Form 10-Q
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

For the Quarterly Period Ended

June 30, 2011

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

SECURITIES EXCHANGE ACT OF 1934

Commission File Number: 1-14106

 

 

DAVITA INC.

 

 

1551 Wewatta Street

Denver, CO 80202

Telephone number (303) 405-2100

 

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

 

 

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

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

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

 

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

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

As of July 29, 2011, the number of shares of the Registrant’s common stock outstanding was approximately 93.4 million shares and the aggregate market value of the common stock outstanding held by non-affiliates based upon the closing price of these shares on the New York Stock Exchange was approximately $7.8 billion.

 

 

 


Table of Contents

DAVITA INC.

INDEX

 

             Page No.      
  PART I. FINANCIAL INFORMATION   

Item 1.

 

Condensed Consolidated Financial Statements:

  
 

Consolidated Statements of Income for the three and six months ended June 30, 2011 and June  30, 2010

     1   
 

Consolidated Balance Sheets as of June 30, 2011 and December 31, 2010

     2   
 

Consolidated Statements of Cash Flows for the six months ended June 30, 2011 and June 30, 2010

     3   
 

Consolidated Statements of Equity and Comprehensive Income for the six months ended June  30, 2011 and for the year ended December 31, 2010

     4   
 

Notes to Condensed Consolidated Financial Statements

     5   

Item 2.

 

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

     25   

Item 3.

 

Quantitative and Qualitative Disclosures about Market Risk

     39   

Item 4.

 

Controls and Procedures

     40   
 

PART II. OTHER INFORMATION

  

Item 1.

 

Legal Proceedings

     41   

Item 1A.

 

Risk Factors

     41   

Item 2.

 

Unregistered Sales of Equity Securities and Use of Proceeds

     56   

Item 6.

 

Exhibits

     57   
 

Signature

     58   

 

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

 

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Table of Contents

DAVITA INC.

CONSOLIDATED STATEMENTS OF INCOME

(unaudited)

(dollars in thousands, except per share data)

 

     Three months ended June 30,     Six months ended June 30,  
     2011     2010     2011     2010  

Net operating revenues

   $ 1,711,529      $ 1,586,907      $ 3,317,487      $ 3,146,325   

Operating expenses and charges:

        

Patient care costs

     1,165,220        1,110,552        2,281,216        2,193,341   

General and administrative

     163,793        136,104        315,395        273,381   

Depreciation and amortization

     64,470        58,353        126,507        115,821   

Provision for uncollectible accounts

     49,417        42,367        91,706        83,930   

Equity investment income

     (2,417     (2,834     (3,936     (5,179

Goodwill impairment charge

     24,000        —          24,000        —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses and charges

     1,464,483        1,344,542        2,834,888        2,661,294   
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating income

     247,046        242,365        482,599        485,031   

Debt expense

     (59,897     (43,655     (118,492     (88,238

Debt redemption charges

     —          (4,127     —          (4,127

Other income

     556        739        1,397        1,570   
  

 

 

   

 

 

   

 

 

   

 

 

 

Income before income taxes

     187,705        195,322        365,504        394,236   

Income tax expense

     67,040        71,429        130,087        145,343   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income

     120,665        123,893        235,417        248,893   

Less: Net income attributable to noncontrolling interests

     (20,650     (16,040     (40,900     (31,617
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income attributable to DaVita Inc.

   $ 100,015      $ 107,853      $ 194,517      $ 217,276   
  

 

 

   

 

 

   

 

 

   

 

 

 

Earnings per share:

        

Basic earnings per share attributable to DaVita Inc.

   $ 1.05      $ 1.05      $ 2.03      $ 2.11   
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted earnings per share attributable to DaVita Inc.

   $ 1.03      $ 1.04      $ 1.99      $ 2.08   
  

 

 

   

 

 

   

 

 

   

 

 

 

Weighted average shares for earnings per share:

        

Basic

       95,488,449          103,003,623          95,872,466          103,182,403   
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted

     97,657,578        104,449,065        98,014,315        104,605,489   
  

 

 

   

 

 

   

 

 

   

 

 

 

See notes to condensed consolidated financial statements.

 

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Table of Contents

DAVITA INC.

