cash from various state regulatory agencies. The Company also expects to liquidate these remaining investments as soon as the various state regulatory agencies approve the release of these investments.

The investments in mutual funds classified as available for sale are held within a trust to fund existing obligations associated with several of the Company’s non-qualified deferred compensation plans.

 

14


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DAVITA INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (continued)

(unaudited)

(dollars and shares in thousands, except per share data)

 

7. Fair value of financial instruments

The Company measures the fair value of certain assets, liabilities and noncontrolling interests subject to put provisions (temporary equity) based upon certain valuation techniques that include observable or unobservable inputs and assumptions that market participants would use in pricing these assets, liabilities, temporary equity and commitments. The Company also has classified certain assets, liabilities and temporary equity that are measured at fair value into the appropriate fair value hierarchy levels.

The following table summarizes the Company’s assets, liabilities and temporary equity measured at fair value on a recurring basis as of March 31, 2012:

 

     Total      Quoted prices in
active markets for
identical assets
(Level 1)
     Significant other
observable inputs
(Level 2)
     Significant
unobservable
inputs
(Level 3)
 

Assets

           

Available for sale securities

   $ 11,097       $   11,097       $ —         $ —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Interest rate cap agreements

   $ 958       $ —         $ 958       $ —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Liabilities

           

Interest rate swap agreements

   $ 23,196       $ —         $   23,196       $ —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Temporary equity

           

Noncontrolling interests subject to put provisions

   $ 504,491       $ —         $ —         $   504,491   
  

 

 

    

 

 

    

 

 

    

 

 

 

The available for sale securities represent investments in various open-ended registered investment companies, or mutual funds, and are recorded at fair value based upon quoted prices reported by each mutual fund. See Note 6 to the condensed consolidated financial statements for further discussion.

The interest rate swap and cap agreements are recorded at fair value based upon valuation models utilizing the income approach and commonly accepted valuation techniques that use inputs from closing prices for similar assets and liabilities in active markets as well as other relevant observable market inputs at quoted intervals such as current interest rates, forward yield curves, implied volatility and credit default swap pricing. The Company does not believe the ultimate amount that could be realized upon settlement of these interest rate swap and cap agreements would be materially different than the fair values as currently reported. See Note 4 to the condensed consolidated financial statements for further discussion.

See Note 8 to the condensed consolidated financial statements for a discussion of the Company’s methodology for estimating the fair value of noncontrolling interests subject to put provisions.

The Company has other financial instruments in addition to the above that consist primarily of cash, accounts receivable, accounts payable, other accrued liabilities, and debt. The balances of the non-debt financial instruments are presented in the condensed consolidated financial statements at March 31, 2012 at their approximate fair values due to the short-term nature of their settlements. The carrying amount of the Company’s Senior Secured Credit Facilities totaled $2,857,198 as of March 31, 2012 and the fair value was $2,863,323 based upon quoted market prices. The fair value of the Company’s senior notes was approximately $1,615,720 at March 31, 2012, based upon quoted market prices, as compared to the carrying amount of $1,550,000.

 

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Table of Contents

DAVITA INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (continued)

(unaudited)

(dollars and shares in thousands, except per share data)

 

8. Noncontrolling interests subject to put provisions and other commitments

The Company has potential obligations to purchase the noncontrolling interests held by third parties in several of its joint ventures and non-wholly-owned subsidiaries. These obligations are in the form of put provisions and are exercisable at the third-party owners’ discretion within specified periods as outlined in each specific put provision. If these put provisions were exercised, the Company would be required to purchase the third-party owners’ noncontrolling interests at either the appraised fair market value or a predetermined multiple of earnings or cash flow attributable to the noncontrolling interests put to the Company, which is intended to approximate fair value. The methodology the Company uses to estimate the fair values of noncontrolling interests subject to put provisions assumes either the higher of a liquidation value of net assets or an average multiple of earnings, based on historical earnings, patient mix and other performance indicators, as well as other factors. The estimated fair values of the noncontrolling interests subject to put provisions can fluctuate and the implicit multiple of earnings at which these noncontrolling interests obligations may be settled will vary significantly depending upon market conditions including potential purchasers’ access to the capital markets, which can impact the level of competition for dialysis and non-dialysis related businesses, the economic performance of these businesses and the restricted marketability of the third-party owners’ noncontrolling interests. The amount of noncontrolling interests subject to put provisions that contractually employ a predetermined multiple of earnings rather than fair value are immaterial.

Additionally, the Company has certain other potential commitments to provide operating capital to several dialysis centers that are wholly-owned by third parties or centers in which the Company owns a minority equity investment as well as to physician-owned vascular access clinics that the Company operates under management and administrative services agreements of approximately $4,000.

Certain consolidated joint ventures are contractually scheduled to dissolve after terms ranging from ten to fifty years. Accordingly, the noncontrolling interests in these joint ventures are considered mandatorily redeemable instruments for which the classification and measurement requirements have been indefinitely deferred. Future distributions upon dissolution of these entities would be valued below the related noncontrolling interest carrying balances in the condensed consolidated balance sheet.

9. Income taxes

As of March 31, 2012, the Company’s total liability for unrecognized tax benefits relating to tax positions that do not meet the more-likely-than-not threshold is $9,291, all of which would impact the Company’s effective tax rate if recognized. This balance represents an increase of $348 from the December 31, 2011 balance of $8,943 mostly due to the addition of interest in 2012.

The Company recognizes accrued interest and penalties related to unrecognized tax benefits in its income tax expense. At March 31, 2012 and December 31, 2011, the Company had approximately $4,040 and $3,420, respectively, accrued for interest and penalties related to unrecognized tax benefits, net of federal tax benefits.

10. Acquisitions

Dialysis and other acquisitions

During the first quarter of 2012, the Company acquired dialysis businesses consisting of 28 dialysis centers located in the United States and one direct primary care business for a total of $132,699 in cash and deferred

 

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Table of Contents

DAVITA INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (continued)

(unaudited)

(dollars and shares in thousands, except per share data)

 

purchase price obligations totaling $286. The assets and liabilities for all acquisitions were recorded at their estimated fair market values at the dates of the acquisitions and are included in the Company’s financial statements and operating results from the designated effective dates of the acquisitions.

The following table summarizes the assets acquired and liabilities assumed in these transactions and recognized at their acquisition dates at estimated fair values, as well as the estimated fair value of the noncontrolling interests assumed in these transactions:

 

     Three months ended
March 31, 2012
 

Tangible assets, principally leasehold improvements and equipment

   $ 9,745   

Amortizable intangible assets

     10,635   

Goodwill

     117,975   

Liabilities assumed

     (3,900

Noncontrolling interests assumed

     (1,470
  

 

 

 
   $ 132,985   
  

 

 

 

Amortizable intangible assets acquired during the first three months of 2012 had weighted-average estimated useful lives of 9.3 years. The total amount of goodwill deductible for tax purposes associated with these acquisitions is approximately $117 million.

The DSI Renal Inc. purchase price allocations will be finalized upon completion of the final short period tax returns.

11. Segment reporting

The Company operates principally as a dialysis and related lab services business but also operates other ancillary services and strategic initiatives. These ancillary services and strategic initiatives consist primarily of pharmacy services, infusion therapy services, disease management services, vascular access services, ESRD clinical research programs, physician services, direct primary care and the Company’s international dialysis operations. For internal management reporting, the dialysis and related lab services business and each of the ancillary services and strategic initiatives have been defined as separate operating segments by management since separate financial information is regularly produced and reviewed by the Company’s chief operating decision maker in making decisions about allocating resources and assessing financial results. The Company’s chief operating decision maker is its Chief Executive Officer. The U.S. dialysis and related lab services business qualifies as a separately reportable segment and all references to dialysis and related lab services continue to refer only to the Company’s U.S. dialysis and related lab services business. All of the other ancillary services and strategic initiatives operating segments, including the Company’s international dialysis operations, have been combined and disclosed in the other segments category.

The Company’s operating segment financial information is prepared on an internal management reporting basis that the Chief Executive Officer uses to allocate resources and analyze the performance of operating segments. For internal management reporting, segment operations include direct segment operating expenses with the exception of stock-based compensation expense and equity investment income.

 

17


Table of Contents

DAVITA INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (continued)

(unaudited)

(dollars and shares in thousands, except per share data)

 

The following is a summary of segment operating revenues, segment operating margin (loss), and a reconciliation of segment operating margin to consolidated income before income taxes:

 

     Three months ended March 31,  
             2012                     2011          

Segment operating revenues:

    

Dialysis and related lab services

    

Patient service operating revenues:

    

External sources

   $ 1,762,578      $ 1,497,434   

Intersegment revenues

     4,059        2,206   
  

 

 

   

 

 

 

Total dialysis and related lab services patient service operating revenues

     1,766,637        1,499,640   

Less: Provision for uncollectible accounts related to patient service revenues

     (53,008     (41,071
  

 

 

   

 

 

 

Net dialysis and related lab services patient service operating revenues

     1,713,629        1,458,569   

Other revenues (1)

     2,885        2,532   
  

 

 

   

 

 

 

Total net dialysis and related lab services operating revenues

     1,716,514        1,461,101   
  

 

 

   

 

 

 

Other – Ancillary services and strategic initiatives

    

Net patient service operating revenues

   $ 1,122      $ —     

External sources

     153,058        103,418   

Intersegment revenues

     2,044        2,297   
  

 

 

   

 

 

 

Total ancillary services and strategic initiatives operating revenues

     156,224        105,715   
  

 

 

   

 

 

 

Total net segment operating revenues

     1,872,738        1,566,816   

Elimination of intersegment revenues

     (6,103     (4,503
  

 

 

   

 

 

 

Consolidated net operating revenues

   $ 1,866,635      $ 1,562,313   
  

 

 

   

 

 

 

Consolidated operating revenues before provision for uncollectible accounts

   $ 1,919,643      $ 1,603,384   
  

 

 

   

 

 

 

Segment operating margin (loss) (2):

    

Dialysis and related lab services

   $ 348,030      $ 252,315   

Other – Ancillary services and strategic initiatives

     (17,392     (8,784
  

 

 

   

 

 

 

Total segment margin

     330,638        243,531   

Reconciliation of segment operating margin to consolidated income before income taxes:

    

Stock-based compensation

     (12,550     (9,716

Equity investment income

     2,632        1,519   
  

 

 

   

 

 

 

Consolidated operating income

     320,720        235,334   

Debt expense

     (61,381     (58,595

Other income

     1,039        841   
  

 

 

   

 

 

 

Consolidated income from continuing operations before income taxes

   $ 260,378      $ 177,580   
  

 

 

   

 

 

 

 

18


Table of Contents

DAVITA INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (continued)

(unaudited)

(dollars and shares in thousands, except per share data)

 

 

(1)

Includes management fees related to providing management and administrative services to dialysis centers that are wholly-owned by third parties or centers in which the Company owns a minority equity investment.

(2) 

Certain costs associated with our international operations that were previously reported in the dialysis and related lab services have been reclassified to the ancillary services and strategic initiatives to conform to the current year presentation.

