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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

For the Quarter Ended

March 31, 2003

 

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

SECURITIES EXCHANGE ACT OF 1934

 

Commission File Number: 1-4034

 

 

DAVITA INC.

 

21250 Hawthorne Blvd., Suite 800

Torrance, California 90503-5517

Telephone number (310) 792-2600

 

Delaware

(State of incorporation)

 

51-0354549

(I.R.S. Employer Identification No.)

 

 

The Registrant 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 and has been subject to such filing requirements for the past 90 days.

 

The Registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).

 

As of May 1, 2003, there were approximately 61.1 million shares of the Registrant’s common stock (par value $0.001) outstanding.

 



Table of Contents

DAVITA INC.

 

INDEX

 

        

Page No.


   

PART I.    FINANCIAL INFORMATION

    

Item 1.

 

Condensed Consolidated Financial Statements:

    
   

Consolidated Balance Sheets as of March 31, 2003 and December 31, 2002

  

1

   

Consolidated Statements of Income and Comprehensive Income for the three months ended March 31, 2003 and March 31, 2002

  

2

   

Consolidated Statements of Cash Flows for the three months ended March 31, 2003 and March 31, 2002

  

3

   

Notes to Condensed Consolidated Financial Statements

  

4

Item 2.

 

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

  

13

Item 3.

 

Quantitative and Qualitative Disclosures About Market Risk

  

17

Item 4.

 

Controls and Procedures

  

17

Risk Factors

  

18

   

PART II.    OTHER INFORMATION

    

Item 1.

 

Legal Proceedings

  

23

Item 6.

 

Exhibits and Reports on Form 8-K

  

24

Signature

  

25

Certifications

  

26


Note:   Items 2, 3, 4 and 5 of Part II are omitted because they are not applicable.

 

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DAVITA INC.

 

CONSOLIDATED BALANCE SHEETS

(unaudited)

(dollars in thousands, except per share data)

 

    

March 31, 2003


    

December 31, 2002


 

ASSETS

                 

Cash and cash equivalents

  

$

304,994

 

  

$

96,475

 

Accounts receivable, less allowance of $48,743 and $48,927

  

 

346,145

 

  

 

344,292

 

Inventories

  

 

25,465

 

  

 

34,929

 

Other current assets

  

 

24,049

 

  

 

28,667

 

Deferred income taxes

  

 

41,773

 

  

 

40,163

 

    


  


Total current assets

  

 

742,426

 

  

 

544,526

 

Property and equipment, net

  

 

305,742

 

  

 

298,475

 

Amortizable intangibles, net

  

 

60,080

 

  

 

63,159

 

Investments in third-party dialysis businesses

  

 

3,368

 

  

 

3,227

 

Other long-term assets

  

 

2,609

 

  

 

1,520

 

Goodwill

  

 

865,449

 

  

 

864,786

 

    


  


    

$

1,979,674

 

  

$

1,775,693

 

    


  


LIABILITIES AND SHAREHOLDERS’ EQUITY

                 

Accounts payable

  

$

71,295

 

  

$

77,890

 

Other liabilities

  

 

113,505

 

  

 

101,389

 

Accrued compensation and benefits

  

 

82,391

 

  

 

95,435

 

Current portion of long-term debt

  

 

43,908

 

  

 

7,978

 

Income taxes payable

  

 

26,550

 

  

 

9,909

 

    


  


Total current liabilities

  

 

337,649

 

  

 

292,601

 

Long-term debt

  

 

1,420,585

 

  

 

1,311,252

 

Other long-term liabilities

  

 

10,346

 

  

 

9,417

 

Deferred income taxes

  

 

72,381

 

  

 

65,930

 

Minority interests

  

 

27,156

 

  

 

26,229

 

Shareholders’ equity:

                 

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

                 

Common stock ($0.001 par value, 195,000,000 shares authorized; 89,162,390 and 88,874,896 shares issued)

  

 

89

 

  

 

89

 

Additional paid-in capital

  

 

523,572

 

  

 

519,369

 

Retained earnings

  

 

249,750

 

  

 

213,337

 

Treasury stock, at cost (28,187,326 and 28,216,177 shares)

  

 

(661,854

)

  

 

(662,531

)

    


  


Total shareholders’ equity

  

 

111,557

 

  

 

70,264

 

    


  


    

$

1,979,674

 

  

$

1,775,693

 

    


  


 

See notes to condensed consolidated financial statements.

 

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Table of Contents

DAVITA INC.

 

CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME

(unaudited)

(dollars in thousands, except per share data)

 

    

Three months ended

March 31,


    

2003


  

2002


Net operating revenues

  

$

459,807

  

$

427,665

Operating expenses and charges:

             

Dialysis centers and labs

  

 

316,710

  

 

291,634

General and administrative

  

 

36,787

  

 

36,053

Depreciation and amortization

  

 

17,445

  

 

15,805

Provision for uncollectible accounts

  

 

8,237

  

 

5,255

Minority interests and equity income, net

  

 

1,294

  

 

2,135

    

  

Total operating expenses and charges

  

 

380,473

  

 

350,882

    

  

Operating income

  

 

79,334

  

 

76,783

Debt expense

  

 

19,456

  

 

15,072

Other income, net

  

 

785

  

 

267

    

  

Income before income taxes

  

 

60,663

  

 

61,978

Income tax expense

  

 

24,250

  

 

26,000

    

  

Net income

  

$

36,413

  

$

35,978

    

  

Comprehensive income

  

$

36,413

  

$

35,978

    

  

Earnings per share:

             

Basic

  

$

0.60

  

$

0.43

    

  

Diluted

  

$

0.52

  

$

0.40

    

  

Weighted average shares for earnings per share:

             

Basic

  

 

60,905,056

  

 

82,967,141

    

  

Diluted

  

 

78,772,410

  

 

102,246,452

    

  

 

 

See notes to condensed consolidated financial statements.

 

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Table of Contents

 

DAVITA INC.

 

CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)

(dollars in thousands)

 

    

Three months ended

March 31,


 
    

2003


    

2002


 

Cash flows from operating activities:

                 

Net income

  

$

36,413

 

  

$

35,978

 

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

                 

Depreciation and amortization

  

 

17,445

 

  

 

15,805

 

Loss (gain) on divestitures

  

 

119

 

  

 

(458

)

Deferred income taxes

  

 

4,841

 

  

 

7,861

 

Non-cash debt expense

  

 

840

 

  

 

634

 

Stock options, principally tax benefits

  

 

1,378

 

  

 

8,931

 

Equity investment income

  

 

(519

)

  

 

(298

)

Minority interests in income of consolidated subsidiaries

  

 

1,813

 

  

 

2,433

 

Distributions to minority interests

  

 

(2,465

)

  

 

(1,501

)

Changes in operating assets and liabilities, excluding acquisitions and divestitures:

                 

Accounts receivable

  

 

(676

)

  

 

(11,163

)

Inventories

  

 

9,543

 

  

 

6,726

 

Other current assets

  

 

4,721

 

  

 

(2,840

)

Other long-term assets

  

 

(2,457

)

        

Accounts payable

  

 

(6,674

)

  

 

8,969

 

Accrued compensation and benefits

  

 

(13,075

)

  

 

(2,617

)

Other current liabilities

  

 

11,952

 

  

 

15,050

 

Income taxes

  

 

16,641

 

  

 

261

 

Other long-term liabilities

  

 

809

 

  

 

(287

)

    


  


Net cash provided by operating activities

  

 

80,649

 

  

 

83,484

 

    


  


Cash flows from investing activities:

                 

Additions of property and equipment, net

  