CONSOLIDATED BALANCE SHEETS

(unaudited)

(dollars in thousands, except per share data)

 

     June 30,
2011
    December 31,
2010
 
ASSETS     

Cash and cash equivalents

   $ 729,825      $ 860,117   

Short-term investments

     23,014        23,003   

Accounts receivable, less allowance of $225,150 and $235,629

     1,132,051        1,048,976   

Inventories

     68,629        76,008   

Other receivables

     274,783        304,366   

Other current assets

     49,784        43,994   

Income tax receivables

     5,451        40,330   

Deferred income taxes

     229,827        226,060   
  

 

 

   

 

 

 

Total current assets

     2,513,364        2,622,854   

Property and equipment, net

     1,223,662        1,170,808   

Amortizable intangibles, net

     152,856        162,635   

Equity investments

     30,106        25,918   

Long-term investments

     10,083        8,848   

Other long-term assets

     35,264        32,054   

Goodwill

     4,227,386        4,091,307   
  

 

 

   

 

 

 
   $ 8,192,721      $ 8,114,424   
  

 

 

   

 

 

 
LIABILITIES AND EQUITY     

Accounts payable

   $ 254,129      $ 181,033   

Other liabilities

     317,291        342,943   

Accrued compensation and benefits

     388,965        325,477   

Current portion of long-term debt

     75,226        74,892   
  

 

 

   

 

 

 

Total current liabilities

     1,035,611        924,345   

Long-term debt

     4,210,823        4,233,850   

Other long-term liabilities

     104,644        89,290   

Alliance and product supply agreement, net

     22,652        25,317   

Deferred income taxes

     456,361        421,436   
  

 

 

   

 

 

 

Total liabilities

     5,830,091        5,694,238   

Commitments and contingencies

    

Noncontrolling interests subject to put provisions

     416,504        383,052   

Equity:

    

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

    

Common stock ($0.001 par value, 450,000,000 shares authorized; 134,862,283 shares issued; 93,481,011 and 96,001,535 shares outstanding)

     135        135   

Additional paid-in capital

     614,304        620,546   

Retained earnings

     2,912,334        2,717,817   

Treasury stock, at cost (41,381,272 and 38,860,748 shares)

     (1,634,127     (1,360,579

Accumulated other comprehensive (loss) income

     (11,787     503   
  

 

 

   

 

 

 

Total DaVita Inc. shareholders’ equity

     1,880,859        1,978,422   

Noncontrolling interests not subject to put provisions

     65,267        58,712   
  

 

 

   

 

 

 

Total equity

     1,946,126        2,037,134   
  

 

 

   

 

 

 
   $     8,192,721      $     8,114,424   
  

 

 

   

 

 

 

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)

 

00000000000000 00000000000000
     Six months ended
June 30,
 
     2011     2010  

Cash flows from operating activities:

    

Net income

   $ 235,417      $ 248,893   

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

    

Depreciation and amortization

     126,507        115,821   

Stock-based compensation expense

     23,058        22,399   

Tax benefits from stock award exercises

     33,765        12,896   

Excess tax benefits from stock award exercises

     (19,009     (1,647

Deferred income taxes

     24,225        (10,697

Equity investment income, net

     472        (2,781

Loss on disposal of assets and other non-cash charges

     10,842        3,085   

Goodwill impairment charge

     24,000        —     

Debt redemption charges

     —          4,127   

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

    

Accounts receivable

     (83,075     33,724   

Inventories

     9,369        2,005   

Other receivables and other current assets

     23,791        33,053   

Other long-term assets

     2,164        (587

Accounts payable

     41,436        62,255   

Accrued compensation and benefits

     68,008        65,495   

Other current liabilities

     (25,716     (26,127

Income taxes

     34,799        (5,103

Other long-term liabilities

     4,140        955   
  

 

 

   

 

 

 

Net cash provided by operating activities

     534,193        557,766   
  

 

 

   

 

 

 

Cash flows from investing activities:

    

Additions of property and equipment, net

     (154,929     (99,351

Acquisitions

     (151,196     (91,701

Proceeds from asset sales

     2,954        17,681   

Purchase of investments available for sale

     (1,868     (745

Purchase of investments held-to-maturity

     (19,684     (15,836

Proceeds from sale of investments available for sale

     1,149        900   

Proceeds from maturities of investments held-to-maturity

     19,683        19,249   

Purchase of equity investments and other assets

     (5,005     (350

Distributions received on equity investments

     340       350   
  

 

 

   

 

 

 

Net cash used in investing activities

     (308,556     (169,803
  

 

 

   

 