Depreciation and amortization expense for the dialysis and related lab services for the three months ended March 31, 2012 was $73,726 and was $2,249 for the ancillary services and strategic initiatives.

Depreciation and amortization expense for the dialysis and related lab services for the three months ended March 31, 2011 was $60,123, and was $1,715 for the ancillary services and strategic initiatives.

Summary of assets by segment is as follows:

 

     March 31,
2012
     December 31,
2011
 

Segment assets

     

Dialysis and related lab services

   $ 8,833,197       $ 8,588,671   

Other – Ancillary services and strategic initiatives

     296,931         276,176   

Equity investments

     26,956         27,325   
  

 

 

    

 

 

 

Consolidated assets

   $ 9,157,084       $ 8,892,172   
  

 

 

    

 

 

 

For the three months ended March 31, 2012, the total amount of expenditures for property and equipment including capital leases for the dialysis and related lab services was $116,456 and was $5,657 for the ancillary services and strategic initiatives.

For the three months ended March 31, 2011, the total amount of expenditures for property and equipment including capital leases for the dialysis and related lab services were $67,119 and were $1,563 for the ancillary services and strategic initiatives.

As of March 31, 2012, there was $4,968,608 and $95,969 of goodwill associated with the dialysis and related lab services business and the ancillary services and strategic initiatives, respectively.

As of December 31, 2011, there was $4,865,864 and $81,112 of goodwill associated with the dialysis and related lab services business and the ancillary services and strategic initiatives, respectively.

 

19


Table of Contents

DAVITA INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (continued)

(unaudited)

(dollars and shares in thousands, except per share data)

 

12. Changes in DaVita Inc.’s ownership interest in consolidated subsidiaries

The effects of changes in DaVita Inc.’s ownership interest on the Company’s equity are as follows:

 

     Three months ended
March 31,
 
     2012     2011  

Net income attributable to DaVita Inc.

   $ 140,120      $ 94,502   
  

 

 

   

 

 

 

Increase in paid-in capital for sales of noncontrolling interests

     5        27   

Decrease in paid-in capital for the purchase of noncontrolling interests

     (897     (614
  

 

 

   

 

 

 

Net transfer to noncontrolling interests

     (892     (587
  

 

 

   

 

 

 

Change from net income attributable to DaVita Inc. and transfers to noncontrolling interests

   $ 139,228      $ 93,915   
  

 

 

   

 

 

 

13. Variable interest entities

The Company is required to consolidate each entity determined to be a variable interest entity for which the Company is the primary beneficiary. Variable interest entities (VIEs) typically include those for which the entity’s equity is not sufficient to finance its activities without additional subordinated financial support; those for which the equity holders as a group lack the power to direct the activities that most significantly influence the entity’s economic performance, the obligation to absorb the entity’s expected losses, or the right to receive the entity’s expected returns; or those for which the voting rights of some investors are not proportional to their obligations to absorb the entity’s losses.

The Company is deemed to be the primary beneficiary of all the variable interest entities it is associated with. These VIEs are principally operating subsidiaries owned by related party nominee owners for the Company’s benefit in jurisdictions in which the Company does not qualify for direct ownership under applicable regulations or joint ventures that require subordinated support in addition to their equity capital to finance operations. These include both dialysis operations and physician practice management entities.

Under the terms of the applicable arrangement, the Company bears substantially all of the economic risks and rewards of ownership for these operating VIEs. In some cases, the Company has contractual arrangements with its respective related party nominee owners which indemnify them from the economic losses, and entitle the Company to the economic benefits, that may result from ownership of these VIEs. DaVita Inc. manages these VIEs and provides operating and capital funding as necessary to accomplish their operational and strategic objectives.

Accordingly, since the Company bears the majority of the risks and rewards attendant to their ownership, the Company consolidates these VIEs as their primary beneficiary. Total assets of these consolidated operating VIEs were approximately $6,000 and their liabilities to unrelated third parties were approximately $5,000 at March 31, 2012.

The Company also sponsors certain deferred compensation plans whose trusts qualify as VIEs and as their primary beneficiary the Company consolidates each of these plans. The assets of these plans are recorded in

 

20


Table of Contents

DAVITA INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (continued)

(unaudited)

(dollars and shares in thousands, except per share data)

 

short-term or long-term investments with matching offsetting liabilities in accrued compensation and benefits and other long-term liabilities. See Note 6 for disclosures on the assets of these consolidated non-qualified deferred compensation plans.

14. Accounts receivable

Accounts receivable are reduced by an allowance for doubtful accounts. In evaluating the ultimate collectability and net realizable value of the Company’s accounts receivable, the Company analyzes its historical cash collection experience and trends for each of its government payors and commercial payors to estimate the adequacy of the allowance for doubtful accounts and the amount of the provision for bad debts. Management regularly updates its analysis based upon the most recent information available to it to determine its current provision for bad debts and the adequacy of its allowance for doubtful accounts. For receivables associated with services provided to patients covered by government payors, like Medicare, the Company receives 80% of the payment directly from Medicare as established under the governments bundled payment system and determines an appropriate allowance for doubtful accounts and provision for bad debts on the remaining balance due depending upon the Company’s estimate of the amounts ultimately collectible from other secondary coverage sources or from the patients. For receivables associated with services to patients covered by commercial payors that are either based upon contractual terms or for non-contracted health plan coverage, the Company provides an allowance for doubtful accounts and a provision for bad debts based upon its historical collection experience, potential inefficiencies in its billing processes and for which collectability is determined to be unlikely. Less than 1% of the Company’s accounts receivable are associated with patient pay and it is the Company’s policy to reserve 100% of these outstanding accounts receivable balances when the amounts due are outstanding for more than four months.

During the quarter ended March 31, 2012, the Company’s allowance for doubtful accounts increased by approximately $38,895. This was primarily as a result of the provision for bad debts exceeding the amount of write-offs that occurred during the quarter as well as additional reserves associated with acquisitions. There were no unusual transactions impacting the allowance for doubtful accounts.

15. Goodwill

Each of the Company’s operating segments described in Note 11 to the condensed consolidated financial statements is considered to represent an individual reporting unit for goodwill impairment testing purposes, except that our new direct primary care segment is comprised of two reporting units and each sovereign jurisdiction within our new international operations segment is considered a separate reporting unit.

Within the U.S. dialysis and related lab services operating segment, the Company considers each of its dialysis centers to constitute an individual business for which discrete financial information is available. However, since these dialysis centers have similar operating and economic characteristics and resource allocation and significant investment decisions concerning these businesses are highly centralized and the benefits broadly distributed, the Company has aggregated these centers and deemed them to constitute a single reporting unit.

The Company has applied a similar aggregation to the infusion therapy branches in its infusion therapy services reporting unit, to the consolidated vascular access service centers in its vascular access services reporting unit, and to the physician practices in its physician services reporting unit. For the Company’s

 

21


Table of Contents

DAVITA INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (continued)

(unaudited)

(dollars and shares in thousands, except per share data)

 

operating segments not mentioned above, no component below the level of the operating segment is considered a discrete business and therefore these operating segments directly constitute individual reporting units.

During the first quarter of 2012, the Company did not record any goodwill impairment charges and, as of March 31, 2012, none of the goodwill associated with the Company’s various reporting units was considered at risk of impairment. Since the date of the Company’s last annual goodwill impairment test, there have been no material developments, events, changes in operating performance or other changes in circumstances that would cause management to believe it is more likely than not that the fair value of any of its reporting units would be less than its carrying amount.

16. Significant new accounting standards

On January 1, 2012, we adopted the Financial Accounting Standards Board’s, or FASB, Accounting Standard Update (ASU) No. 2011-08, Intangibles—Goodwill and Other. This standard amends the current two-step goodwill impairment test required under the existing accounting guidance. This amendment allows entities the option to first assess certain qualitative factors to ascertain whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount to determine if the two-step impairment test is necessary. If an entity concludes that certain events or circumstances prove that it is more likely than not that the fair value of a reporting unit is less than its carrying amount then an entity is required to proceed to step one of the two-step goodwill impairment test. This standard was effective on January 1, 2012. The adoption of this standard did not have a material impact on the Company’s consolidated financial statements.

On January 1, 2012, we adopted FASB’s ASU No. 2011-07, Health Care Entities-Presentation and Disclosure of Patient Service Revenue, Provision for Bad Debts, and the Allowance for Doubtful Accounts. This standard amends the current presentation and disclosure requirements for Health Care Entities that recognize significant amounts of patient service revenues at the time the services are rendered without assessing the patient’s ability to pay. This standard requires health care entities to reclassify the provision for bad debts from an operating expense to a deduction from patient service revenues. In addition, this standard requires more disclosure on the policies for recognizing revenue, assessing bad debts, as well as quantitative and qualitative information regarding changes in the allowance for doubtful accounts. This standard was applied retrospectively to all prior periods presented and was effective on January 1, 2012. Upon adoption of this standard, the Company changed its presentation of its provision for uncollectible accounts related to patient service revenues as a deduction from its patient service operating revenues and enhanced its disclosures as indicated above. See Note 14 to the condensed consolidated financial statements for further details.

On January 1, 2012, we adopted FASB’s ASU No. 2011-05, Comprehensive Income—Presentation of Comprehensive Income. This standard amends the current presentation requirements for comprehensive income by eliminating the presentation of the components of other comprehensive income within the statement of equity. This standard allows two options on how to present the various components of comprehensive income. These options are either to report the components of comprehensive income separately on the income statement or to present total other comprehensive income and the components of other comprehensive income in a separate statement. This standard does not change the items that must be reported in other comprehensive income or when an item must be reclassified into net income. The FASB temporarily deferred the requirement to present separate line items on the statement of income for the amounts that would be realized and reclassified out of accumulated other comprehensive income into net income. No timetable has been set for FASB’s reconsideration of this item. This standard, except for the requirements that were deferred, as stated above, was applied retrospectively and

 

22


Table of Contents

DAVITA INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (continued)

(unaudited)

(dollars and shares in thousands, except per share data)

 

was effective on January 1, 2012. Upon adoption of this standard, the Company presented total other comprehensive income and the components of other comprehensive income in a separate statement of comprehensive income.

On January 1, 2012, we adopted FASB’s ASU No. 2011-04, Fair Value Measurement. This standard amends the current fair value measurement and disclosure requirements to improve comparability between U.S. GAAP and International Financial Reporting Standards (IFRS). The intent of this standard is to update the disclosures that describe several of the requirements in U.S. GAAP for measuring fair value and to enhance disclosures about fair value measurements which will improve consistency between U.S. GAAP and IFRS. This standard does not change the application of the requirements on fair value measurements and disclosures. This was applied prospectively and was effective on January 1, 2012. The adoption of this standard did not have a material impact on the Company’s consolidated financial statements.