 

(21,708

)

  

 

(16,115

)

Acquisitions and divestitures, net

  

 

(718

)

  

 

(1,379

)

Investments in affiliates, net

  

 

1,931

 

  

 

499

 

Intangible assets

  

 

(300

)

        
    


  


Net cash used in investing activities

  

 

(20,795

)

  

 

(16,995

)

    


  


Cash flows from financing activities:

                 

Borrowings

  

 

623,822

 

  

 

335,883

 

Payments on long-term debt

  

 

(478,659

)

  

 

(355,803

)

Deferred financing costs

           

 

(57

)

Purchase of treasury stock

           

 

(67,877

)

Proceeds from issuance of common stock

  

 

3,502

 

  

 

16,351

 

    


  


Net cash provided by (used in) financing activities

  

 

148,665

 

  

 

(71,503

)

    


  


Net increase (decrease) in cash

  

 

208,519

 

  

 

(5,014

)

Cash and cash equivalents at beginning of period

  

 

96,475

 

  

 

36,711

 

    


  


Cash and cash equivalents at end of period

  

$

304,994

 

  

$

31,697

 

    


  


 

See notes to condensed consolidated financial statements.

 

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Table of Contents

DAVITA INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

(dollars in thousands, except per share data)

 

Unless otherwise indicated in this Form 10-Q “the Company”, “we”, “us”, “our” and similar terms refer to DaVita Inc. and its 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 revenue recognition and provisions for uncollectible accounts, impairments and valuation adjustments, accounting for income taxes and variable compensation accruals. The results of operations for the three month period ended March 31, 2003 are not necessarily indicative of the operating results for the full year. The consolidated interim financial statements should be read in conjunction with the Management’s Discussion and Analysis and consolidated financial statements and notes thereto included in the Company’s 2002 Form 10-K. Financial statement presentations and classifications have been conformed for all periods presented.

 

Stock-based compensation

 

If the Company had adopted the fair value-based compensation expense provisions of Financial Accounting Standards Board (FASB) Statement of Financial Accounting Standards No. 123 upon the issuance of that standard, net income and net income per share would have been adjusted to the pro forma amounts indicated below:

 

Pro forma - As if all stock options were expensed

  

Three months ended

March 31,


 
    

2003


    

2002


 

Net income:

                 

As reported

  

$

36,413

 

  

$

35,978

 

Add: Stock-based employee compensation expense included in reported net income, net of tax

  

 

161

 

  

 

88

 

Deduct: Total stock-based employee compensation expense under the fair value-based method, net of tax

  

 

(1,911

)

  

 

(3,561

)

    


  


Pro forma net income

  

$

34,663

 

  

$

32,505

 

    


  


Pro forma basic earnings per share:

                 

Pro forma net income for basic earnings per share calculation

  

$

34,663

 

  

$

32,505

 

    


  


Weighted average shares outstanding during the quarter

  

 

60,847

 

  

 

82,925

 

Vested deferred stock units

  

 

58

 

  

 

42

 

    


  


Weighted average shares for basic earnings per share calculation

  

 

60,905

 

  

 

82,967

 

    


  


Basic net income per share—pro forma

  

$

0.57

 

  

$

0.39

 

    


  


Basic net income per share—as reported

  

$

0.60

 

  

$

0.43

 

    


  


 

4


Table of Contents

DAVITA INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(continued)

(unaudited)

(dollars in thousands, except per share data)

 

 

    

Three months ended

March 31,


    

2003


  

2002


Pro forma diluted earnings per share:

             

Pro forma net income

  

$

34,663

  

$

32,505

Debt expense savings, net of tax, from assumed conversion of convertible debt

  

 

4,915

  

 

1,067

    

  

Pro forma net income for diluted earnings per share calculation

  

$

39,578

  

$

33,572

    

  

Weighted average shares outstanding during the quarter

  

 

60,847

  

 

82,925

Vested deferred stock units

  

 

58

  

 

42

Assumed incremental shares from stock plans

  

 

3,268

  

 

5,386

Assumed incremental shares from convertible debt

  

 

15,394

  

 

4,879

    

  

Weighted average shares for diluted earnings per share calculation

  

 

79,567

  

 

93,232

    

  

Diluted net income per share—pro forma

  

$

0.50

  

$

0.36

    

  

Diluted net income per share—as reported

  

$

0.52

  

$

0.40

    

  

 

2.    Significant new accounting standards

 

In January 2003 the FASB issued Interpretation (FIN) No. 46 Consolidation of Variable Interest Entities, which addresses the consolidation of certain entities (“variable interest entities”) in which an enterprise has a controlling financial interest through other than voting interests. FIN No. 46 requires that a variable interest entity be consolidated by the holder of the majority of the expected risks and rewards associated with the activities of the variable interest entity. FIN No. 46 is not expected to have a material effect on the Company’s consolidated financial statements.

 

 

5


Table of Contents

DAVITA INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(continued)

(unaudited)

(dollars in thousands, except per share data)

 

 

3.     Earnings per share

 

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

 

    

Three months ended

March 31,


    

2003


  

2002


Basic:

             

Net income

  

$

36,413

  

$

35,978

    

  

Weighted average shares outstanding during the period

  

 

60,847

  

 

82,925

Vested deferred stock units

  

 

58

  

 

42

    

  

Weighted average shares for basic earnings per share calculations

  

 

60,905

  

 

82,967

    

  

Basic net income per share

  

$

0.60

  

$

0.43

    

  

Diluted:

             

Net income

  

$

36,413

  

$

35,978

Debt expense savings, net of tax, from assumed conversion of convertible debt

  

 

4,915

  

 

4,915

    

  

Net income for diluted earnings per share calculations

  

$

41,328

  

$

40,893

    

  

Weighted average shares outstanding during the period

  

 

60,847

  

 

82,925

Vested deferred stock units

  

 

58

  

 

42

Assumed incremental shares from stock plans

  

 

2,473

  

 

3,885

Assumed incremental shares from convertible debt

  

 

15,394

  

 

15,394

    

  

Weighted average shares for diluted earnings per share calculations

  

 

78,772

  

 

102,246

    

  

Diluted net income per share

  

$

0.52

  

$

0.40

    

  

 

Options to purchase 2,854,224 shares at $22.40 to $33.00 per share and 643,573 shares at $23.61 to $33.00 per share were excluded from the diluted earnings per share calculations for the three months ended March 31, 2003 and 2002, respectively, because they were anti-dilutive. The calculation of diluted earnings per share assumes conversion of both the 55/8% convertible subordinated notes and the 7% convertible subordinated notes for all periods presented.

 

 

6


Table of Contents

DAVITA INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(continued)

(unaudited)

(dollars in thousands, except per share data)

 

 

4.    Long-term debt

 

In January 2003 the Company borrowed $150,000 that was available under the Term Loan A senior credit facility that was entered into in 2002. At March 31, 2003, $143,662 of the Term Loan A remained outstanding. The Term Loan A bears interest equal to LIBOR plus a margin ranging from 1.5% to 2.75% based on the Company’s leverage ratio. The current margin is 2.25% for an overall effective rate of 3.61%. The aggregate annual principal payments for the Term Loan A are approximately $34,000 in years one through three and the balance of approximately $42,000 in year four, due no later than March 2007.

