DaVita - 10-Q quarterly report FY

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.

As of July 31, 2002, there were approximately 63.9 million shares of the Registrant’s common stock (par value $0.001) outstanding.

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

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 and bad debt provisions, and, correspondingly, accounts receivable. The results of operations for the six month period ended June 30, 2002 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 2001 Form 10-K. Certain reclassifications have been made for consistent presentation.

The Company has adopted Statement of Financial Accounting Standards (SFAS) No. 142, Goodwill and Other Intangible Assets, and SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. Under SFAS No. 142, goodwill is not amortized effective January 1, 2002. SFAS No. 142 also requires that the goodwill balance be regularly assessed for possible valuation impairment and that there be an impairment charge against current earnings if the recorded goodwill balance exceeds fair value. If this standard had been implemented as of January 1, 2001, amortization expense would have been reduced by approximately $6,300 and $12,600 net of tax, for the three and six months ended June 30, 2001. Income before extraordinary item and diluted income before extraordinary item per share would have been approximately $34,900 and $72,100 and $0.38 and $0.80 per share for the same periods.

In March 2002, the Company initiated a recapitalization plan consisting of debt restructuring and repurchases of common stock.

On April 26, 2002 the Company completed the initial phase of the recapitalization plan by repurchasing all of its $225,000 outstanding 9¼% Senior Subordinated Notes due 2011 at a total cost of approximately $266,000. The difference between the reacquisition price and the net carrying amount of the Senior Subordinated Notes, together with the write-off of deferred financing costs associated with extinguishing the existing senior credit facilities and notes, resulted in a net extraordinary loss of $29,358.

On June 6, 2002, the Company completed the next phase of the recapitalization plan with the repurchase of 16,682,337 shares of its common stock for approximately $402,000, or $24 per share, through a modified dutch auction tender offer.

On May 30, 2002, the Company’s Board of Directors authorized management to repurchase up to an additional $225,000 of common stock over the next eighteen months. As of June 30, 2002, 199,700 shares had been purchased for $4,748. As of July 31, 2002, 3,676,200 shares at a cost of $78,652, have been repurchased under this authorization. For the six months ended June 30, 2002, stock repurchases totaled 19,827,737 shares for a total cost of approximately $474,000, or a composite average of $23.93 per share.

The Company secured a new senior credit facility agreement in the amount of $1,115,000 to finance these transactions and to pay down all outstanding amounts under the previously existing senior credit facilities. The new senior credit facility consists of a Term Loan A for $150,000, a Term Loan B for $850,000 and a $115,000 undrawn revolving credit facility, which includes up to $50,000 available for letters of credit. The Term Loan A and the revolving credit facility bear interest at a rate equal to LIBOR plus a margin ranging from 1.5% to 2.75% based on the Company’s leverage ratio. The Term Loan B bears interest at LIBOR plus 3.00%. As of June 30, 2002, $850,000 of the Term Loan B had been drawn. The Company is currently evaluating its current and future liquidity requirements for potential borrowings under the Term Loan A but has no obligation to draw the loan. The lenders’ commitment to fund the undrawn portion of the Term Loan A will expire in January 2003. If the entire $1,000,000 term credit facility is drawn, the aggregate annual principal reductions will range from $16,000 to $51,000 in years one through five, and will be $403,000 in each of years six and seven, with the balance due not later than 2009. The new senior credit facility is secured by all personal property of the Company and its wholly-owned subsidiaries, along with the stock of the Company’s subsidiaries. The new senior credit facility also contains certain financial and operating covenants and limits the Company’s investments. As of June 30, 2002, the Company was in compliance with the financial and operating covenants of the credit facility in all material respects.

Long-term debt was comprised of the following:

Scheduled maturities of long-term debt at June 30, 2002 were as follows:

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

Shares associated with stock options that have exercise prices greater than the average market price of shares outstanding during the period, which were not included in the computation of earnings per share assuming dilution because they were anti-dilutive, are as follows:

Impairments and valuation adjustments for the quarter ended June 30, 2002, consisted of the following:

The impairments and valuation adjustments net gain of $1,001 recognized in the second quarter of 2002 for continental U.S. operations consisted of a realized gain of approximately $2,200 on a previously impaired investment offset by certain operating asset impairment losses. On June 1, 2002, the Company completed the divestiture of its remaining non-continental U.S. operations, all of which were located in Puerto Rico. As a result, the Company also recognized a recovery gain of $1,389 on assets previously impaired in contemplation of the closing of this sale.