17. Condensed consolidating financial statements

The following information is presented in accordance with Rule 3-10 of Regulation S-X. The operating and investing activities of the separate legal entities included in the Company’s consolidated financial statements are fully interdependent and integrated. Revenues and operating expenses of the separate legal entities include intercompany charges for management and other services. The senior notes were issued by the Company on October 20, 2010 and are guaranteed by substantially all of its direct and indirect domestic wholly-owned subsidiaries. Each of the guarantor subsidiaries has guaranteed the notes on a joint and several basis. However, the guarantor subsidiaries can be released from their obligations in the event of a sale or other disposition of all or substantially all of the assets of such subsidiary, if such subsidiary guarantor is designated as an unrestricted subsidiary or otherwise ceases to be a restricted subsidiary, and if such subsidiary guarantor no longer guaranties any other indebtedness of the Company. Non-wholly-owned subsidiaries, certain wholly-owned subsidiaries, foreign subsidiaries, joint ventures, partnerships and third parties are not guarantors of these obligations.

 

23


Table of Contents

DAVITA INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (continued)

(unaudited)

(dollars and shares in thousands, except per share data)

 

Condensed Consolidating Statements of Income

 

For the three months ended March 31, 2012

  DaVita Inc.     Guarantor
subsidiaries
    Non-Guarantor
subsidiaries
    Consolidating
adjustments
    Consolidated
total
 

Patient service operating revenues

  $ —        $ 1,315,992      $ 463,090      $ (15,382   $ 1,763,700   

Less: Provision for uncollectible accounts

    —          (38,846     (14,162     —          (53,008
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net patient service operating revenues

    —          1,277,146        448,928        (15,382     1,710,692   

Other revenues

    123,593        146,965        21,255        (135,870     155,943   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total net operating revenues

    123,593        1,424,111        470,183        (151,252     1,866,635   

Operating expenses

    93,158        1,230,436        373,573        (151,252     1,545,915   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating income

    30,435        193,675        96,610        —          320,720   

Debt (expense)

    (62,181     (51,218     (6,366     58,384        (61,381

Other income

    58,346        632        445        (58,384     1,039   

Income tax expense

    10,773        78,112        6,610        —          95,495   

Equity earnings in subsidiaries

    124,293        59,540        —          (183,833     —     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income from continuing operations

    140,120        124,517        84,079        (183,833     164,883   

Discontinued operations

    —          —          —          —          —     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income

    140,120        124,517        84,079        (183,833     164,883   

Less: Net income attributable to noncontrolling interests

    —          —          —          (24,763     (24,763
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income attributable to DaVita Inc.

  $ 140,120      $ 124,517      $ 84,079      $ (208,596   $ 140,120   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

For the three months ended March 31, 2011

                             

Patient service operating revenues

  $ —        $ 1,197,496      $ 310,233      $ (10,295   $ 1,497,434   

Less: Provision for uncollectible accounts

    —          (19,022     (22,049     —          (41,071
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net patient service operating revenues

    —          1,178,474        288,184        (10,295     1,456,363   

Other revenues

    103,273        99,743        15,603        (112,669     105,950   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total net operating revenues

    103,273        1,278,217        303,787        (122,964     1,562,313   

Operating expenses

    66,374        1,124,998        258,571        (122,964     1,326,979   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating income

    36,899        153,219        45,216        —          235,334   

Debt (expense)

    (58,865     (54,140     (180     54,590        (58,595

Other income

    54,867        315        249        (54,590     841   

Income tax expense

    13,160        49,845        (46     —          62,959   

Equity earnings in subsidiaries

    74,761        25,867        —          (100,628     —     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income from continuing operations

    94,502        75,416        45,331        (100,628     114,621   

Discontinued operations

    —          7        124        —          131   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income

    94,502        75,423        45,455        (100,628     114,752   

Less: Net income attributable to noncontrolling interests

    —          —          —          (20,250     (20,250
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income attributable to DaVita Inc.

  $ 94,502      $ 75,423      $ 45,455      $ (120,878   $ 94,502   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

24


Table of Contents

DAVITA INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (continued)

(unaudited)

(dollars and shares in thousands, except per share data)

 

Condensed Consolidating Balance Sheets

 

As of March 31, 2012

   DaVita Inc.      Guarantor
subsidiaries
     Non-Guarantor
subsidiaries
     Consolidating
adjustments
    Consolidated
total
 

Cash and cash equivalents

   $ 421,772       $ —         $ 27,518       $ —        $ 449,290   

Accounts receivable, net

     —           942,721         324,148         —          1,266,869   

Other current assets

     25,683         559,748         72,810         —          658,241   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total current assets

     447,455         1,502,469         424,476         —          2,374,400   

Property and equipment, net

     95,309         995,549         399,714         —          1,490,572   

Amortizable intangibles, net

     50,356         96,016         14,245         —          160,617   

Investments in subsidiaries

     6,928,492         1,127,684         —           (8,056,176     —     

Intercompany receivables

     —           605,935         245,333         (851,268     —     

Other long-term assets and investments

     10,972         53,728         2,218         —          66,918   

Goodwill

     —           4,002,037         1,062,540         —          5,064,577   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total assets

   $ 7,532,584       $ 8,383,418       $ 2,148,526       $ (8,907,444   $ 9,157,084   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Current liabilities

   $ 239,260       $ 888,716       $ 114,139       $ —        $ 1,242,115   

Intercompany payables

     365,902         —           485,366         (851,268     —     

Long-term debt and other long-term liabilities

     4,321,211         622,545         64,792         —          5,008,548   

Noncontrolling interests subject to put provisions

     331,681         —           —           172,810        504,491   

Total DaVita Inc. shareholders’ equity

     2,274,530         6,872,157         1,184,019         (8,056,176     2,274,530   

Noncontrolling interest not subject to put provisions

     —           —           300,210         (172,810     127,400   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total equity

     2,274,530         6,872,157         1,484,229         (8,228,986     2,401,930   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total liabilities and equity

   $ 7,532,584       $ 8,383,418       $ 2,148,526       $ (8,907,444   $ 9,157,084   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

As of December 31, 2011

                                 

Cash and cash equivalents

   $ 365,276       $ —         $ 28,476       $ —        $ 393,752   

Accounts receivable, net

     —           926,041         269,122         —          1,195,163   

Other current assets

     14,665         598,721         79,307         —          692,693   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total current assets

     379,941         1,524,762         376,905         —          2,281,608   

Property and equipment, net

     78,038         971,867         382,746         —          1,432,651   

Amortizable intangibles, net

     53,276         95,900         10,315         —          159,491   

Investments in subsidiaries

     6,696,039         1,089,920         —           (7,785,959     —     

Intercompany receivables

     —           472,200         253,447         (725,647     —     

Other long-term assets and investments

     11,388         56,134         3,924         —          71,446   

Goodwill

     —           3,903,542         1,043,434         —          4,946,976   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total assets

   $ 7,218,682       $ 8,114,325       $ 2,070,771       $ (8,511,606   $ 8,892,172   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Current liabilities

   $ 148,994       $ 889,172       $ 114,950       $ —        $ 1,153,116   

Intercompany payables

     271,890         —           453,757         (725,647     —     

Long-term debt and other long-term liabilities

     4,351,346         585,675         55,694         —          4,992,715   

Noncontrolling interests subject to put provisions

     305,377         —           —           172,839        478,216   

Total DaVita Inc. shareholders’ equity

     2,141,075         6,639,478         1,146,481         (7,785,959     2,141,075   

Noncontrolling interest not subject to put provisions

     —           —           299,889         (172,839     127,050   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total equity

     2,141,075         6,639,478         1,446,370         (7,958,798     2,268,125   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total liabilities and equity

   $ 7,218,682       $ 8,114,325       $ 2,070,771       $ (8,511,606   $ 8,892,172   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

 

25


Table of Contents

DAVITA INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (continued)

(unaudited)

(dollars and shares in thousands, except per share data)

 

Condensed Consolidating Statements of Cash Flows

 

For the three months ended March 31, 2012

   DaVita Inc.     Guarantor
subsidiaries
    Non-Guarantor
subsidiaries
    Consolidating
adjustments
    Consolidated
total
 

Cash flows from operating activities:

          

Net income

   $ 140,120      $ 124,517      $ 84,079      $ (183,833   $ 164,883   

Changes in operating assets and liabilities and non-cash items included in net income

     (49,986     60,253        (27,109     183,833        166,991   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net cash provided by operating activities

     90,134        184,770        56,970        —          331,874   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cash flows from investing activities:

          

Additions of property and equipment, net

     (18,640     (58,812     (35,007     —          (112,459

Acquisitions

     —          (116,269     (16,430     —          (132,699

Proceeds from asset sales

     —          825        —          —          825   

Proceeds from investment sales and other items

     6,302        4,341        —          —          10,643   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net cash used in investing activities

     (12,338     (169,915     (51,437     —          (233,690
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cash flows from financing activities:

          

Long-term debt and related financing costs, net

     (17,158     (10,678     4,437        —          (23,399

Intercompany borrowing

     (11,910     95        11,815        —          —     

Other items

     7,768        (4,272     (22,754     —          (19,258
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net cash used in financing activities

     (21,300     (14,855     (6,502     —          (42,657
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Effect of exchange rate changes on cash

     —          —          11        —          11   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net increase (decrease) in cash and cash equivalents

     56,496        —          (958     —          55,538   

Cash and cash equivalents at beginning of period

     365,276        —          28,476        —          393,752   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cash and cash equivalents at end of period

   $ 421,772      $ —        $ 27,518      $ —        $ 449,290   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

For the three months ended March 31, 2011

                              

Cash flows from operating activities:

          

Net income

   $ 94,502      $ 75,423      $ 45,455      $ (100,628   $ 114,752   

Changes in operating assets and liabilities and non-cash items included in net income

     (18,903     120,077        13,229        100,628        215,031   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net cash provided by operating activities

     75,599        195,500        58,684        —          329,783   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cash flows from investing activities:

          

Additions of property and equipment, net

     (6,946     (41,030     (19,554     —          (67,530

Acquisitions

     —          (81,523     —          —          (81,523

Proceeds from asset sales

     —          2,812        —          —          2,812   

Proceeds from investment sales and other items

     850        3        —          —          853   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net cash used in investing activities

     (6,096     (119,738     (19,554     —          (145,388
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cash flows from financing activities:

          

Long-term debt and related financing costs, net

     (31,425     (147     663        —          (30,909

Intercompany borrowing

     98,982        (75,644     (23,338     —          —     

Other items

     10,606        29        (18,228     —          (7,593
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net cash provided by (used in) financing activities

     78,163        (75,762     (40,903     —          (38,502
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net increase (decrease) in cash and cash equivalents

     147,666        —          (1,773     —          145,893   

Cash and cash equivalents at beginning of period

     856,803        —          3,314        —          860,117   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cash and cash equivalents at end of period

   $ 1,004,469      $ —        $ 1,541      $ —        $ 1,006,010   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

26


Table of Contents

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Forward-looking statements

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of the federal securities laws. All statements that do not concern historical facts are forward-looking statements and include, among other things, statements about our expectations, beliefs, intentions and/or strategies for the future. These forward-looking statements include statements regarding our future operations, financial condition and prospects, expectations for treatment growth rates, revenue per treatment, expense growth, levels of the provision for uncollectible accounts receivable, operating income, cash flow, operating cash flow, estimated tax rates, capital expenditures, the development of new centers and center acquisitions, government and commercial payment rates, revenue estimating risk and the impact of our related level of indebtedness on our financial performance, including earnings per share. These statements involve substantial known and unknown risks and uncertainties that could cause our actual results to differ materially from those described in the forward-looking statements, including, but not limited to, risks resulting from uncertainties associated with governmental regulations, general economic and other market conditions, competition, accounting estimates, the variability of our cash flows, the concentration of profits generated from commercial payor plans, continued downward pressure on average realized payment rates from commercial payors, which may result in the loss of revenue or patients, a reduction in the number of patients under higher-paying commercial plans, a reduction in government payment rates under the Medicare ESRD program or other government-based programs, the impact of health care reform legislation that was enacted in the United States in March 2010, changes in pharmaceutical or anemia management practice patterns, payment policies, or pharmaceutical pricing, our ability to maintain contracts with physician medical directors, legal compliance risks, including our continued compliance with complex government regulations, current or potential investigations by various governmental entities and related government or private-party proceedings, continued increased competition from large and medium-sized dialysis providers that compete directly with us, our ability to complete any acquisitions, mergers or dispositions that we might be considering or announce, or integrate and successfully operate any business we may acquire, expansion of our operations and services to markets outside the United States, or to businesses outside of dialysis and the other risk factors set forth in Part II, Item 1A. of this Quarterly Report on Form 10-Q. We base our forward-looking statements on information currently available to us, and we undertake no obligation to update or revise any forward-looking statements, whether as a result of changes in underlying factors, new information, future events or otherwise.