 

Long-term debt was comprised of the following:

 

    

March 31,

2003


    

December 31,

2002


 

Term Loans under senior secured credit facilities

  

$

985,162

 

  

$

841,825

 

Convertible subordinated notes, 7%, due 2009

  

 

345,000

 

  

 

345,000

 

Convertible subordinated notes, 5 5/8%, due 2006

  

 

125,000

 

  

 

125,000

 

Capital lease obligations

  

 

8,713

 

  

 

6,820

 

Acquisition obligations and other notes payable

  

 

618

 

  

 

585

 

    


  


    

 

1,464,493

 

  

 

1,319,230

 

Less current portion

  

 

(43,908

)

  

 

(7,978

)

    


  


    

$

1,420,585

 

  

$

1,311,252

 

    


  


 

Scheduled maturities of long-term debt at March 31, 2003 were as follows:

 

2004

  

$

43,908

2005

  

 

43,082

2006

  

 

43,025

2007

  

 

176,569

2008

  

 

406,178

Thereafter

  

 

751,731

 

5.    Contingencies

 

The Company’s revenues 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 fiscal intermediaries or regulatory authorities; (3) differing opinions regarding a patient’s medical diagnosis or the medical necessity of services provided; (4) retroactive applications or interpretations of governmental requirements; and (5) claims for refunds from private payors.

 

Laboratory payment dispute

 

The Company’s Florida laboratory is subject to a third-party carrier review of its Medicare reimbursement claims. The carrier has reviewed claims for services provided in six separate review periods, extending from January 1995 to May 2001. The carrier had made determinations that many of the claims submitted were not supported by the prescribing physicians’ medical justification. The carrier had also suspended all payments of

 

7


Table of Contents

DAVITA INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(continued)

(unaudited)

(dollars in thousands, except per share data)

 

Medicare claims to this laboratory from May 1998 to June 2002, and referred the matter to the Centers for Medicare and Medicaid Services, or CMS, and the Department of Justice, or DOJ. The Company has disputed each of the carrier’s determinations and has provided supporting documentation of its claims.

 

In June 2002 an administrative law judge ruled that the sampling procedures and extrapolations that the carrier used as the basis of its overpayment determinations for the first two review periods were invalid. This decision invalidated the carrier’s overpayment determinations, totaling $20,600, for the first two review periods. The administrative law judge’s decision on the first two review periods does not apply to the remaining four review periods. The hearings before a carrier hearing officer for the third and fourth review periods are scheduled to take place in the second quarter of 2003. A total of $27,700 in claims are in dispute. The Company has also filed a notice of appeal to the carrier for the fifth and sixth review periods, for which a total of $3,800 in claims are in dispute.

 

During 2000 the Company stopped accruing Medicare revenue from this laboratory because of the uncertainties regarding both the timing of resolution and the ultimate revenue valuations. Following the favorable ruling by the administrative law judge in 2002, the carrier lifted the payment suspension and began making payments in July 2002 for lab services provided subsequent to May 2001. After making its determinations with respect to the fifth and sixth review periods in December 2002, the carrier paid the laboratory all amounts that it is not disputing for the third through sixth review periods. In the second half of 2002, the Company received a total of $68,778, which represented approximately 70% of the total outstanding Medicare lab billings for the period from January 1995 through June 2002. These cash collections were recognized as revenue in the quarter received. We do not expect to receive any significant additional payments relative to prior periods unless and until the dispute over the remaining disallowed claims are resolved in our favor. The Company will continue to recognize Medicare lab revenue associated with prior periods as cash collections actually occur, to the extent that cumulative recoveries do not exceed the aggregate amount that management believes the Company will ultimately recover upon final review and settlement of disputed billings.

 

In addition to processing prior period claims, the carrier also began processing billings for current period services on a timely basis. Based on these developments, the Company began recognizing estimated current period Medicare lab revenue in the third quarter of 2002.

 

The carrier is also currently conducting a study of the utilization of dialysis-related laboratory services to determine what ongoing program safeguards are appropriate. During the study, the carrier has suspended dialysis laboratory prepayment screens. In its initial findings from the study, the carrier had determined that some of its prior prepayment screens were invalidating appropriate claims. The Company cannot determine what prepayment screens, post-payment review procedures, documentation requirements or other program safeguards the carrier may yet implement as a result of its study. The carrier has also informed the Company that any claims that it reimburses during the study period may also be subject to post-payment review and retraction if determined inappropriate.

 

In November 2001, the Company closed a smaller laboratory that it operated in Minnesota and combined its operations with those of the Florida laboratory. The Medicare carrier for the Minnesota laboratory is conducting a post-payment review of Medicare reimbursement claims for the period January 1996 through December 1999. The scope of the review is similar to the review of our Florida laboratory. The Company responded to the most recent request from the carrier for claims documentation in May 2001. At this time, the Company is unable to determine how long it will take the carrier to complete this review. There is currently no overpayment determination with respect to the Minnesota laboratory. Medicare revenues at the Minnesota laboratory, which was much smaller than the Florida laboratory, were approximately $15,000 for the period under review.

 

8


Table of Contents

DAVITA INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(continued)

(unaudited)

(dollars in thousands, except per share data)

 

 

In addition to the formal appeal processes with the carrier and a federal administrative law judge, the Company also has pursued resolution of this matter through meetings with representatives of CMS and the DOJ. Discussions with CMS are ongoing. The DOJ has requested, and the Company has provided, information with respect to both the Florida and the Minnesota laboratories, most recently in September 2001. If a court determines that there has been wrongdoing by the Company or its laboratories, the fines and penalties under applicable statutes could be substantial.

 

United States Attorney inquiry

 

In February 2001 the Civil Division of the United States Attorney’s Office for the Eastern District of Pennsylvania in Philadelphia contacted the Company and requested its cooperation in a review of some of the Company’s historical practices, including billing and other operating procedures and its financial relationships with physicians. The Company cooperated in this review and provided the requested records to the United States Attorney’s Office. In May 2002, the Company received a subpoena from the Philadelphia office of the Office of Inspector General of the Department of Health and Human Services, or OIG. The subpoena required an update to the information the Company provided in its response to the February 2001 request, and also sought a wide range of documents relating to pharmaceutical and other ancillary services provided to patients, including laboratory and other diagnostic testing services, as well as documents relating to the Company’s financial relationships with physicians and pharmaceutical companies. The subpoena covers the period from May 1996 to May 2002. The Company has provided the documents requested and continues to cooperate with the United States Attorney’s Office and the OIG in its investigation. This inquiry remains at an early stage. As it proceeds, the government could expand its areas of concern. If a court determines that there has been wrongdoing, the penalties under applicable statutes could be substantial.

 

Other

 

In addition to the foregoing, DaVita is subject to claims and suits in the ordinary course of business. Management believes that the ultimate resolution of these additional pending proceedings, whether the underlying claims are covered by insurance or not, will not have a material adverse effect on the Company’s financial condition, results of operations or cash flows.

 

6.    Other commitments

 

The Company has obligations to purchase the third-party interests in several of its joint ventures. These obligations are in the form of put options, exercisable at the third-party owners’ discretion, and require the Company to purchase the minority owners’ interests at either the appraised fair market value or a predetermined multiple of cash flow or earnings. As of March 31, 2003, the Company’s potential obligations under these put options totaled approximately $60,000 of which approximately $34,000 was exercisable within one year. Additionally, the Company has certain other potential working capital commitments relating to managed and minority-owned centers of approximately $5,000 that could be called in the event of non-performance of the centers over the next five years.

 

7.    Condensed consolidating financial statements

 

The following information is presented as required under the Securities and Exchange Commission Financial Reporting Release No. 55 in connection with the Company’s publicly traded debt. The operating and investing activities of the separate legal entities included in the 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 $125,000 5 5/8% Convertible Subordinated Notes due 2006, issued by the wholly-owned subsidiary Renal Treatment Centers, Inc., or RTC, are guaranteed by DaVita Inc.