 

 

Cash flows from financing activities:

    

Borrowings

     19,169,580        9,689,658   

Payments on long-term debt

     (19,201,362     (9,938,312

Interest rate cap premiums and other deferred financing costs

     (13,457     —     

Debt call premium

     —          (3,314

Purchase of treasury stock

     (290,593     (100,048

Distributions to noncontrolling interests

     (46,423     (37,301

Stock award exercises and other share issuances, net

     7,410        34,113   

Excess tax benefits from stock award exercises

     19,009        1,647   

Contributions from noncontrolling interests

     6,490        3,408   

Proceeds from sales of additional noncontrolling interests

     2,067        2,845   

Purchases from noncontrolling interests

     (8,650     (5,402
  

 

 

   

 

 

 

Net cash used in financing activities

     (355,929     (352,706
  

 

 

   

 

 

 

Net (decrease) increase in cash and cash equivalents

     (130,292     35,257   

Cash and cash equivalents at beginning of period

     860,117        539,459   
  

 

 

   

 

 

 

Cash and cash equivalents at end of period

   $ 729,825      $ 574,716   
  

 

 

   

 

 

 

See notes to condensed consolidated financial statements.

 

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Table of Contents

DAVITA INC.

CONSOLIDATED STATEMENTS OF EQUITY

AND COMPREHENSIVE INCOME

(unaudited)

(dollars and shares in thousands)

 

    Non-
controlling
interests
subject to
put
provisions
    DaVita Inc. Shareholders’ Equity     Non-
controlling
interests
not
subject to

put
provisions
    Comprehensive
income
 
      Common
stock
    Additional
paid-in
capital
    Retained
earnings
    Treasury
stock
    Accumulated
other
comprehensive
income (loss)
    Total      

Balance at December 31, 2009

  $ 331,725        134,862      $ 135      $ 621,685      $ 2,312,134        (31,800   $ (793,340   $ (5,548   $ 2,135,066      $ 59,093     

Comprehensive income:

                     

Net income

    52,589              405,683              405,683        25,947      $ 484,219   

Unrealized losses on interest rate swaps, net of tax

                  (134     (134       (134

Less reclassification of net swap realized losses into net income, net of tax

                  5,557        5,557          5,557   

Unrealized gains on investments, net of tax

                  615        615          615   

Less reclassification of net investment realized losses into net income, net of tax

                  13        13          13   
                     

 

 

 

Total comprehensive income

                      $ 490,270   
                     

 

 

 

Stock purchase shares issued

          2,129          86        2,151          4,280       

Stock unit shares issued

          (875       32        875          —         

Stock options and SSARs exercised

          455          1,740        48,231          48,686       

Stock-based compensation expense

          45,551                45,551       

Excess tax benefits from stock awards exercised

          6,283                6,283       

Distributions to noncontrolling interests

    (54,612                     (28,979  

Contributions from noncontrolling interests

    5,439                        4,071     

Sales and assumptions of additional noncontrolling interests

    4,059            (298             (298     2,308     

Purchases from noncontrolling interests

    (4,949         (5,537             (5,537     (3,728  

Impact on fair value due to change in methodology

    (24,571         24,571                24,571       

Changes in fair value of noncontrolling interests

    73,372            (73,372             (73,372    

Other adjustments

          (46             (46    

Purchase of treasury stock

              (8,919     (618,496       (618,496    
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

Balance at December 31, 2010

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

Comprehensive income:

                     

Net income

    25,007              194,517              194,517        15,893      $ 235,417   

Unrealized losses on interest rate swap and cap agreements, net of tax

                  (16,971     (16,971       (16,971

Less reclassification of net swap and cap agreements realized losses into net income, net of tax

                  4,423        4,423          4,423   

Unrealized gains on investments, net of tax

                  315        315          315   

Less reclassification of net investment realized gains into net income, net of tax

                  (57     (57       (57
                     

 

 

 

Total comprehensive income

                      $ 223,127   
                     

 

 

 

Stock purchase shares issued

          1,998          84        2,938          4,936       

Stock unit shares issued

          (2,384       66        2,384          —         

Stock options and SSARs exercised

          (32,041       1,040        37,216          5,175       

Stock-based compensation expense

          23,058                23,058       

Excess tax benefits from stock awards exercised

          19,009                19,009       

Distributions to noncontrolling interests

    (29,564                     (16,859  

Contributions from noncontrolling interests

    2,866                        3,624     

Sales and assumptions of additional noncontrolling interests

    25,934            169                169        5,705     

Purchases from noncontrolling interests

    (1,041         (5,801             (5,801     (1,808  

Changes in fair value of noncontrolling interests

    10,250            (10,250             (10,250    

Purchase of treasury stock

              (3,710     (316,086       (316,086    
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

Balance at June 30, 2011

  $ 416,504        134,862      $ 135      $ 614,304      $ 2,912,334        (41,381   $ (1,634,127   $ (11,787   $ 1,880,859      $ 65,267     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

See notes to condensed consolidated financial statements.