The following should be read in conjunction with our condensed consolidated financial statements.

Results of operations

We operate principally as a dialysis and related lab services business in the United States but also operate other ancillary services and strategic initiatives. These ancillary services and strategic initiatives consist of pharmacy services, infusion therapy services, disease management services, vascular access services, ESRD clinical research programs and physician services, direct primary care and our international dialysis operations. The U.S. dialysis and related lab services business qualifies as a separately reportable segment and all references to dialysis and related lab services continue to refer only to our U.S. dialysis and related lab services business. All of the other ancillary services and strategic initiatives operating segments, including our international dialysis operations, have been combined and disclosed in the other segments category.

 

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Table of Contents

Our consolidated operating results for the first quarter of 2012 compared with the prior sequential quarter and the same quarter of 2011 were as follows:

 

     Three months ended  
     March 31,
         2012        
    December 31,
         2011        
    March 31,
         2011        
 
     (dollar amounts rounded to nearest million)  

Consolidated operating revenues

   $ 1,920        100   $ 1,862        100   $ 1,603        100
  

 

 

     

 

 

     

 

 

   

Patient service operating revenues

   $ 1,764        $ 1,714        $ 1,497     

Less: Provision for uncollectible accounts related to patient service revenues

     (53     3     (52     3     (41     3
  

 

 

     

 

 

     

 

 

   

Net patient service operating revenues

     1,711          1,662          1,456     

Other revenues

     156          148          106     
  

 

 

     

 

 

     

 

 

   

Total net operating revenues

     1,867          1,810          1,562     
  

 

 

     

 

 

     

 

 

   

Operating expenses and charges:

            

Patient care costs

     1,263        66     1,214        65     1,114        69

General and administrative

     207        11     193        10     152        10

Depreciation and amortization

     76        4     73        4     62        4

Provision for uncollectible accounts

     2        —          3        —          1        —     

Equity investment income

     (3     —          (2     —          (2     —     
  

 

 

     

 

 

     

 

 

   

Total operating expenses and charges

     1,546        83 %(1)      1,480        82 %(1)      1,327        85 %(1) 
  

 

 

     

 

 

     

 

 

   

Operating income

   $ 321        17   $ 330        18   $ 235        15
  

 

 

     

 

 

     

 

 

   

 

(1)

The percentages include total operating expenses and charges and the provision for uncollectible accounts related to patient service revenues.

The following table summarizes consolidated net operating revenues:

 

     Three months ended  
     March 31,
2012
    December 31,
2011
    March 31,
2011
 
     (dollar amounts rounded to nearest million)  

Dialysis and related lab services patient service operating revenues

   $ 1,767      $ 1,717      $ 1,500   

Less: Provision for uncollectible accounts related to patient service revenues

     (53     (52     (41
  

 

 

   

 

 

   

 

 

 

Dialysis and related lab services net patient service operating revenues

   $ 1,714      $ 1,665      $ 1,459   

Other revenues

     3        3        2   
  

 

 

   

 

 

   

 

 

 

Total net dialysis and related lab services operating revenues

     1,717        1,668        1,461   

Other – Ancillary services and strategic initiatives

     155        147        106   

Other – Ancillary services and strategic initiatives net patient service operating revenues

     1        1        —     
  

 

 

   

 

 

   

 

 

 

Total net segment operating revenues

     1,873        1,816        1,567   

Elimination of intersegment revenues

     (6     (6     (5
  

 

 

   

 

 

   

 

 

 

Consolidated net operating revenues

   $ 1,867      $ 1,810      $ 1,562   
  

 

 

   

 

 

   

 

 

 

Consolidated operating revenues

   $ 1,920      $ 1,862      $ 1,603   
  

 

 

   

 

 

   

 

 

 

 

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Table of Contents

The following table summarizes consolidated operating income:

 

     Three months ended  
     March 31,
2012
    December 31,
2011
    March 31,
2011
 
     (dollar amounts rounded to nearest million)  

Dialysis and related lab services

   $ 348      $ 353      $ 252   

Other – Ancillary services and strategic initiatives

     (17     (13     (9
  

 

 

   

 

 

   

 

 

 

Total segment operating income

     331        340        244   

Reconciling items:

      

Stock-based compensation

     (13     (12     (10

Equity investment income

     3        2        2   
  

 

 

   

 

 

   

 

 

 

Consolidated operating income

   $ 321      $ 330      $ 235   
  

 

 

   

 

 

   

 

 

 

Consolidated operating revenues

Consolidated operating revenues for the first quarter of 2012 increased by approximately $58 million, or approximately 3.1%, as compared to the fourth quarter of 2011. The increase in consolidated operating revenues was primarily due to an increase in dialysis and related lab services operating revenues of approximately $50 million, principally due to strong volume growth from additional treatments from non-acquired growth and acquisitions, partially offset by a reduction in the number of treatments due to one fewer treatment day in the first quarter of 2012. The increase in the consolidated operating revenues was also due to an increase of approximately $3 in the average dialysis revenue per treatment, as described below.

Consolidated operating revenues for the first quarter of 2012 increased by approximately $317 million, or approximately 19.8%, as compared to the first quarter of 2011. The increase in consolidated operating revenues was primarily due to an increase in dialysis and related lab services operating revenues of approximately $268 million, principally due to strong volume growth from additional treatments from non-acquired treatment growth in existing and new centers and growth through acquisitions, and as a result of one additional treatment day in the first quarter of 2012. The increase in consolidated operating revenues was also due to an increase of approximately $6 in the average dialysis revenue per treatment, as described below, and was also due to an increase of approximately $50 million in the ancillary services and strategic initiatives revenues primarily from growth in our pharmacy services.

Consolidated operating income

Consolidated operating income for the first quarter of 2012 decreased by approximately $9 million, or approximately 2.7%, as compared to the fourth quarter of 2011. The decrease was primarily due to one fewer treatment day in the first quarter of 2012, a decline in productivity, seasonally higher payroll taxes, an increase in our pharmaceuticals costs and an increase in our professional fees for compliance and legal matters, partially offset by strong volume growth in the number of treatments and an increase in the average revenue per treatment in the dialysis and related lab services of approximately $3, as described below.

Consolidated operating income for the first quarter of 2012 increased by approximately $86 million, or approximately 36.6%, as compared to the first quarter of 2011. The increase in consolidated operating income was primarily due to strong volume growth from additional treatments as a result of non-acquired growth in existing and new centers, growth through acquisitions and as a result of one additional treatment day in the first quarter of 2012, as well as from an increase in the average dialysis revenue per treatment of approximately $6, as described below. In addition, consolidated operating income also increased as a result of overall lower pharmaceutical costs mainly from a decline in the intensities of physician-prescribed pharmaceuticals and improvements in productivity, but was negatively impacted by higher labor and benefit costs, an increase in our professional fees for legal and compliance matters, as well as an increase in the operating losses associated with our ancillary services and strategic initiatives.

 

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Table of Contents

Operating segments

Dialysis and related lab services

 

     Three months ended  
     March 31,
        2012         
    December 31,
        2011         
    March 31,
        2011         
 
     (dollar amounts rounded to nearest million, except
per treatment data)
 

Dialysis and related lab services operating revenues

   $ 1,770      $ 1,720      $ 1,502   
  

 

 

   

 

 

   

 

 

 

Patient service operating revenues

   $ 1,767      $ 1,717      $ 1,500   

Less: Provision for uncollectible accounts related to patient service revenues

     (53     (52     (41
  

 

 

   

 

 

   

 

 

 

Net patient service operating revenues

     1,714        1,665        1,459   

Other revenues

     3        3        2   
  

 

 

   

 

 

   

 

 

 

Total net operating revenues

   $ 1,717      $ 1,668      $ 1,461   
  

 

 

   

 

 

   

 

 

 

Segment operating income

   $ 348      $ 353      $ 252   
  

 

 

   

 

 

   

 

 

 

Dialysis treatments

     5,314,275        5,227,167        4,594,550   

Average dialysis treatments per treatment day

     68,132        66,167        59,669   

Average dialysis revenue per treatment (including lab services)

   $ 332      $ 329      $ 326   

Operating revenues

Dialysis and related lab services’ operating revenues for the first quarter of 2012 increased by approximately $50 million, or approximately 2.9%, as compared to the fourth quarter of 2011. The increase in operating revenues was primarily due to an increase in the number of treatments of approximately 1.7% as a result of non-acquired treatment growth in existing and new centers and from growth through acquisitions, partially offset by a reduction in the number of treatments as a result of one fewer treatment day in the first quarter of 2012. The increase in operating revenues was also due to an increase in our average dialysis revenue per treatment of approximately $3, or approximately 1.2%. The increase in the average dialysis revenue per treatment was primarily due to an increase in our Medicare reimbursements and an increase in some of our commercial payment rates, partially offset by a slight decline in our commercial payor mix.

Dialysis and related lab services’ operating revenues increased by approximately $268 million, or 17.8%, in the first quarter of 2012, as compared to the first quarter of 2011. The increase in operating revenues in the first quarter of 2012 was principally due to strong volume growth from additional treatments of approximately 15.7%, and an increase in the average dialysis revenue per treatment of approximately $6, or approximately 1.8%. The increase in the number of treatments was primarily attributable to non-acquired treatment growth at existing and new centers and growth through acquisitions and as a result of one additional treatment day in the first quarter of 2012. The increase in the average dialysis revenue per treatment was primarily due to an increase in our Medicare reimbursements, an increase in some of our commercial payment rates, partially offset by a decline in our commercial payor mix and a decline in the intensities of physician-prescribed pharmaceuticals.