Health care provider 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.

The Company’s Florida-based laboratory subsidiary is the subject of a third-party carrier review of its Medicare reimbursement claims. The carrier has issued formal overpayment determinations in the amount of $5,600 for the review period from January 1995 to April 1996 and $15,000 for the review period from May 1996

The Company is disputing the carrier’s determinations and has provided supporting documentation of its claims. The Company has initiated the process of a formal review of each of the carrier’s determinations. The first step in this formal review process is a hearing before a hearing officer at the carrier. The hearing regarding the initial review period from January 1995 to April 1996 was held in July 1999. In January 2000, the hearing officer issued a decision upholding the overpayment determination of $5,600. The hearing regarding the second review period from May 1996 to March 1998 was held in April 2000. In July 2000, the hearing officer issued a decision upholding $14,200 of the overpayment determination. The Company filed a consolidated appeal of both decisions to a federal administrative law judge.

The judge divided the appeal into two separate hearings. The first took place in January 2002 and addressed the validity of the two statistical samples the carrier used to support its determinations. In June 2002, the administrative law judge ruled that the sampling procedures and extrapolations used as the basis of the Medicare carrier’s overpayment determinations were invalid. This decision invalidated the carrier’s overpayment determinations for the first two review periods, totaling $19,800. The judge’s decision did not address the individual claims in the two samples that were used to support the overpayment extrapolations, which were to be addressed in the second hearing. These claims totaled approximately $90. The Company has withdrawn its appeal of the carrier’s decisions with respect to these $90 in claims. The judge has not yet entered her final order but is expected to do so shortly. After the entry of the final order there is a 60-day period in which the Medicare Appeals Council can decide to review the decision.

We are also appealing the carrier’s decisions with respect to the third and fourth review periods. These appeals are still at the carrier hearing officer level. For the fifth and sixth review periods, the carrier is reviewing the records we have submitted and has not yet made an initial determination. The administrative law judge’s decision on the first two review periods does not impact the remaining four review periods in any way, as each review period is evaluated independently. Moreover, the carrier’s sampling procedures have varied from period to period, and the conclusions the judge arrived at with respect to the first two periods may not hold for the subsequent periods.

In addition to the formal appeal process with the carrier and the federal administrative law judge, beginning in the third quarter of 1999 the Company sought a meeting with the Department of Justice, or DOJ, to begin a process to resolve this matter. The carrier had previously informed the local office of the DOJ and the Department of Health and Human Services, or HHS, of this matter and the Company had provided requested information to the DOJ. The Company met with the DOJ in February 2001, at which time the DOJ requested additional information, which the Company provided in September 2001. The discussions with the DOJ are ongoing.

The carrier had also previously suspended all payments of Medicare claims from the laboratory beginning in May 1998. In May 2002, the carrier lifted the payment suspension, and will begin paying the laboratory’s Medicare claims with dates of service as early as June 2001. The carrier is also conducting a study of the utilization of dialysis-related laboratory services. During the study period, estimated to be at least 90 days, the carrier will suspend all of its previously existing dialysis laboratory prepayment screens. The purpose of the study is to determine what ongoing program safeguards are appropriate. The Company cannot determine what prepayment screens, post-payment review procedures, documentation requirements or other program safeguards the carrier may ultimately 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 refund if determined inappropriate.

The timing of the final resolution of this matter is highly uncertain and beyond the Company’s control or influence. If this matter is resolved in a manner adverse to the Company, the government could impose additional fines and penalties, which could be substantial. 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. Because of the recent lifting of the payment suspension, the carrier will be processing payments beginning in the third quarter of 2002. For the prior period billings, the Company will recognize revenue only to the extent that the carrier makes payments to the laboratory and the risk of potential refund of such payments is considered minimal. For current period billings, the Company will assess what, if any, revenue should be recognized based on the carrier’s payment of current period claims and the outcome of the carrier’s study.

The Medicare carrier for our 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 being conducted at our Florida laboratory. 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. The DOJ has also requested information with respect to this laboratory, which the Company has provided. Medicare revenues at the Minnesota laboratory, which was much smaller than the Florida laboratory, were approximately $15,000 for the period under review. In November 2001, the Company closed the Minnesota laboratory and combined the operations of this laboratory with its Florida laboratory.

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 for HHS, or OIG. The subpoena requires an update to the information the Company provided in its response to the February 2001 request, and also seeks 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 1, 1996 to the present. The Company has provided some documents, and will provide additional documents requested over the next several months. The 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.

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

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.