 

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Table of Contents

DAVITA INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

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

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

1. Condensed consolidated interim financial statements

The condensed consolidated interim financial statements included in this report are prepared by the Company without audit. In the opinion of management, all adjustments consisting only of normal recurring items necessary for a fair presentation of the results of operations are reflected in these consolidated interim financial statements. All significant intercompany accounts and transactions have been eliminated. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. The most significant estimates and assumptions underlying these financial statements and accompanying notes generally involve revenue recognition and provisions for uncollectible accounts, impairments and valuation adjustments, fair value estimates, accounting for income taxes, variable compensation accruals, purchase accounting valuation estimates and stock-based compensation. The results of operations for the six months ended June 30, 2011 are not necessarily indicative of the operating results for the full year. The consolidated interim financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2010. Prior year balances and amounts have been classified to conform to the current year presentation. The Company has evaluated subsequent events through the date these condensed consolidated financial statements were issued and has included all necessary disclosures.

2. Earnings per share

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

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

 

    Three months ended
June 30,
    Six months ended
June 30,
 
    2011     2010     2011     2010  

Basic:

       

Net income attributable to DaVita Inc.

  $ 100,015      $ 107,853      $ 194,517      $ 217,276   

Decrease (increase) in noncontrolling interest redemption rights in excess of fair value

    93        798        120        (71
 

 

 

   

 

 

   

 

 

   

 

 

 

Net income for basic earnings per share calculation

  $ 100,108      $ 108,651      $ 194,637      $ 217,205   
 

 

 

   

 

 

   

 

 

   

 

 

 

Weighted average shares outstanding during the period

    95,485        102,997        95,869        103,175   

Vested stock units

    3        7        3        7   
 

 

 

   

 

 

   

 

 

   

 

 

 

Weighted average shares for basic earnings per share calculation

    95,488        103,004        95,872        103,182   
 

 

 

   

 

 

   

 

 

   

 

 

 

Basic net income per share attributable to DaVita Inc.

  $ 1.05      $ 1.05      $ 2.03      $ 2.11   
 

 

 

   

 

 

   

 

 

   

 

 

 

 

5


Table of Contents

DAVITA INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (continued)

(unaudited)

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

 

    Three months ended
June 30,
    Six months ended
June 30,
 
    2011     2010     2011     2010  

Diluted:

       

Net income for diluted earnings per share calculation

  $ 100,015      $ 107,853      $ 194,517      $ 217,276   

Decrease (increase) in noncontrolling interest redemption rights in excess of fair value

    93        798        120        (71
 

 

 

   

 

 

   

 

 

   

 

 

 

Net income for diluted earnings per share calculation

  $ 100,108      $ 108,651      $ 194,637      $ 217,205   
 

 

 

   

 

 

   

 

 

   

 

 

 

Weighted average shares outstanding during the period

    95,485        102,997        95,869        103,175   

Vested stock units

    3        7        3        7   

Assumed incremental shares from stock plans

    2,170        1,445        2,142        1,423   
 

 

 

   

 

 

   

 

 

   

 

 

 

Weighted average shares for diluted earnings per share calculation

    97,658        104,449        98,014        104,605   
 

 

 

   

 

 

   

 

 

   

 

 

 

Diluted net income per share attributable to DaVita Inc.