Operating expenses and charges

Patient care costs. Dialysis and related lab services’ patient care costs on a per treatment basis in the first quarter of 2012 increased $3 per treatment compared to the fourth quarter of 2011. The increase in patient care costs was primarily due to higher pharmaceuticals costs, a decline in productivity, seasonally higher payroll taxes, partially offset by lower benefit costs.

Dialysis and related lab services’ patient care costs on a per treatment basis decreased by approximately $11 in the first quarter of 2012 as compared to the first quarter of 2011. The decrease in the per treatment costs was

 

30


Table of Contents

primarily attributable to lower pharmaceutical costs mainly from a decline in the intensities of physician-prescribed pharmaceuticals, improvements in productivity, partially offset by higher labor and benefit costs.

General and administrative expenses. Dialysis and related lab services’ general and administrative expenses of approximately $167 million for the first quarter of 2012 increased by approximately $14 million and $45 million as compared to the fourth quarter of 2011 and first quarter of 2011, respectively. The increase in the first quarter of 2012 as compared to the fourth quarter of 2011 was primarily due to higher labor costs and related payroll taxes, an increase in professional fees in conjunction with compliance and legal matters, partially offset by lower benefit costs. The increase in the first quarter of 2012 as compared to the first quarter of 2011 was primarily due to higher labor and benefit costs and an increase in professional fees in conjunction with compliance and legal matters.

Depreciation and amortization. Depreciation and amortization for dialysis and related lab services was approximately $74 million for the first quarter of 2012, $71 million for the fourth quarter of 2011 and $60 million for the first quarter of 2011. The increases in depreciation and amortization in the first quarter of 2012, as compared to both the fourth quarter of 2011 and the first quarter of 2011, was primarily due to growth in newly developed centers and from acquired centers.

Provision for uncollectible accounts. The provision for uncollectible accounts receivable for dialysis and related lab services was 3.0% for both the first quarter of 2012 and the fourth quarter of 2011, and was 2.7% for the first quarter of 2011. We assess our level of the provision for uncollectible accounts based upon our historical cash collection experience and trends, and have and will continue to adjust the provision as necessary as a result of changes in our cash collections.

Segment operating income

Dialysis and related lab services’ operating income for the first quarter of 2012 decreased by approximately $5 million, as compared to the fourth quarter of 2011. The decrease in operating income was primarily due to one fewer treatment day in the first quarter of 2012, a decline in productivity, seasonally higher payroll taxes, an increase in pharmaceutical costs and an increase in our professional fees in conjunction with compliance and legal matters. However, operating income benefitted from strong volume growth, an increase in the average dialysis revenue per treatment of approximately $3, as discussed above, and from lower benefit costs.

Dialysis and related lab services’ operating income for the first quarter of 2012 increased by approximately $96 million, as compared to the first quarter of 2011. The increase in operating income was primarily attributable to strong volume growth in revenues from additional treatments as a result of non-acquired treatment growth and growth through acquisitions, and as a result of one additional treatment day in the first quarter of 2012, as well as from an increase in the average dialysis revenue per treatment of approximately $6, as described above. Dialysis and related lab services’ operating income also increased as a result of lower overall pharmaceutical costs mainly from a decline in the intensities of physician-prescribed pharmaceuticals and improvements in productivity, but was negatively impacted by higher labor costs and related payroll taxes, additional benefit costs and an increase in professional fees in conjunction with compliance and legal matters.

Other – Ancillary services and strategic initiatives

 

     Three months ended  
     March 31,
2012
    December 31,
2011
    March 31,
2011
 
     (dollar amounts rounded to nearest million)  

Other revenues

   $ 155      $ 147      $ 106   

Net patient service operating revenues

     1        1        —     
  

 

 

   

 

 

   

 

 

 

Total net operating revenues

   $ 156      $ 148      $ 106   
  

 

 

   

 

 

   

 

 

 

Segment operating loss

   $ (17   $ (13   $ (9
  

 

 

   

 

 

   

 

 

 

 

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Table of Contents

Net operating revenues

The ancillary services and strategic initiatives’ net operating revenues for the first quarter of 2012 increased by approximately $8 million as compared to the fourth quarter of 2011. The increase was primarily due to an increase in revenues in our pharmacy services due to volume growth and an increase in revenues associated with our disease management services, partially offset by a decrease in revenues associated with our ESRD clinical research programs.

The increase in net operating revenues for the first quarter of 2012 of approximately $50 million, as compared to the first quarter of 2011, was primarily due to volume growth in our pharmacy services, an increase in revenues in our disease management services and in our infusion therapy services.

Operating expenses

Ancillary services and strategic initiatives’ operating expenses for the first quarter of 2012 increased by approximately $12 million as compared to the fourth quarter of 2011. The increase in operating expenses was primarily due to volume growth and an increase in labor costs associated with our pharmacy services, start up costs associated with our new direct primary care services and an increase in expenses in our disease management services.

Ancillary services and strategic initiatives’ operating expenses for the first quarter of 2012 increased by approximately $58 million as compared to the first quarter in 2011. The increase in operating expenses was primarily due to volume growth in our pharmacy services, an increase in medical supply costs, an increase in labor and benefit costs and start up costs associated with our new direct primary care services.

Segment operating results

Ancillary services and strategic initiatives’ operating losses increased by approximately $4 million in the first quarter of 2012 as compared to the fourth quarter of 2011. The increase in operating losses was primarily due to a decrease in revenues associated with our ESRD clinical research programs and additional operating losses associated with the start up of our new direct primary care services.

Ancillary services and strategic initiatives’ operating losses increased by approximately $8 million in the first quarter of 2012, as compared to the first quarter of 2011, which was primarily due to a decline in operating performance in our disease management services and in our ESRD clinical research programs, additional operating losses associated with the start up of our new direct primary care services, as well as additional expenses associated with our international expansion.

Corporate level charges

Stock-based compensation. Stock-based compensation of approximately $12.6 million in the first quarter of 2012 remained flat as compared to the fourth quarter of 2011 and increased by approximately $3 million as compared to the first quarter of 2011. The increase from the first quarter of 2011 was primarily due to an increase in the exercise price and fair value of grants that contributed expense to these respective periods.

Other income. Other income for the first quarter of 2012 increased by approximately $0.3 million as compared to the fourth quarter of 2011 and increased by approximately $0.2 million as compared to the first quarter of 2011.

Debt expense. Debt expense of $61.4 million in the first quarter of 2012 decreased by approximately $0.4 million as compared to the fourth quarter of 2011 and increased by $2.8 million as compared to the first quarter of 2011. The decrease in debt expense in the first quarter of 2012 as compared to the fourth quarter of 2011 was

 

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primarily due to fewer days outstanding during the first quarter of 2012. The increase in debt expense in the first quarter of 2012 as compared to the first quarter of 2011was primarily due to additional borrowings associated with the new Term Loan A-2 which bear higher interest rates. The overall weighted average effective interest rate for both the first quarter of 2012 and for the fourth quarter of 2011 was 5.27%, compared to 5.20% for the first quarter of 2011.

Equity investment income. Equity investment income was approximately $2.6 million for the first quarter of 2012, as compared to $2.2 million for the fourth quarter of 2011 and $1.5 million for the first quarter of 2011. The increases in equity income in the first quarter of 2012, as compared to the fourth quarter of 2011 and the first quarter of 2011, were primarily due to improvements in the operating performance of certain joint ventures.

Noncontrolling interests

Net income attributable to noncontrolling interests. Net income attributable to noncontrolling interests was $24.8 million for the first quarter of 2012, as compared to $28.0 million for the fourth quarter of 2011 and $20.3 million for the first quarter of 2011. The decrease in net income attributable to noncontrolling interests in the first quarter of 2012 as compared to the fourth quarter of 2011 was primarily due to lower profitability of our dialysis joint ventures. The increase in net income attributable to noncontrolling interests in the first quarter of 2012 as compared to the first quarter of 2011was primarily due to an increase in the overall number of joint ventures and an increase in the overall profitability of our dialysis joint ventures.

Accounts receivable

Our accounts receivable balances at March 31, 2012 and December 31, 2011 were $1,267 million and $1,195 million, respectively, which represented approximately 63 days and 61 days of revenue, respectively, net of bad debt provision. The increase in DSO was primarily the result of a slowdown in our Medicare cash collections as a result of Medicare implementing some additional new billing requirements. Our DSO calculation is based on the current quarter’s average revenues per day. There were no significant changes during the first quarter of 2012 from the fourth quarter of 2011 in the amount of unreserved accounts receivable over one year old or the amounts pending approval from third-party payors.

Outlook

We are raising our operating income guidance for 2012 to now be in the range of $1,230 million to $1,310 million. Our previous operating income guidance for 2012 was in the range of $1,200 million to $1,300 million. We also still expect our operating cash flows for 2012 to be in the range of $950 million to $1,050 million. These projections and the underlying assumptions involve significant risks and uncertainties, and actual results may vary significantly from these current projections. These risks and uncertainties, among others, include those relating to the concentration of profits generated from commercial payor plans, continued downward pressure on average realized payment rates from commercial payors, which may result in the loss of revenues or patients, a reduction in the number of patients under higher-paying commercial plans, a reduction in government payment rates under the Medicare ESRD program or other government-based programs, the impact of healthcare legislation that was enacted in the United States in March 2010, changes in pharmaceutical or anemia management practice patterns, payment policies or pharmaceutical pricing, our ability to maintain contracts with physician medical directors, legal compliance risks, including our continued compliance with complex government regulations, current or potential investigations by various government entities and related government or private-party proceedings, continued increased competition from large and medium-sized dialysis providers that compete directly with us, our ability to complete any acquisitions, mergers or dispositions that we might be considering or announce, or integrate and successfully operate any business we may acquire, and expansion of our operations and services to markets outside of the United States, or to businesses outside of dialysis. See “Risk Factors” in Part II, Item 1A. in this Quarterly Report on Form 10-Q and the cautionary language contained in the forward looking statements and associated risks as discussed under “Forward-looking statements” on page 27 for more information about these and other potential

 

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risks. We undertake no obligation to update or revise these projections, whether as a result of changes in underlying factors, new information, future events or otherwise.

Liquidity and capital resources

Liquidity and capital resources. Cash flow from operations during the first quarter of 2012 was $332 million, compared to $330 million during the first quarter of 2011. The increase in operating cash flow was primarily the result of improved cash earnings and the timing of payments for certain working capital expenditures, partially offset by an increase in our accounts receivable from a slowdown in cash collections. Non-operating cash outflows for the first quarter of 2012 included capital asset expenditures of $112 million, including $57 million for new center developments and relocations and $55 million for maintenance and information technology. We spent an additional $133 million for acquisitions. We paid distributions to noncontrolling interests of $26 million. Non-operating cash outflows for the first quarter of 2011 included capital asset expenditures of $68 million, including $28 million for new center developments and relocations and $40 million for maintenance and information technology. We also spent an additional $82 million for acquisitions and paid distributions to noncontrolling interests of $22 million.

During the first quarter of 2012, we acquired a total of 28 dialysis centers and opened 13 dialysis centers located in the United States. We previously provided management and administrative services to nine of the acquired centers. In addition, we also opened a total of four centers outside of the United States. During the first quarter of 2011, we acquired and opened a total of 33 dialysis centers, sold one center and closed two centers.