 

9


Table of Contents

DAVITA INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(continued)

(unaudited)

(dollars in thousands, except per share data)

 

 

Condensed Consolidating Balance Sheets

 

    

DaVita Inc.


  

RTC


  

Non-

guarantor

subsidiaries


  

Consolidating

adjustments


    

Consolidated

total


As of March 31, 2003

                                    

Cash and cash equivalents

  

$

304,986

  

$

8

                  

$

304,994

Accounts receivable, net

  

 

194,600

  

 

114,108

  

$

37,437

           

 

346,145

Other current assets

  

 

73,018

  

 

15,745

  

 

2,524

           

 

91,287

    

  

  

  


  

Total current assets

  

 

572,604

  

 

129,861

  

 

39,961

           

 

742,426

Property and equipment, net

  

 

174,908

  

 

92,180

  

 

38,654

           

 

305,742

Investments in subsidiaries

  

 

423,834

                

$

(423,834

)

      

Receivables from subsidiaries

  

 

119,790

                

 

(119,790

)

      

Amortizable intangible assets, net

  

 

40,282

  

 

16,015

  

 

3,783

           

 

60,080

Other assets

  

 

5,578

  

 

354

  

 

45

           

 

5,977

Goodwill

  

 

432,613

  

 

320,945

  

 

111,891

           

 

865,449

    

  

  

  


  

Total assets

  

$

1,769,609

  

$

559,355

  

$

194,334

  

$

(543,624

)

  

$

1,979,674

    

  

  

  


  

Current liabilities

  

$

309,512

  

$

15,598

  

$

12,539

           

$

337,649

Payables to subsidiaries/parent

         

 

97,969

  

 

21,821

  

$

(119,790

)

      

Long-term liabilities

  

 

1,348,540

  

 

148,795

  

 

5,977

           

 

1,503,312

Minority interests

                       

 

27,156

 

  

 

27,156

Shareholders’ equity

  

 

111,557

  

 

296,993

  

 

153,997

  

 

(450,990

)

  

 

111,557

    

  

  

  


  

Total liabilities and shareholders’ equity

  

$

1,769,609

  

$

559,355

  

$

194,334

  

$

(543,624

)

  

$

1,979,674

    

  

  

  


  

As of December 31, 2002

                                    

Cash and cash equivalents

  

$

96,468

  

$

7

                  

$

96,475

Accounts receivable, net

  

 

213,410

  

 

98,825

  

$

32,057

           

 

344,292

Other current assets

  

 

86,777

  

 

14,368

  

 

2,614

           

 

103,759

    

  

  

  


  

Total current assets

  

 

396,655

  

 

113,200

  

 

34,671

           

 

544,526

Property and equipment, net

  

 

185,676

  

 

80,532

  

 

32,267

           

 

298,475

Investments in subsidiaries

  

 

399,190

                

$

(399,190

)

      

Receivables from subsidiaries

  

 

81,833

                

 

(81,833

)

      

Amortizable intangible assets, net

  

 

44,090

  

 

15,062

  

 

4,007

           

 

63,159

Other assets

  

 

3,973

  

 

729

  

 

45

           

 

4,747

Goodwill

  

 

461,153

  

 

291,602

  

 

112,031

           

 

864,786

    

  

  

  


  

Total assets

  

$

1,572,570

  

$

501,125

  

$

183,021

  

$

(481,023

)

  

$

1,775,693

    

  

  

  


  

Current liabilities

  

$

270,060

  

$

12,386

  

$

10,155

           

$

292,601

Payables to parent

         

 

60,489

  

 

21,344

  

$

(81,833

)

      

Long-term liabilities

  

 

1,232,246

  

 

148,877

  

 

5,476

           

 

1,386,599

Minority interests

                       

 

26,229

 

  

 

26,229

Shareholders’ equity

  

 

70,264

  

 

279,373

  

 

146,046

  

 

(425,419

)

  

 

70,264

    

  

  

  


  

Total liabilities and shareholders’ equity

  

$

1,572,570

  

$

501,125

  

$

183,021

  

$

(481,023

)

  

$

1,775,693

    

  

  

  


  

 

10


Table of Contents

DAVITA INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(continued)

(unaudited)

(dollars in thousands, except per share data)

 

Condensed Consolidating Statements of Income

 

    

DaVita Inc.


  

RTC


    

Non-guarantor subsidiaries


  

Consolidating adjustments


    

Consolidated total


For the three months ended March 31, 2003

                                      

Net operating revenues

  

$

291,365

  

$

153,522

    

$

51,631

  

$

(36,711

)

  

$

459,807

Operating expenses

  

 

239,358

  

 

133,157

    

 

42,856

  

 

(34,898

)

  

 

380,473

    

  

    

  


  

Operating income

  

 

52,007

  

 

20,365

    

 

8,775

  

 

(1,813

)

  

 

79,334

Debt expense

  

 

16,661

  

 

1,710

    

 

1,085

           

 

19,456

Other income

  

 

785

                           

 

785

Income taxes

  

 

16,434

  

 

7,816

                    

 

24,250

Equity earnings in consolidated subsidiaries

  

 

16,716

                  

 

(16,716

)

      
    

  

    

  


  

Net income

  

$

36,413

  

$

10,839

    

$

7,690

  

$

(18,529

)

  

$

36,413

    

  

    

  


  

For the three months ended March 31, 2002

                                      

Net operating revenues

  

$

272,862

  

$

137,960

    

$

46,690

  

$

(29,847

)

  

$

427,665

Operating expenses

  

 

227,371

  

 

115,500

    

 

35,425

  

 

(27,414

)

  

 

350,882

    

  

    

  


  

Operating income

  

 

45,491

  

 

22,460

    

 

11,265

  

 

(2,433

)

  

 

76,783

Debt expense

  

 

12,170

  

 

1,767

    

 

1,135

           

 

15,072

Other income

  

 

267

                           

 

267

Income taxes

  

 

17,300

  

 

8,694

    

 

6

           

 

26,000

Equity earnings in consolidated subsidiaries

  

 

19,690

                  

 

(19,690

)

      
    

  

    

  


  

Net income

  

$

35,978

  

$

11,999

    

$

10,124

  

$

(22,123

)

  

$

35,978

    

  

    

  


  

 

11


Table of Contents

DAVITA INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(continued)

(unaudited)

(dollars in thousands, except per share data)

 

 

Condensed Consolidating Statements of Cash Flows

 

    

DaVita Inc.


