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 November 1, 2002, there were approximately 60.5 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 condensed 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 nine month period ended September 30, 2002 are not necessarily indicative of the operating results for the full year. The condensed 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.

Effective January 1, 2002, the Company 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 after December 31, 2001, but is routinely assessed for possible valuation impairment. An impairment charge must be recorded against current earnings if the book value of goodwill exceeds its fair value. If this standard had been effective as of January 1, 2001, amortization expense would have been reduced by approximately $6,300 and $18,900, net of tax, for the three and nine months ended September 30, 2001. Income before extraordinary item and diluted income before extraordinary item per share would have been approximately $50,500 and $122,600 and $0.53 and $1.33 per share for the same periods.

In April 2002, the FASB issued SFAS No. 145, Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections. The Company will adopt SFAS No. 145 effective January 1, 2003. Upon adoption of this standard, gains or losses from extinguishment of debt will no longer be classified as extraordinary items, but will be included as a component of income from continuing operations. All comparable periods will be reclassified for consistent presentation. There will be no impact on the Company’s reported net income or net income per share.

In March 2002, the Company initiated a recapitalization plan consisting of restructuring debt and repurchasing common stock. In April 2002, the Company completed the initial phase of the recapitalization plan by retiring all of its $225,000 outstanding 9¼% Senior Subordinated Notes due 2011 for $266,000. The excess of the consideration paid over the book value of the Senior Subordinated Notes and related deferred financing costs resulted in an extraordinary loss of $29,358, net of tax. Concurrent with the retirement of this debt, the Company secured a new senior credit facility agreement in the amount of $1,115,000.

In June 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.

In May 2002, the Company’s Board of Directors authorized the purchase of an additional $225,000 of common stock over eighteen months. As of September 30, 2002, 5,808,940 shares had been acquired for $127,200 under this authorization. As of October 31, 2002, an additional 1,660,500 shares at a cost of $39,322 had been repurchased. For the nine months ended September 30, 2002, stock repurchases, including 2,945,700 shares acquired prior to initiating the recapitalization plan, amounted to $597,200 for 25,436,977 shares, for a composite average of $23.48 per share.

The new senior credit facility secured during the second quarter of 2002 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. During the second quarter of 2002, the Company borrowed all $850,000 of the Term Loan B, and $843,950 of the Term Loan B remained outstanding as of September 30, 2002. The Term Loan B bears interest equal to LIBOR plus 3.00%. The interest rate under the Term Loan A (which is currently undrawn) and the revolving credit facility is equal to LIBOR plus a margin ranging from 1.5% to 2.75% based on the Company’s leverage ratio. The Company is currently evaluating its 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 payments will range from $10,600 to $50,700 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 that of its wholly-owned subsidiaries, along with the stock of the Company’s subsidiaries. The new senior credit facility also contains financial and operating covenants including investment limitations. The Company was in compliance with the covenants of the credit facility as of September 30, 2002.

Long-term debt was comprised of the following:

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

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

Stock options that have exercise prices greater than the average market price of the Company’s common stock during the period, as summarized below, were not included in the computation of earnings per share assuming dilution because they were anti-dilutive.

Impairments and valuation adjustments for the nine months ended September 30, 2002, consisted of the following net gains:

The net gain of $1,001 associated with continental U.S. operations consisted of a realized gain of approximately $2,200 on a previously impaired investment offset by other operating asset impairment losses. The gain of $1,389 for non-continental U.S. operations was associated with the completion of the divestiture of these operations during the second quarter of 2002.

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. In 1998 the carrier issued a formal overpayment determination in the amount of $5,600 for the review period from January 1995 to April 1996. The carrier also suspended all payments of Medicare claims from the laboratory beginning in May 1998. In 1999, the carrier issued a formal overpayment determination in the amount of $15,000 for the review period from May 1996 to March 1998. Subsequently, the

The Company has disputed the carrier’s determinations and has provided supporting documentation of its claims. 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 the Centers for Medicare and Medicaid Services, or CMS, and the Department of Justice, or DOJ. The Company initially met with the DOJ in February 2001, at which time the DOJ requested additional information, which the Company provided in September 2001.

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 for the first two review periods. The judge’s decision did not address the individual claims in the two samples that were used to support the overpayment extrapolations, which totaled approximately $100. The administrative law judge’s decision on the first two review periods also does not apply to the remaining four review periods, 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. The carrier has assigned hearing officers for the third and fourth review periods, but the hearings have not been scheduled. For the fifth and sixth review periods, the carrier is reviewing the records we have submitted and has yet to inform the Company of its initial determinations.

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 earlier this year related to the first two review periods covering January 1995 to March 1998, the carrier lifted the payment suspension and began making payments in July 2002 for lab services provided subsequent to May 2001. As of September 30, 2002, the Company had received $27,200, which represented approximately 30% 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 third quarter of 2002. Based on recent communications with CMS and the Medicare carrier, the Company expects to receive additional payments of $20,000 or more related to prior years’ Medicare lab claims over the next few months. 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, we began recognizing estimated current-period Medicare lab revenue in the third quarter of 2002, which amounted to $5,400 for the quarter.

The carrier is also currently conducting a study of the utilization of dialysis-related laboratory services. During the study, the carrier has suspended all of its previously existing dialysis laboratory prepayment screens. The purpose of the study is to determine what ongoing program safeguards are appropriate. In its initial findings from the study, the carrier has determined that some of its prior prepayment screens were invalidating

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 of the Department of Health and Human Services, 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 1996 to May 2002. The Company has provided the documents requested. 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.

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.

The following information is presented as required under the Securities and Exchange Commission’s 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.