During the first three months of 2012, we made mandatory principal payments under our Senior Secured Credit Facilities totaling $12.5 million on the Term Loan A, $0.5 million on the Term Loan A-2 and $4.4 million on the Term Loan B.

As of March 31, 2012, we maintained a total of nine interest rate swap agreements with amortizing notional amounts totaling $938 million. These agreements had the economic effect of modifying the LIBOR variable component of our interest rate on an equivalent amount of our Term Loan A to fixed rates ranging from 1.59% to 1.64%, resulting in an overall weighted average effective interest rate of 4.11%, including the Term Loan A margin of 2.50%. The swap agreements expire by September 30, 2014 and require monthly interest payments. During the three months ended March 31, 2012, we accrued net charges of $3.2 million from these swaps which are included in debt expense. As of March 31, 2012, the total fair value of these swap agreements was a liability of $23.2 million. We estimate that approximately $11.9 million of existing unrealized pre-tax losses in other comprehensive income at March 31, 2012 will be reclassified into income over the next twelve months.

As of March 31, 2012, we maintained five interest rate cap agreements with notional amounts totaling $1.25 billion. These agreements have the economic effect of capping the LIBOR variable component of our interest rate at a maximum of 4.00% on an equivalent amount of our Term Loan B debt. The cap agreements expire on September 30, 2014. As of March 31, 2012, the total fair value of these cap agreements was an asset of $1.0 million. During the three months ended March 31, 2012, we recorded $0.3 million, net of tax, as a decrease to other comprehensive income due to unrealized valuation changes in the cap agreements, net of the amortization of the interest rate cap premiums that were reclassified into net income.

As a result of the swap and cap agreements, our overall weighted average effective interest rate on the Senior Secured Credit Facilities was 4.63%, based upon the current margins in effect of 2.50% for the Term Loan A, 3.50% for the Term Loan A-2 and 3.00% for the Term Loan B, as of March 31, 2012.

As of March 31, 2012, interest rates on our Term Loan A-2 and Term Loan B debt are set at their interest rate floors. Interest rates on our senior notes and Term Loan A are fixed and economically fixed, respectively, while rates on $1.25 billion of our Term Loan B are subject to interest rate caps.

 

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Our overall weighted average effective interest rate during the first quarter of 2012 was 5.27% and as of March 31, 2012 was 5.28%.

As of March 31, 2012, we had undrawn revolving credit facilities totaling $350 million of which approximately $52 million was committed for outstanding letters of credit.

We believe that we will have sufficient liquidity and will generate significant operating cash flows to fund our scheduled debt service and other obligations for the foreseeable future, including the next 12 months, under the terms of our debt agreements. Our primary sources of liquidity are cash from operations and cash from borrowings.

Stock-based compensation

Stock-based compensation recognized in a period represents the amortization during that period of the estimated grant-date fair value of current and prior stock-based awards over their vesting terms, adjusted for expected forfeitures. Shares issued upon exercise of stock awards are generally issued from shares in treasury. We have used the Black-Scholes-Merton valuation model for estimating the grant-date fair value of stock-settled stock appreciation rights granted in all periods. During the three months ended March 31, 2012, we granted 0.1 million stock-settled stock appreciation rights with an aggregate grant-date fair value of $1.9 million and a weighted-average expected life of approximately 3.5 years, and also granted 8,000 stock units with an aggregate grant-date fair value of $0.7 million and a weighted-average expected life of approximately 2.0 years.

For the three months ended March 31, 2012 and 2011, we recognized $12.6 million and $9.7 million, respectively, in stock-based compensation expense for stock appreciation rights, stock units and discounted employee stock plan purchases, which are primarily included in general and administrative expenses. The estimated tax benefits recorded for stock-based compensation through March 31, 2012 and 2011was $4.7 million and $3.7 million, respectively. As of March 31, 2012, there was $82.4 million of total estimated unrecognized compensation cost related to nonvested stock-based compensation arrangements under our equity compensation and stock purchase plans. We expect to recognize this cost over a weighted average remaining period of 1.4 years.

During the three months ended March 31, 2012 and 2011, we received $1.4 million and $2.2 million, respectively, in cash proceeds from stock option exercises and $10.9 million and $13.9 million, respectively, in actual tax benefits upon the exercise of stock awards.

Off-balance sheet arrangements and aggregate contractual obligations

In addition to the debt obligations reflected on our balance sheet, we have commitments associated with operating leases and letters of credit, as well as potential obligations associated with our equity investments in nonconsolidated businesses and to dialysis centers that are wholly-owned by third parties. Substantially all of our facilities are leased. We have potential acquisition obligations for several joint ventures and for some of our non-wholly-owned subsidiaries in the form of put provisions. If these put provisions were exercised, we would be required to purchase the third-party owners’ noncontrolling interests at either the appraised fair market value or a predetermined multiple of earnings or cash flow attributable to the noncontrolling interests put to us, which is intended to approximate fair value. The methodology we use to estimate the fair values of noncontrolling interests subject to put provisions assumes either the higher of a liquidation value of net assets or an average multiple of earnings, based on historical earnings, patient mix and other performance indicators, as well as other factors. The estimated fair values of the noncontrolling interests subject to put provisions is a critical accounting estimate that involves significant judgments and assumptions and may not be indicative of the actual values at which the noncontrolling interests may ultimately be settled, which could vary significantly from our current estimates. The estimated fair values of noncontrolling interests subject to put provisions can fluctuate and the implicit multiple of earnings at which these noncontrolling interests obligations may be settled will vary

 

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significantly depending upon market conditions including potential purchasers’ access to the capital markets, which can impact the level of competition for dialysis and non-dialysis related businesses, the economic performance of these businesses and the restricted marketability of the third-party owners’ noncontrolling interests. The amount of noncontrolling interests subject to put provisions that contractually employ a predetermined multiple of earnings rather than fair value are immaterial. For additional information see Note 8 to the condensed consolidated financial statements.

We also have certain potential commitments to provide operating capital to several dialysis centers that are wholly-owned by third parties or centers in which we own a minority equity investment as well as to physician-owned vascular access clinics that we operate under management and administrative services agreements.

The following is a summary of these contractual obligations and commitments as of March 31, 2012 (in millions):

 

     Remainder of
2012
     1-3
years
     4-5
years
     After
5 years
     Total  

Scheduled payments under contractual obligations:

              

Long-term debt

   $ 56       $ 300       $ 2,535       $ 1,556       $ 4,447   

Interest payments on the senior notes

     100         202         202         279         783   

Interest payments on the Term Loan B (1)

     59         155         137         —           351   

Interest payments on Term Loan A-2 (2)

     6         18         16         —           40   

Capital lease obligations

     2         6         5         39         52   

Operating leases

     205         473         398         701         1,777   

Construction of the new corporate headquarters

     30         —           —           —           30   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
   $ 458       $ 1,154       $ 3,293       $ 2,575       $ 7,480   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Potential cash requirements under existing commitments:

              

Letters of credit

   $ 52       $ —         $ —         $ —         $ 52   

Noncontrolling interests subject to put provisions

     278         109         71         46         504   

Pay-fixed swaps potential obligations

     9         14         —           —           23   

Operating capital advances

     4         —           —           —           4   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
   $ 343       $ 123       $ 71       $ 46       $ 583   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) 

Assuming no changes to LIBOR-based interest rates as the Term Loan B currently bears interest at LIBOR (floor of 1.50%) plus an interest rate margin of 3.00%.

(2)

Assuming no changes to LIBOR-based interest rates as the Term Loan A-2 currently bears interest at LIBOR (floor of 1.00%) plus an interest rate margin of 3.50%.

The pay-fixed swap obligations represent the estimated fair market values of our interest rate swap agreements as reported by various broker dealers that are based upon relevant observable market inputs as well as other current market conditions that existed as of March 31, 2012, and represent the estimated potential obligation that we would be required to pay based upon the estimated future settlement of each specific tranche over the term of the swap agreements, assuming no future changes in the forward yield curve. The actual amount of our obligation associated with these swaps in the future will depend upon changes in the LIBOR-based interest rates that can fluctuate significantly depending upon market conditions, and other relevant factors that can affect the fair market value of these swap agreements.

In addition to the above commitments, we are obligated to purchase a certain amount of our hemodialysis products and supplies at fixed prices through 2015 from Gambro Renal Products, Inc. in connection with the Alliance and Product Supply Agreement. Our total expenditures for the three months ended March 31, 2012 on such products were approximately 2% of our total operating costs. In addition, we are obligated to purchase a certain amount of dialysis equipment, parts and supplies from Fresenius Medical Care, or Fresenius, through

 

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2013. Our total expenditures for the three months ended March 31, 2012 on such products were approximately 2% of our total operating costs.

The actual amount of purchases in future years from Gambro Renal Products and Fresenius will depend upon a number of factors, including the operating requirements of our centers, the number of centers we acquire, growth of our existing centers, and in the case of the Alliance and Product Supply Agreement, Gambro Renal Products’ ability to meet our needs.

In November 2011, we entered into a seven year Sourcing and Supply Agreement with Amgen USA Inc. that expires on December 31, 2018. Under the terms of the agreement we will purchase EPO in amounts necessary to meet no less than 90% of our requirements for erythropoiesis stimulating agents. The actual amount of EPO that we will purchase from Amgen will depend upon the amount of EPO administered during dialysis as prescribed by physicians and the overall number of patients that we serve.

The settlements of approximately $13 million of existing income tax liabilities for unrecognized tax benefits are excluded from the above table as reasonably reliable estimates of the timing cannot be made.

Significant new accounting standards

On January 1, 2012, we adopted FASB’s Accounting Standard Update (ASU) No. 2011-08, Intangibles—Goodwill and Other. This standard amends the current two-step goodwill impairment test required under the existing accounting guidance. This amendment allows entities the option to first assess certain qualitative factors to ascertain whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount to determine if the two-step impairment test is necessary. If an entity concludes that certain events or circumstances prove that it is more likely than not that the fair value of a reporting unit is less than its carrying amount then an entity is required to proceed to step one of the two-step goodwill impairment test. This standard was effective on January 1, 2012. The adoption of this standard did not have a material impact on our consolidated financial statements.

On January 1, 2012, we adopted FASB’s ASU No. 2011-07, Health Care Entities-Presentation and Disclosure of Patient Service Revenue, Provision for Bad Debts, and the Allowance for Doubtful Accounts. This standard amends the current presentation and disclosure requirements for Health Care Entities that recognize significant amounts of patient service revenues at the time the services are rendered without assessing the patient’s ability to pay. This standard requires health care entities to reclassify the provision for bad debts from an operating expense to a deduction from patient service revenues. In addition, this standard requires more disclosure on the policies for recognizing revenue, assessing bad debts, as well as quantitative and qualitative information regarding changes in the allowance for doubtful accounts. This standard was applied retrospectively to all prior periods presented and was effective on January 1, 2012. Upon adoption of this standard, we changed our presentation of our provision for uncollectible accounts related to patient service revenues as a deduction from our patient service operating revenues and enhanced its disclosures as indicated above. See Note 14 to the condensed consolidated financial statements for further details.