    

RTC


      

Non-guarantor subsidiaries


    

Consolidating adjustments


    

Consolidated total


 

For the three months ended March 31, 2003

                                              

Cash flows from operating activities:

                                              

Net income

  

$

36,413

 

  

$

10,839

 

    

$

7,690

 

  

$

(18,529

)

  

$

36,413

 

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

  

 

28,968

 

  

 

(2,176

)

    

 

(1,085

)

  

 

18,529

 

  

 

44,236

 

    


  


    


  


  


Net cash provided by (used in) operating activities

  

 

65,381

 

  

 

8,663

 

    

 

6,605

 

  

 

—  

 

  

 

80,649

 

    


  


    


  


  


Cash flows from investing activities:

                                              

Purchases of property and equipment, net

  

 

(5,767

)

  

 

(8,643

)

    

 

(7,298

)

           

 

(21,708

)

Acquisitions and divestitures, net

                      

 

(718

)

           

 

(718

)

Other items

  

 

170

 

             

 

1,461

 

           

 

1,631

 

    


  


    


  


  


Net cash used in investing activities

  

 

(5,597

)

  

 

(8,643

)

    

 

(6,555

)

           

 

(20,795

)

    


  


    


  


  


Cash flows from financing activities:

                                              

Long-term debt

  

 

145,232

 

  

 

(19

)

    

 

(50

)

           

 

145,163

 

Other items

  

 

3,502

 

                               

 

3,502

 

    


  


    


  


  


Net cash provided (used in) financing activities

  

 

148,734

 

  

 

(19

)

    

 

(50

)

           

 

148,665

 

    


  


    


  


  


Net decrease in cash

  

 

208,518

 

  

 

1

 

    

 

—  

 

           

 

208,519

 

Cash at the beginning of the period

  

 

96,468

 

  

 

7

 

                      

 

96,475

 

    


  


    


  


  


Cash at the end of the period

  

$

304,986

 

  

$

8

 

    

$

—    

 

  

$

—  

 

  

$

304,994

 

    


  


    


  


  


For the three months ended March 31, 2002

                                              

Cash flows from operating activities:

                                              

Net income

  

$

35,978

 

  

$

11,999

 

    

$

10,124

 

  

$

(22,123

)

  

$

35,978

 

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

  

 

39,013

 

  

 

(4,746

)

    

 

(8,884

)

  

 

22,123

 

  

 

47,506

 

    


  


    


  


  


Net cash provided by (used in) operating activities

  

 

74,991

 

  

 

7,253

 

    

 

1,240

 

  

 

—  

 

  

 

83,484

 

    


  


    


  


  


Cash flows from investing activities:

                                              

Purchases of property and equipment, net

  

 

(6,870

)

  

 

(7,955

)

    

 

(1,290

)

           

 

(16,115

)

Acquisitions and divestitures, net

           

 

(1,379

)

                      

 

(1,379

)

Other items

  

 

499

 

                               

 

499

 

    


  


    


  


  


Net cash used in investing activities

  

 

(6,371

)

  

 

(9,334

)

    

 

(1,290

)

           

 

(16,995

)

    


  


    


  


  


Cash flows from financing activities:

                                              

Long-term debt

  

 

(20,294

)

  

 

324

 

    

 

50

 

           

 

(19,920

)

Other items

  

 

(51,583

)

                               

 

(51,583

)

    


  


    


  


  


Net cash provided (used in) financing activities

  

 

(71,877

)

  

 

324

 

    

 

50

 

           

 

(71,503

)

    


  


    


  


  


Net decrease in cash

  

 

(3,257

)

  

 

(1,757

)

    

 

—  

 

           

 

(5,014

)

Cash at the beginning of the period

  

 

34,949

 

  

 

1,762

 

                      

 

36,711

 

    


  


    


  


  


Cash at the end of the period

  

$

31,692

 

  

$

5

 

    

$

—  

 

  

$

—  

 

  

$

31,697

 

    


  


    


  


  


 

 

 

12


Table of Contents

 

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

 

Forward-looking statements

 

This Form 10-Q contains statements that are forward-looking statements within the meaning of the federal securities laws, including statements about our expectations, beliefs, intentions or strategies for the future. These statements involve known and unknown risks and uncertainties, including risks resulting from the regulatory environment in which we operate, economic and market conditions, competitive activities, other business conditions, accounting estimates, and the risk factors set forth in this Form 10-Q. These risks, among others, include those relating to possible reductions in private mix and private and government reimbursement rates, the concentration of profits generated from PPO and private and indemnity patients and from ancillary services including the administration of pharmaceuticals, changes in pharmaceutical practice patterns or reimbursement policies, the ongoing review of the Company’s Florida laboratory subsidiary by its Medicare carrier and the DOJ, the ongoing review by the US Attorney’s Office and the OIG in Philadelphia and the Company’s ability to maintain contracts with physician medical directors. Our actual results may differ materially from results anticipated in our forward-looking statements. We base our forward-looking statements on information currently available to us, and we have no current intention to update these statements, whether as a result of changes in underlying factors, new information, future events or other developments

 

Results of operations

 

    

Quarter ended


 
    

March 31,

2003


    

December 31,

2002


    

March 31,

2002


 
    

(dollars in millions)

 

Net operating revenues:

                                         

Current period services

  

$

460

  

100

%

  

$

461

  

100

%

  

$

428

  

100

%

Prior period services—laboratory

                

 

42

                    
    

         

         

      

Total net operating revenues

  

$

460

         

$

503

         

$

428

      
    

         

         

      

Operating expenses and charges:

                                         

Dialysis centers and labs

  

 

317

  

69

%

  

 

317

  

69

%

  

 

292

  

68

%

General and administrative

  

 

37

  

8

%

  

 

41

  

9

%

  

 

36

  

8

%

Depreciation and amortization

  

 

18

  

4

%

  

 

17

  

4

%

  

 

16

  

4

%

Provision for uncollectible accounts, net of recoveries

  

 

8

  

2

%

  

 

8

  

2

%

  

 

5

  

1

%

Minority interest and equity income, net

  

 

1

         

 

2

         

 

2

      
    

         

         

      

Total operating expenses and charges

  

 

381

  

83

%

  

 

385

  

83

%

  

 

351

  

82

%

    

         

         

      

Operating income

  

$

79

  

17

%

  

$

118

  

23

%

  

$

77

  

18

%

    

         

         

      

Operating income excluding prior period service revenue

  

$

79

  

17

%

  

$

76

  

17

%

  

$

77

  

18

%

    

         

         

      

Dialysis treatments (000’s)

  

 

1,503

         

 

1,538

         

 

1,434

      

Average dialysis treatments per treatment day

  

 

19,673

         

 

19,319

         

 

18,767

      

Average dialysis revenue per dialysis treatment

  

$

296

         

$

291

         

$

290

      

 

The quarter ended March 31, 2002 includes $4 million of revenues and $4 million of operating expenses related to non-continental U.S. operations in Puerto Rico that were divested in the second quarter of 2002.

 

13


Table of Contents

 

Net operating revenue

 

The net operating revenues of $460 million for the first quarter of 2003 represents an increase of $32 million, or an increase of $36 million excluding non-continental U.S. operations that were fully divested during 2002. This represented an 8.5% increase in continental U.S. revenue compared with the first quarter of 2002. Of this 8.5% increase, approximately 4.5% was due to an increase in the number of dialysis treatments, and approximately 2.0% was attributable to increases in the average reimbursement rate per dialysis treatment. The increase in 2003 also included approximately $6 million of Medicare laboratory revenue. No Medicare lab revenue had been recognized during the first quarter of 2002 due to the payment withholds by the third-party carrier, as discussed below. The increase in the number of treatments was principally attributable to a non-acquired annual growth rate of approximately 3.3%. The balance of the increase in treatment volumes was due to acquisitions. We continue to expect the non-acquired growth rate to remain in the range of 3.0% to 5.0% throughout 2003. The average dialysis revenue per treatment (excluding lab and clinical research revenues and management fee income) was $296 for the first quarter of 2003 as compared to $290 for the first quarter of 2002. The increase in average revenue per treatment was primarily due to rate increases and continued improvements in revenue capture.

 

First quarter 2003 current period operating revenues were approximately the same as the fourth quarter of 2002. The number of treatments decreased by approximately 2% in the first quarter of 2003 as compared to the fourth quarter of 2002 because of fewer treatments days in the first quarter. An increase in the average number of treatments per day of 1.8% and an increase in the net dialysis revenue per treatment of approximately $5 in the first quarter of 2003 offset substantially all of the decrease in revenue due to fewer treatment days. The increase in the revenue per treatment was primarily due to rate increases and continued improvements in revenue capture.