On January 1, 2012, we adopted FASB’s ASU No. 2011-05, Comprehensive Income—Presentation of Comprehensive Income. This standard amends the current presentation requirements for comprehensive income by eliminating the presentation of the components of other comprehensive income within the statement of equity. This standard allows two options on how to present the various components of comprehensive income. These options are either to report the components of comprehensive income separately on the income statement or to present total other comprehensive income and the components of other comprehensive income in a separate statement. This standard does not change the items that must be reported in other comprehensive income or when an item must be reclassified into net income. The FASB temporarily deferred the requirement to present separate line items on the statement of income for the amounts that are realized and reclassified out of accumulated other comprehensive income into net income. No timetable has been set for FASB’s reconsideration of this item. This

 

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standard, except for the requirements that were deferred, as stated above, was applied retrospectively and was effective on January 1, 2012. Upon adoption of this standard, we presented total other comprehensive income and the components of other comprehensive income in a separate statement of comprehensive income.

On January 1, 2012, we adopted FASB’s ASU No. 2011-04, Fair Value Measurement. This standard amends the current fair value measurement and disclosure requirements to improve comparability between U.S. GAAP and International Financial Reporting Standards (IFRS). The intent of this standard is to update the disclosures that describe several of the requirements in U.S. GAAP for measuring fair value and to enhance disclosures about fair value measurements which will improve consistency between U.S. GAAP and IFRS. This standard does not change the application of the requirements on fair value measurements and disclosures. This was applied prospectively and was effective on January  1, 2012. The adoption of this standard did not have a material impact on our consolidated financial statements.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

Interest rate sensitivity

The tables below provide information about our financial instruments that are sensitive to changes in interest rates. The table below presents principal repayments and current weighted average interest rates on our debt obligations as of March 31, 2012. The variable rates presented reflect the weighted average LIBOR rates in effect for all debt tranches plus interest rate margins in effect as of March 31, 2012. The Term Loan A margin currently in effect is 2.50% and along with the revolving line of credit is subject to adjustment depending upon changes in certain of our financial ratios including a leverage ratio. The Term Loan A-2 currently bears interest at LIBOR (floor of 1.00%) plus an interest rate margin of 3.50% subject to a ratings based step-down to 3.25%. The Term Loan B currently bears interest at LIBOR (floor of 1.50%) plus an interest rate margin of 3.00% subject to a ratings based step-down to 2.75%.

 

     Expected maturity date      Thereafter      Total      Average
interest
rate
    Fair
value
 
   2012      2013      2014      2015      2016      2017             

Long term debt:

                            

Fixed rate

   $ 20       $ 25       $ 25       $ 25       $ 1,860       $ 6       $ 1,589       $ 3,550         5.58   $ 3,608   

Variable rate

   $ 38       $ 102       $ 154       $ 653       $ 2       $ —         $ —         $ 949         2.83   $ 953   

 

    Notional
amount
    Contract maturity date     Pay fixed     Receive variable     Fair
value
 
      2012     2013     2014     2015     2016        
    (dollars in millions)                    

Swaps:

                 

Pay-fixed rate

  $ 938      $ 38      $ 100      $ 800      $ —        $ —          1.59% to 1.64%        LIBOR      $ (23.2

Cap agreements

  $ 1,250      $ —        $ —        $ 1,250      $ —        $ —            LIBOR above 4.00   $ 1.0   

Our Senior Secured Credit Facilities, which include the Term Loan A, the Term Loan A-2 and the Term Loan B, consist of various individual tranches of debt that can range in maturity from one month to twelve months (currently, all tranches are one month in duration). For the Term Loan A, each tranche bears interest at a LIBOR rate that is determined by the duration of such tranche plus an interest rate margin. The LIBOR variable component of the interest rate for each tranche is reset as such tranche matures and a new tranche is established. LIBOR can fluctuate significantly depending upon conditions in the credit and capital markets.

The Term Loan A-2 and Term Loan B are subject to LIBOR floors of 1.00% and 1.50%, respectively. Because LIBOR, as of March 31, 2012, was lower than either of these floors, the interest rates on the Term Loan A-2 and the Term Loan B are treated as “fixed” for purposes of the table above. We have included both of these Term Loans in the fixed rate totals in the table above until such time as the LIBOR-based component of our interest rate exceeds 1.00% on the Term Loan A-2 and 1.50% on the Term Loan B. At such time, we will then be

 

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subject to LIBOR-based interest rate volatility on the LIBOR variable component of our interest rate on all of the Term Loan A-2, as well as for the Term Loan B, but limited to a maximum rate of 4.00% on $1.25 billion of outstanding principal debt on the Term Loan B. The remaining $478 million outstanding principal balance of the Term Loan B is subject to LIBOR-based interest rate volatility above a floor of 1.50%.

As of March 31, 2012, we maintained a total of nine interest rate swap agreements with amortizing notional amounts totaling $938 million. These agreements had the economic effect of modifying the LIBOR variable component of our interest rate on an equivalent amount of our Term Loan A to fixed rates ranging from 1.59% to 1.64%, resulting in an overall weighted average effective interest rate of 4.11%, including the Term Loan A margin of 2.50%. The swap agreements expire by September 30, 2014 and require monthly interest payments. During the three months ended March 31, 2012, we accrued net charges of $3.2 million from these swaps which are included in debt expense. As of March 31, 2012, the total fair value of these swap agreements was a liability of $23.2 million. We estimate that approximately $11.9 million of existing unrealized pre-tax losses in other comprehensive income at March 31, 2012 will be reclassified into income over the next twelve months.

As of March 31, 2012, we maintained five interest rate cap agreements with notional amounts totaling $1.25 billion. These agreements have the economic effect of capping the LIBOR variable component of our interest rate at a maximum of 4.00% on an equivalent amount of our Term Loan B debt. The cap agreements expire on September 30, 2014. As of March 31, 2012, the total fair value of these cap agreements was an asset of $1.0 million. During the three months ended March 31, 2012, we recorded $0.3 million, net of tax, as a decrease to other comprehensive income due to unrealized valuation changes in the cap agreements, net of the amortization of the interest rate cap premiums that were reclassified into net income.

As a result of the swap and cap agreements, the overall weighted average effective interest rate on the Senior Secured Credit Facilities was 4.63%, based upon the current margins in effect of 2.50% for the Term Loan A, 3.50% for the Term Loan A-2 and 3.00% for the Term Loan B, as of March 31, 2012.

As of March 31, 2012, interest rates on our Term Loan A-2 and Term Loan B debt are set at their interest rate floors. Interest rates on our senior notes and Term Loan A are fixed and economically fixed, respectively, while rates on $1.25 billion of our Term Loan B are subject to interest rate caps.

The overall weighted average effective interest rate during the first quarter of 2012 was 5.27% and as of March 31, 2012 was 5.28%.

Item 4. Controls and Procedures

Management has established and maintains disclosure controls and procedures designed to ensure that information required to be disclosed in the reports that it files or submits pursuant to the Securities Exchange Act of 1934, as amended, or Exchange Act, is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and that such information is accumulated and communicated to the Company’s management, including its Chief Executive Officer and Chief Financial Officer, as appropriate to allow for timely decisions regarding required disclosures.

At the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures in accordance with the Exchange Act requirements. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures are effective for timely identification and review of material information required to be included in the Company’s Exchange Act reports, including this report on Form 10-Q. Management recognizes that these controls and procedures can provide only reasonable assurance of desired outcomes, and that estimates and judgments are still inherent in the process of maintaining effective controls and procedures.

 

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There has not been any change in the Company’s internal control over financial reporting that was identified during the evaluation that occurred during the fiscal quarter covered by this report on Form 10-Q that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

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PART II

OTHER INFORMATION

 

Item 1. Legal Proceedings

The information in Note 5 of the Notes to Condensed Consolidated Financial Statements in Part I, Item 1 of this report is incorporated by this reference in response to this item.

 

Item 1A. Risk Factors

A restated description of the risk factors associated with our business is set forth below. This description includes any material changes to and supersedes the description of the risk factors associated with our business previously disclosed in Part I, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2011. The risks discussed below are not the only ones facing our business. Please read the cautionary notice regarding forward-looking statements under the heading “Management’s Discussion and Analysis of Financial Condition and Results of Operations”.

If the average rates that commercial payors pay us decline significantly, it would have a material adverse effect on our revenues, earnings and cash flows.

Approximately 34% of our dialysis and related lab services revenues for the quarter ended March 31, 2012 were generated from patients who have commercial payors as the primary payor. The majority of these patients have insurance policies that pay us on terms and at rates that are generally significantly higher than Medicare rates. The payments we receive from commercial payors generate nearly all of our profit and all of our nonacute dialysis profits come from commercial payors. We continue to experience downward pressure on some of our commercial payment rates and it is possible that commercial payment rates could be materially lower in the future. The downward pressure on commercial payment rates is a result of general conditions in the market, recent and future consolidations among commercial payors, increased focus on dialysis services and other factors.

We are continuously in the process of negotiating our existing or potentially new agreements with commercial payors who tend to be aggressive in their negotiations with us. Sometimes many significant agreements are up for renewal or being renegotiated at the same time. In the event that our continual negotiations result in overall commercial rate reductions in excess of overall commercial rate increases, the cumulative effect could have a material adverse effect on our financial results. Consolidations have significantly increased the negotiating leverage of commercial payors. Our negotiations with payors are also influenced by competitive pressures. We expect that some of our contracted rates with commercial payors may decrease or that we may experience decreases in patient volume as our negotiations with commercial payors continue. In addition to increasing downward pressure on contracted commercial payor rates, payors have been attempting to impose restrictions and limitations on non-contracted or out-of-network providers. In some circumstances for some commercial payors, our centers are designated as out-of-network providers. Rates for out-of-network providers are on average higher than rates for in-network providers. We believe commercial payors have or will begin to restructure their benefits to create disincentives for patients to select or remain with out-of-network providers and to decrease payment rates for out-of-network providers. Decreases in out-of-network rates and restrictions on out-of-network access combined with decreases in contracted rates could result in a significant decrease in our overall revenues derived from commercial payors. If the average rates that commercial payors pay us decline significantly, it would have a material adverse effect on our revenues, earnings and cash flows.

If the number of patients with higher-paying commercial insurance declines, then our revenues, earnings and cash flows would be substantially reduced.

Our revenue levels are sensitive to the percentage of our patients with higher-paying commercial insurance coverage. A patient’s insurance coverage may change for a number of reasons, including changes in the patient’s

 

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or a family member’s employment status. Currently, for a patient covered by an employer group health plan, Medicare generally becomes the primary payor after 33 months, or earlier, if the patient’s employer group health plan coverage terminates. When Medicare becomes the primary payor, the payment rate we receive for that patient shifts from the employer group health plan rate to the lower Medicare payment rate. We have seen an increase in the number of patients who have government-based programs as their primary payors which we believe is largely a result of improved mortality and recent economic conditions which have a negative impact on the percentage of patients covered under commercial insurance plans. To the extent there are sustained or increased job losses in the United States, independent of whether general economic conditions might be improving, we could experience a continued decrease in the number of patients covered under commercial plans. We could also experience a further decrease if changes to the healthcare regulatory system result in fewer patients covered under commercial plans or an increase of patients covered under more restrictive commercial plans with lower reimbursement rates. In addition, our continuous process of negotiations with commercial payors under existing or potentially new agreements could result in a decrease in the number of patients under commercial plans to the extent that we cannot reach agreement with commercial payors on rates and other terms, resulting in termination or non-renewals of existing agreements or our inability to enter into new ones. If there is a significant reduction in the number of patients under higher-paying commercial plans relative to government-based programs that pay at lower rates, it would have a material adverse effect on our revenues, earnings and cash flows.

Changes in the structure of, and payment rates under the Medicare ESRD program, including the Budget Control Act of 2011 and other healthcare reform initiatives, could substantially reduce our revenues, earnings and cash flows.

Approximately 49% of our dialysis and related lab services revenues for the quarter ended March 31, 2012 was generated from patients who have Medicare as their primary payor. Prior to January 1, 2011, the Medicare ESRD program paid us for dialysis treatment services at a fixed composite rate. The Medicare composite rate was the payment rate for a dialysis treatment including the supplies used in those treatments, specified laboratory tests and certain pharmaceuticals. Certain other pharmaceuticals, including EPO, vitamin D analogs and iron supplements, as well as certain specialized laboratory tests, were separately billed.

In July 2008, the Medicare Improvements for Patients and Providers Act of 2008 was passed by Congress. This legislation introduced a new payment system for dialysis services beginning in January 2011 whereby payment for dialysis treatment and related services is now made under a bundled payment rate which provides a fixed rate to encompass all goods and services provided during the dialysis treatment, including pharmaceuticals that were historically separately reimbursed to the dialysis providers, such as EPO, vitamin D analogs and iron supplements, as well as laboratory testing. In August 2010, the Centers for Medicare & Medicaid Services, or CMS, published the final rule implementing the bundled payment in the Federal Register. The initial 2011 bundled rate included reductions of 2% from the prior reimbursement and further reduced overall rates by 5.94% tied to an expanded list of case-mix adjustors which can be earned back based upon the presence of certain patient characteristics and co-morbidities at the time of treatment. There are also other provisions which may impact payment including an outlier pool and a low volume facility adjustment.

Another important provision in the law is an annual adjustment, or market basket update, to the base ESRD Prospective Payment Rate (PPS). Absent action by Congress the PPS base rate will be automatically updated by a formulaic inflation adjustment.

On November 1, 2011, CMS issued the final ESRD PPS rule for 2012. The base will increase by 2.1%, representing a market base of increase of 3.0% less a productivity adjustment of 0.9%. The increase in the final base rate for 2012 (2.1%) is slightly greater than the increase of 1.8% stated in the proposed 2012 ESRD PPS rule published in July 2011, and was made irrespective of the Medicare Payment Advisory Commission, or MedPAC, recommendation for a reduced increase. The MedPAC focus on such a reduction indicates further scrutiny of the annual update is possible.

 

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We believe the new payment system presents operating, clinical and financial risks. For example, with regard to the expanded list of case-mix adjustors, there is a risk that our dialysis centers or billing and other systems may not accurately document and track the appropriate patient-specific characteristics, resulting in a reduction or overpayment in the amounts of the payments that we would otherwise be entitled to receive.

Beginning January 1, 2014, certain oral-only ESRD drugs (currently paid separately to pharmacies under Medicare Part D) will be included in the ESRD bundled payment to dialysis facilities. CMS delayed the inclusion of these oral only ESRD drugs until 2014 in order to assess whether the pricing mechanism used for oral drugs with injectable equivalents (included in the bundle beginning January 1, 2011) could be applied to oral only drugs. It is currently unclear how CMS will “price” the oral-only drugs for inclusion in the ESRD bundle in 2014. Inadequate pricing could have a significant negative financial impact on our dialysis facilities given the volume and value of these drugs.

We expect to continue experiencing increases in operating costs that are subject to inflation, such as labor and supply costs, regardless of whether there is a compensating inflation-based increase in Medicare payment rates or in payments under the new bundled payment rate system.

On August 2, 2011, the President signed into law the “Budget Control Act of 2011” (Public Law 112-25), which raised the debt ceiling and put into effect a series of actions to reduce the federal budget deficit over ten years. As a result of certain failures to act by a special committee created by the legislation and subsequent failure by Congress to enact deficit reduction legislation, we expect Medicare providers will be cut by 2% of total program costs in 2013.

We also cannot predict whether we will be able to comply with the CMS rules related to the bundled payment system as processes and systems are modified substantially to capture all required data. To the extent we are not able to adequately bill and collect for certain payment adjustors and are not able to offset the mandated reductions in reimbursement or if we face regulatory enforcement actions and penalties as a result of alleged improper billing of governmental programs, it could have a material adverse effect on our revenues, earnings and cash flows. (For additional details regarding the risks we face for failing to adhere to our Medicare and Medicaid regulatory compliance obligations, see the risk factor below under the heading “If we fail to adhere to all of the complex government regulations that apply to our business, we could suffer severe consequences that would substantially reduce our revenues, earnings and cash flows”).

Health care reform could substantially reduce our revenues, earnings and cash flows.

In March 2010, broad health care reform legislation was enacted in the United States. Although many of the provisions of the new legislation do not take effect immediately, and may be modified before they are implemented, the reforms could have an impact on our business in a number of ways. We cannot predict how employers, private payors or persons buying insurance might react to these changes or what form many of these regulations will take before implementation. In July 2011, the Department of Health and Human Services, or HHS, issued two proposed rules related to the establishment of health care insurance exchanges due to be operating by 2014 that will provide a marketplace for eligible individuals to purchase health care insurance. The proposed rules provide clarifications on the requirements related to implementation of such exchanges, outline areas of state flexibility in their implementation of such exchanges and provide standards for certain risk adjustment mechanisms. We believe the establishment of health care insurance exchanges could result in a reduction in patients covered by commercial insurance or an increase of patients covered under more restrictive commercial plans with lower reimbursement rates. To the extent that the implementation of such exchanges results in a reduction in patients covered by commercial insurance or a reduction in reimbursement rates for our services from commercial and/or government payors, our revenues, earnings and cash flows could be adversely affected.

In October 2011, CMS issued a final rule concerning the Medicare Shared Savings Program established by the health care reform legislation, which under the statute was required to be implemented no later than

 

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January 1, 2012. The Medicare Shared Savings Program will provide financial incentives to health care providers and suppliers that work together to furnish coordinated, high-quality care to Medicare beneficiaries through accountable care organizations, or ACOs.

To qualify for financial incentives, ACOs must successfully satisfy quality performance standards and also reduce health care costs. ACOs will receive higher percentages of shared savings if they demonstrate they are providing high quality care and achieving a minimum savings based upon the average per capita Medicare expenditures for beneficiaries who have been assigned to the ACOs. Separate expenditure calculations will be made for certain Medicare beneficiary populations, including beneficiaries with ESRD. During an ACO’s initial three-year agreement period, the ACO may elect to operate under a one-sided model, where the ACO shares in savings but is not responsible for losses (i.e., costs that exceed a target established by CMS) or a two-sided model, whereby the ACO is eligible for higher sharing rates but in addition to sharing in savings, is at risk for sharing in any losses. During subsequent agreement periods, the ACO must operate under the two-sided model.

CMS will start accepting applications from prospective ACOs in early 2012: ACOs may apply to participate in the program with a start date of April 1, 2012 or July 1, 2012. We are currently uncertain of the extent to which ACOs will impact the health care market. As a provider of dialysis services, we may choose to participate in one or several ACOs. Even if we do not participate in this program, we will need to be aware of how we are performing under the program’s criteria. An ACO’s quality measures and expenditures include the care furnished by non-participating providers. Therefore, if our patients are assigned to ACOs, the quality and cost of care that we furnish will be included in the ACOs’ calculations regardless of our participation in the program. We may also be competing against ACOs. If we are unable to perform at the levels established under the program we may be at risk for losing our Medicare patient base, which would have a materially adverse effect on our revenues, earnings and cash flow. Furthermore, even if providers and suppliers elect not to participate in ACOs, there are many similar initiatives with government and private payors that are being implemented and which may arise in the future, including the development of models similar to ACOs, Independent Practice Associations and Integrated Delivery Systems or evolutions of those concepts.

For example, the CMS Center for Medicare & Medicaid Innovation, or Innovation Center, has developed several other demonstration projects aimed at reforming care delivery that include shared savings, such as the Pioneer Accountable Care Organizations Model, the Bundled Payments for Care Improvement Initiative and the Comprehensive Primary Care Initiative. In addition, the Innovation Center may establish other demonstration projects that involve shared savings in the future and it is possible that partial capitation arrangements and specific diseases or care settings may be targeted. The further development of these types of models could create situations where ACOs or similar entities are accountable for coordinating more care for patients. This shift in accountability may require us to negotiate contracts for services with intermediaries instead of directly with the payors. It is possible that payment rates negotiated with intermediaries could be materially lower in the future, which would have a material adverse effect on our revenues, earnings and cash flows.

In addition, the health care reform legislation introduced severe penalties for the knowing and improper retention of overpayments collected from government payors. As a result, we made initial significant investments in additional resources to accelerate the time it takes to identify and process overpayments and we may be required to make additional investments in the future. Acceleration in our ability to identify and process overpayments could result in us refunding overpayments to government or other payors sooner than we have in the past, which could have a material adverse effect on our operating cash flows. The failure to return identified overpayments within the specified time frame is now a violation of the federal False Claims Act, or FCA.

The health care reform legislation also reduced the timeline to file Medicare claims, which now must be filed with the government within one calendar year after the date of service. To comply with this reduced timeline, we must deploy significant resources and may change our claims processing methods to ensure that our Medicare claims are filed in a timely fashion. Failure to file a claim within the one year window could result in payment denials, adversely affecting our revenues, earnings and cash flows.

 

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Effective March 2011, CMS instituted new screening procedures and a new $500 enrollment fee for providers enrolling and re-enrolling in government health care programs. A provider is subject to screening upon initial enrollment and each time the provider re-validates its enrollment application. Screening includes verification of enrollment information and review of various federal databases to ensure the provider has valid tax identification, NPI numbers and is not excluded. We expect this screening process to delay the Medicare contractor approval process, potentially causing a delay in reimbursement. The enrollment fee is also applicable upon initial enrollment, re-validation, and each time an existing provider adds a new facility location. This fee is an additional expense that must be paid for each center every three years and could be more significant if other government and commercial payors follow this trend. Ultimately, we anticipate the new screening and enrollment requirements will require additional personnel and financial resources and will potentially delay the enrollment and revalidation of our centers which in turn will delay payment.

Other reform measures allow CMS to place a moratorium on new enrollment of providers and to suspend payment to providers upon a credible allegation of fraud from any source. These types of reform measures, or others, depending upon the scope and breadth of the implementing regulations, could adversely impact our revenues, earnings and cash flows.

There are numerous steps required to implement the broad healthcare reform legislation adopted by Con