 

Lab and other services

 

As discussed in Note 6 to the condensed consolidated interim financial statements (Contingencies), our Florida-based laboratory subsidiary has been under an ongoing third-party carrier review for Medicare reimbursement claims since 1998. Prior to the third quarter 2002, no Medicare payments had been received since May 1998. Following a favorable ruling by an administrative law judge in June 2002 the carrier began releasing funds for lab services provided subsequent to May 2001. The carrier also paid us amounts it is not disputing for prior periods. During 2002, the carrier paid us a total of approximately $69 million, representing approximately 70% of the total outstanding Medicare lab billings for the period from January 1995 through June 2002. These cash collections were recognized as revenue in the quarter received. Approximately $42 million of these total collections were received in the fourth quarter of 2002. We do not expect to receive significant additional Medicare lab payments relating to prior periods unless and until the dispute over the remaining disallowed claims are resolved in our favor.

 

Dialysis centers and lab expenses

 

Center operating expenses were approximately 69% of net operating revenues in the first quarter of 2003 and the fourth quarter of 2002 (excluding prior period lab revenue) compared to 68% in the first quarter of 2002. On a per-treatment basis, center operating expenses for the first quarter of 2003 increased approximately $5 from the fourth quarter of 2002 and approximately $10 from the first quarter of 2002. The increase in both periods was primarily attributable to higher pharmaceutical, insurance and labor costs.

 

General and administrative expenses

 

General and administrative expenses were approximately 8% of current period net operating revenues for both the first quarters of 2003 and 2002. General and administrative expenses in the fourth quarter of 2002 included impairments and valuation adjustments of $2 million. Excluding these impairment charges, the fourth quarter general and administrative expenses were also approximately 8% of net operating revenue.

 

14


Table of Contents

 

Provision for uncollectible accounts receivable

 

The provisions for uncollectible accounts receivable before considering cash recoveries were approximately 1.8% of current period net operating revenues for all periods presented. During the fourth quarter of 2002 and the first quarter of 2002, we realized recoveries of approximately $1 million and $2 million, respectively.

 

Debt expense

 

Debt expense of approximately $19.5 million for the first quarter of 2003 was approximately $4.5 million higher than the first quarter of 2002 as a result of higher debt balances, primarily associated with our recapitalization during the second quarter of 2002. Average interest rates for the first quarter of 2003 were 4.9% compared to 7.0% for first quarter of 2002.

 

Projections for 2003

 

Based on the current conditions and trends, our current projections for 2003 remain unchanged. Operating income for 2003 is currently projected to be in the range of $300 million to $320 million. These projections and the underlying assumptions involve significant risks and uncertainties, and actual results may vary significantly from these current projections. These risks, among others, include those relating to possible reductions in private and government reimbursement rates, the concentration of profits generated from non-governmental payors and physician-prescribed pharmaceuticals, changes in pharmaceutical practice patterns or reimbursement policies, and the ongoing review by the United States Attorney’s Office and the OIG. Additionally, the termination or restructuring of managed care contracts, medical director agreements or other arrangements may result in future impairments or otherwise negatively affect our operating results. We undertake no duty to update these projections, whether due to changes in current or expected trends, underlying market conditions, decisions of the United States Attorney’s Office, the DOJ or the OIG in any pending or future review of our business, or otherwise.

 

Significant new accounting standards

 

In January 2003 the FASB issued Interpretation (FIN) No. 46 Consolidation of Variable Interest Entities, which addresses the consolidation of certain entities (“variable interest entities”) in which an enterprise has a controlling financial interest through other than voting interests. FIN No. 46 requires that a variable interest entity be consolidated by the holder of the majority of the expected risks and rewards associated with the activities of the variable interest entity. FIN No. 46 is not expected to have a material effect on our consolidated financial statements.

 

Liquidity and capital resources

 

Cash flow from operations during the first quarter of 2003 amounted to $81 million. Investing cash outflows consisted principally of capital asset additions of $22 million, which includes approximately $12 million for center development and $10 million for equipment and information technology projects.

 

In January 2003 the Company borrowed $150,000 that was available under the Term Loan A senior credit facility that was secured during 2002. The Term Loan A bears interest equal to LIBOR plus a margin ranging from 1.5% to 2.75% based on the Company’s leverage ratio. The current margin is 2.25% for an overall effective rate of 3.61%. The aggregate annual principal payments for the Term Loan A are approximately $34,000 in years one through three and approximately $42,000 in year four.

 

Accounts receivable at March 31, 2003 amounted to $346 million, an increase of approximately $2 million during the quarter. The first quarter accounts receivable balance represented 69 days of revenue, compared to 70 days as of December 31, 2002.

 

15


Table of Contents

 

Our current plans continue to call for capital expenditures to be in the same range as 2002, including investment expenditures for information technology projects and for new dialysis centers, relocations and expansions. During the first quarter of 2003, we acquired a controlling ownership interest in two centers of which we were previously minority owners and opened seven new centers.

 

We believe that we will have sufficient liquidity and operating cash flows to fund our scheduled debt service and other obligations over the next twelve months.

 

16


Table of Contents

 

Item 3.    Quantitative and Qualitative Disclosures About Market Risk.

 

Interest rate sensitivity

 

The table below provides information about our financial instruments that are sensitive to changes in interest rates.

 

    

Expected maturity date


  

Thereafter


  

Total


  

Fair

Value


  

Average Interest

Rate


 
    

2003


  

2004


  

2005


  

2006


  

2007


  

2008


           
    

(dollars in millions)

 

Long-term debt:

                                                                     

Fixed rate

                       

$

125

                

$

345

  

$

470

  

$

478

  

6.63

%

Variable rate

  

$

33

  

$

43

  

$

43

  

$

49

  

$

318

  

$

404

  

$

104

  

$

994

  

$

994

  

4.44

%

 

Item 4.    Controls and Procedures.

 

Management maintains disclosure controls and procedures designed to ensure that information required to be disclosed in the reports filed by the Company 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 regulations, 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. Management recognizes that these controls and procedures can provide only reasonable assurance of desired outcomes, and that estimates and judgements are still inherent in the process of maintaining effective controls and procedures.

 

Within 90 days of the date of 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.

 

We have established and maintain a system of internal controls designed to provide reasonable assurance that transactions are executed with proper authorization and are properly recorded in the Company’s records, and that errors or irregularities that could be material to the financial statements are prevented or would be detected within a timely period. Internal controls are periodically reviewed and revised if necessary, and are augmented by appropriate oversight and audit functions.

 

Subsequent to the date that these controls were last evaluated by the Chief Executive Officer and Chief Financial Officer, we have not made any significant changes in the design and operation of our internal controls, nor have there been changes in other factors that could significantly affect the overall effectiveness of the control environment to process, record and disclose transactions.

 

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RISK FACTORS

 

This Form 10-Q contains statements that are forward-looking statements within the meaning of the federal securities laws, including statements about our expectations, beliefs, intentions or strategies for the future. These forward-looking statements include statements regarding our expectations for treatment growth rates, revenue per treatment, expense growth, levels of the provision for uncollectible accounts receivable, operating income, and capital expenditures. We base our forward-looking statements on information currently available to us, and we do not intend to update these statements, whether as a result of changes in underlying factors, new information, future events or other developments.

 

These statements involve known and unknown risks and uncertainties, including risks resulting from economic and market conditions, the regulatory environment in which we operate, competitive activities and other business conditions. Our actual results may differ materially from results anticipated in these forward-looking statements. Important factors that could cause actual results to differ materially from the forward-looking statements include those set forth below. The risks discussed below are not the only ones facing our business.

 

If the percentage of our collections at or near our billed prices declines, then our revenues, cash flows and earnings would be substantially reduced.

 

Approximately 45% of our dialysis revenues are generated from patients who have private payors as the primary payor. A minority of these patients have insurance policies that reimburse us at or near our billed prices, which are significantly higher than Medicare rates. The majority of these patients have insurance policies that reimburse us at lower rates but, in most cases, higher than Medicare rates. We believe that pressure from private payors to decrease the rates they pay us may increase. If the percentage of collections at or near our billed prices decreases significantly, it would have a material adverse effect on our revenues, cash flows and earnings.

 

If the percentage of patients with insurance paying at or near our billed prices declines, then our revenues, cash flows and earnings would be substantially reduced.

 

Our revenue levels are sensitive to the mix of reimbursements from higher paying commercial plans to total reimbursements from all payor plans and program types. If there is a significant change in the number of patients under higher paying commercial plans relative to plans that pay at lower rates, for example a reduction in the average number of patients under indemnity and PPO plans compared with the average number of patients under HMO plans and government programs, it would negatively impact our revenues, cash flows and earnings.

 

If we are unable to renegotiate material contracts with managed care plans on acceptable terms, we may experience a decline in same center growth.

 

We have contracts with some large managed care plans that include unfavorable terms. Although we are attempting to renegotiate the terms of these contracts, we cannot predict whether we will reach agreement on new terms or whether we will renew these contracts. As a result, we may lose numerous patients of these managed care plans and experience a decline in our same center growth, which would negatively impact our revenues.

 

Changes in clinical practices and reimbursement rates or rules for EPO and other drugs could substantially reduce our revenue and earnings.

 

The administration of EPO and other drugs accounts for approximately one third of our net operating revenues. Changes in physician practice patterns and accepted clinical practices, changes in private and governmental reimbursement rates and rules, the introduction of new drugs and the conversion to alternate types of administration, for example from intravenous administration to subcutaneous or oral administration, that may

 

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also result in lower or less frequent dosages, could reduce our revenues and earnings from the administration of EPO and other drugs. For example, some Medicare fiscal intermediaries are seeking to implement local medical review policies for EPO and vitamin D analogs that would effectively limit utilization of and reimbursement for these drugs.

 

Future declines, or the lack of further increases, in Medicare reimbursement rates would reduce our net income and cash flows.

 

Approximately 49% of our dialysis revenues are generated from patients who have Medicare as their primary payor. The Medicare ESRD program reimburses us for dialysis and ancillary services at fixed rates. Unlike many other Medicare programs, the Medicare ESRD program does not provide for periodic inflation increases in reimbursement rates. Increases of 1.2% in 2000 and 2.4% in 2001 were the first increases in the composite rate since 1991, and were significantly less than the cumulative rate of inflation since 1991. Since then there has been no increase in the composite rate. Increases in operating costs that are subject to inflation, such as labor and supply costs, have occurred and are expected to continue to occur with or without a compensating increase in reimbursement rates. We cannot predict the nature or extent of future rate changes, if any. To the extent these rates are not adjusted to keep pace with inflation, our net income and cash flows would be adversely affected.

 

Future changes in the structure of, and reimbursement rates under, the Medicare ESRD program could substantially reduce our operating earnings and cash flows.

 

In legislation enacted in December 2000, Congress mandated government studies on whether:

 

    The Medicare composite rate for dialysis should be modified to include additional services, such as laboratory and other diagnostic tests and the administration of EPO and other pharmaceuticals, in the composite rate—this study was due July 2002, but has not yet been delivered to Congress; and

 

    Reimbursement for many of the outpatient prescription drugs that we administer to dialysis patients should be changed from the historic rate of 95% of the average wholesale price, or AWP. This study was delivered to Congress but Congress has not acted upon it.

 

If Medicare began to include in its composite reimbursement rate any ancillary services that it currently reimburses separately, our revenue would decrease to the extent there was not a corresponding increase in that composite rate. In particular, Medicare revenue from EPO is approximately 27% of our total Medicare revenue. In January 2003, CMS implemented a new payment structure utilizing a single drug pricer for all drugs that Medicare reimburses, including many we administer. Based on the initial prices CMS has set, we do not expect our reimbursement under this single drug pricer in 2003 to differ materially from what it would have been under the AWP-based reimbursement structure. We expect, however, that CMS will change the prices set under this single drug pricer in the future or make other changes to the payment structure for these drugs. If EPO were included in the composite rate, and if the composite rate were not increased sufficiently, our operating earnings and cash flows could decrease substantially. Reductions in current reimbursement rates for EPO or other outpatient prescription drugs would also reduce our net earnings and cash flows.

 

Future declines in Medicaid reimbursement rates would reduce our net income and cash flows.

 

Approximately 5% of our dialysis revenues are generated from patients who have Medicaid as their primary coverage. In addition approximately 3% of our dialysis revenues are from Medicaid secondary coverage. Approximately 45% of our Medicaid revenue is derived from patients in California. If state governments change Medicaid programs or the rates paid by those programs for our services, then our revenue and earnings may decline. Some of the states’ Medicaid programs have proposed eligibility changes or have announced that they are considering reductions in the rates for certain services. Any action to reduce the Medicaid coverage rules or reimbursement rates for dialysis and related services would adversely affect our revenue and earnings.

 

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If a significant number of physicians were to cease referring patients to our dialysis centers, whether due to regulatory or other reasons, our revenue and earnings would decline.

 

If a significant number of physicians stop referring patients to our centers, it could have a material adverse effect on our revenue and earnings. Many physicians prefer to have their patients treated at centers where they or other members of their practice supervise the overall care provided as medical directors of the centers. As a result, the primary referral source for most of our centers is often the physician or physician group providing medical director services to the center. If a medical director agreement terminates, whether before or at the end of its term, and a new medical director is appointed, it may negatively impact the former medical director’s decision to treat his or her patients at our center. Additionally, the medical directors have no obligation to refer their patients to our centers.

 

Our medical director contracts are for fixed periods, generally five to ten years. Medical directors have no obligation to extend their agreements with us. As of April 1, 2003, there were 24 centers at which the medical director agreements required renewal on or before March 31, 2004.

 

We also may take actions to restructure existing relationships or take positions in negotiating extensions of relationships in order to assure compliance with anti-kickback and similar laws. These actions could negatively impact physicians’ decisions to extend their medical director agreements with us or to refer their patients to us. In addition, if the terms of an existing agreement were found to violate applicable laws, we may not be successful in restructuring the relationship, which could lead to the early termination of the agreement, or force the physician to stop referring patients to the centers.

 

If the current shortage of skilled clinical personnel continues, we may experience disruptions in our business operations and increases in operating expenses.

 

We are experiencing increased labor costs and difficulties in hiring nurses due to a nationwide shortage of skilled clinical personnel. We compete for nurses with hospitals and other health care providers. This nursing shortage may limit our ability to expand our operations. If we are unable to hire skilled clinical personnel when needed, our operations and our same center growth will be negatively impacted.

 

Adverse developments with respect to EPO could materially reduce our net income and cash flows and affect our ability to care for our patients.

 

Amgen is the sole supplier of EPO and may unilaterally decide to increase its price for EPO at any time. For example, Amgen unilaterally increased its base price for EPO by 3.9% in each of 2002, 2001 and 2000. Also, we cannot predict whether we will continue to receive the same discount structure for EPO that we currently receive, or whether we will continue to achieve the same levels of discounts within that structure as we have historically achieved. In addition, Amgen has developed a new product, Aranesp®, that may replace EPO or reduce its use with dialysis patients. We cannot predict if or when Aranesp® will be introduced to the U.S. dialysis market, what its cost and reimbursement structure will be, or how it may impact our revenues from EPO. Increases in the cost of EPO and the introduction of Aranesp® could have a material adverse effect on our net income and cash flows.

 

The pending federal review of some of our historical practices and third-party carrier review of our laboratory subsidiary could result in substantial penalties against us.

 

We are voluntarily cooperating with the Civil Division of the United States Attorney’s Office and OIG in Philadelphia in a review of some of our practices, including billing and other operating procedures, financial relationships with physicians and pharmaceutical companies, and the provision of pharmaceutical and other ancillary services. In addition, our Florida laboratory and our now closed Minnesota laboratory are each the subject of a third-party carrier review of claims it has submitted for Medicare reimbursement. The DOJ has also requested and received information regarding these laboratories. We are unable to determine when these matters

 

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will be resolved, whether any additional areas of inquiry will be opened or any outcome of these matters, financial or otherwise. Any negative findings could result in substantial financial penalties against us and exclusion from future participation in the Medicare and Medicaid programs.

 

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 revenue and earnings.

 

Our dialysis operations are subject to extensive federal, state and local government regulations, including Medicare and Medicaid reimbursement rules and regulations, federal and state anti-kickback laws, and federal and state laws regarding the collection, use and disclosure of patient health information. The regulatory scrutiny of healthcare providers, including dialysis providers, has increased significantly in recent years. In addition, the frequency and intensity of Medicare certification surveys and inspections of dialysis centers has increased markedly since 2000.

 

We endeavor to comply with all of the requirements for receiving Medicare and Medicaid reimbursement and to structure all of our relationships with referring physicians to comply with the anti-kickback laws; however, the laws and regulations in this area are complex and subject to varying interpretations. In addition, our historic dependence on manual processes that vary widely across our network of dialysis centers exposes us to greater risk of errors in billing and other business processes.

 

Due to regulatory considerations unique to each of these states, all of our dialysis operations in New York and part of our dialysis operations in New Jersey are conducted through privately-owned companies to which we provide a broad range of administrative services. These operations account for approximately 7% of our dialysis revenues. We believe that we have structured these operations to comply with the laws and regulations of these states, but we can give no assurances that they will not be challenged.

 

If any of our operations are found to violate these or other government regulations, we could suffer severe consequences, including:

 

    Mandated practice changes that significantly increase operating expenses;

 

    Suspension of payments from government reimbursement programs;

 

    Refunds of amounts received in violation of law or applicable reimbursement program requirements;

 

    Loss of required government certifications or exclusion from government reimbursement programs;

 

    Loss of licenses required to operate healthcare facilities in some of the states in which we operate;

 

    Fines or monetary penalties for anti-kickback law violations, submission of false claims or other failures to meet reimbursement program requirements and patient privacy law violations; and

 

    Claims for monetary damages from patients who believe their protected health information has been used or disclosed in violation of federal or state patient privacy laws.

 

Our rollout of new information technology systems will significantly disrupt our billing and collection activity, may not work as planned and could have a negative impact on our results of operations and financial condition.

 

We will be continuing the rollout of new information technology systems and new processes in our billing offices over the next year. It is likely that this rollout will disrupt our billing and collection activity and may cause other disruptions to our business operations, which may negatively impact our cash flows. Also, the new information systems may not work as planned or improve our billing and collection processes as expected. If they do not, we may have to spend substantial amounts to enhance or replace these systems.

 

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Provisions in our charter documents and compensation programs we have adopted may deter a change of control that our stockholders would otherwise determine to be in their best interests.

 

Our charter documents include provisions which may deter hostile takeovers, delay or prevent changes of control or changes in our management, or limit the ability of our stockholders to approve transactions that they may otherwise determine to be in their best interests. These include provisions prohibiting our stockholders from acting by written consent, requiring 60 days advance notice of stockholder proposals or nominations to our Board of Directors and granting our Board of Directors the authority to issue up to five million shares of preferred stock and to determine the rights and preferences of the preferred stock without the need for further stockholder approval, and a poison pill that would substantially dilute the interest sought by an acquirer that our board of directors does not approve.

 

In addition, most of our outstanding employee stock options include a provision accelerating the vesting of the options in the event of a change of control. We have also adopted a change of control protection program for our employees who do not have a significant number of stock options, which provides for cash bonuses to the employees in the event of a change of control. Based on the shares of our common stock outstanding and the market price of our stock on March 31, 2003, these cash bonuses would total approximately $44 million if a control transaction occurred at that price and our Board of Directors did not modify the program. These compensation programs may affect the price an acquirer would be willing to pay.

 

These provisions could also discourage bids for our common stock at a premium and cause the market price of our common stock to decline.

 

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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.

 

Items 2, 3, 4 and 5 are not applicable.

 

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Item 6.     Exhibits and Reports on Form 8-K

 

(a)  Exhibits

 

Exhibit Number


  

Description


12.1

  

Ratio of earnings to fixed charges.ü

99.1

  

Certification of the Chief Executive Officer, dated May 7, 2003, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.ü

99.2

  

Certification of the Chief Financial Officer, dated May 7, 2003, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.ü


ü   Filed herewith.

 

(b)  Reports on Form 8-K

 

Current report on Form 8-K dated May 5, 2003, furnished under Item 9, “Regulation FD Disclosure” but furnished pursuant to Item 12, “Disclosure of Results of Operations and Financial Condition”, pursuant to interim guidance issued by the SEC in Release Nos. 33-8216 and 34-47583. A copy of the press release announcing the Company’s financial results for the quarter ended March 31, 2003 was attached to the Form 8-K as Exhibit 99.1.

 

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SIGNATURE

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

DAVITA INC.

By:

 

/s/    GARY W. BEIL        


   

Gary W. Beil

Vice President and Controller*

 

 

Date: May 8, 2003

 


*   Mr. Beil has signed both on behalf of the registrant as a duly authorized officer and as the Registrant’s principal accounting officer.

 

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CERTIFICATIONS

 

 

I, Kent J. Thiry, certify that:

 

  1.   I have reviewed this quarterly report on Form 10-Q of DaVita Inc.;

 

  2.   Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

 

  3.   Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

 

  4.   The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

 

  a)   designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;

 

  b)   evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and

 

  c)   presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

 

  5.   The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function):

 

  a)   all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and

 

  b)   any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

 

  6.   The registrant’s other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

 

/s/    KENT J. THIRY        


Kent J. Thiry

Chief Executive Officer

 

Date: May 8, 2003

 

 

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CERTIFICATIONS

 

 

I, Richard K. Whitney, certify that:

 

  1.   I have reviewed this quarterly report on Form 10-Q of DaVita Inc.;

 

  2.   Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

 

  3.   Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

 

  4.   The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

 

  a)   designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;

 

  b)   evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and

 

  c)   presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

 

  5.   The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function):

 

  a)   all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and

 

  b)   any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

 

  6.   The registrant’s other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

 

/s/    RICHARD K. WHITNEY        


Richard K. Whitney

Chief Financial Officer

 

Date: May 8, 2003

 

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INDEX TO EXHIBITS

 

 

Exhibit Number


  

Description


12.1

  

Ratio of earnings to fixed charges.ü

99.1

  

Certification of the Chief Executive Officer, dated May 7, 2003, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.ü

99.2

  

Certification of the Chief Financial Officer, dated May 7, 2003, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.ü


ü   Filed herewith.

 

28