  $ 1.03      $ 1.04      $ 1.99      $ 2.08   
 

 

 

   

 

 

   

 

 

   

 

 

 

Share-based anti-dilutive awards excluded from
calculation
(1)

    1,939        1,648        1,249        1,149   
 

 

 

   

 

 

   

 

 

   

 

 

 

 

(1)

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

3. Stock-based compensation and other common stock transactions

Stock-based compensation recognized in a period represents the amortization during that period of the estimated grant-date fair value of current and prior stock-based awards over their vesting terms, adjusted for expected forfeitures. Shares issued upon exercise of stock awards are generally issued from shares in treasury. The Company has used the Black-Scholes-Merton valuation model for estimating the grant-date fair value of stock options and stock-settled stock appreciation rights granted in all periods. During the six months ended June 30, 2011, the Company granted 2,270 stock-settled stock appreciation rights with a grant-date fair value of $51,596 and a weighted-average expected life of approximately 4.3 years, and also granted 138 stock units with a grant-date fair value of $11,901 and a weighted-average expected life of approximately 3.2 years.

For the six months ended June 30, 2011 and 2010, the Company recognized $23,058 and $22,399, respectively, in stock-based compensation expense for stock-settled stock appreciation rights, stock options, stock units and discounted employee stock plan purchases, which are primarily included in general and administrative expenses. The estimated tax benefits recorded for stock-based compensation through June 30, 2011 and 2010 was $8,762 and $8,518, respectively. As of June 30, 2011, there was $109,980 of total estimated unrecognized compensation cost related to nonvested stock-based compensation arrangements under the Company’s equity compensation and stock purchase plans. The Company expects to recognize this cost over a weighted average remaining period of 1.5 years.

During the six months ended June 30, 2011 and 2010, the Company received $5,175 and $32,104, respectively, in cash proceeds from stock option exercises and $33,765 and $12,896, respectively, in actual tax benefits upon the exercise of stock awards.

 

6


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DAVITA INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (continued)

(unaudited)

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

 

During the first six months of 2011, the Company repurchased a total of 3,710 shares of its common stock for $316,086, or an average price of $85.20 per share. As of June 30, 2011, a total of $25,493 of share repurchases had not yet been settled in cash. In addition, the Company repurchased 85 additional shares of its common stock for $7,261, or an average price of $85.83 per share during the period July 1, 2011 through July 31, 2011. As a result of these transactions, the Company’s remaining board authorization for share repurchases as of July 31, 2011 is approximately $358,200.

On March 10, 2011, the Company and The Bank of New York Mellon Trust Company, N.A., as rights agent, entered into an amendment (the “Amendment”) to the Rights Agreement, dated November 14, 2002 (the “Rights Plan”). The Amendment accelerates the expiration of the rights issued under the Rights Plan from the close of business on November 14, 2012 to the close of business on March 10, 2011. Accordingly, as of the close of business on March 10, 2011, the rights issued under the Rights Plan expired and are no longer outstanding.

On June 6, 2011, our stockholders approved the DaVita Inc. 2011 Incentive Award Plan (The 2011 Plan). The 2011 Plan constitutes an amendment and restatement of the DaVita Inc. 2002 Equity Compensation Plan, as amended (The 2002 Plan). The 2011 Plan authorizes the Company to provide equity-based compensation in the form of stock options, stock appreciation rights, restricted stock units, restricted stock, and certain other performance-based awards. The 2011 Plan is designed to enable the Company to grant performance-based equity and cash awards that qualify as performance-based compensation under Section 162(m) of the Internal Revenue Code. The 2011 Plan does not increase the number of shares authorized under the 2002 Plan but reflects a broad range of compensation and governance best practices such as limitations on the aggregate number of awards that can be granted to any one person, prohibitions on the amendment of stock awards to reduce the exercise price, prohibitions on the replacement of an option or stock appreciation right with cash or any other award when the price per share exceeds fair value of the underlying shares and prohibitions on the grant of options or stock appreciation rights with an exercise price or base price that is less than fair market value.

4. Long-term debt

Long-term debt was comprised of the following:

 

     June 30,
2011
    December 31,
2010
 

Senior Secured Credit Facilities:

    

Term Loan A

   $ 975,000      $ 1,000,000   

Term Loan B

     1,741,250        1,750,000   

Senior notes

     1,550,000        1,550,000   

Acquisition obligations and other notes payable

     11,626        9,049   

Capital lease obligations

     15,815        8,074   
  

 

 

   

 

 

 

Total debt principal outstanding

     4,293,691        4,317,123   

Discount on long-term debt

     (7,642     (8,381
  

 

 

   

 

 

 
     4,286,049        4,308,742   

Less current portion

     (75,226     (74,892
  

 

 

   

 

 

 
   $     4,210,823      $     4,233,850   
  

 

 

   

 

 

 

 

7


Table of Contents

DAVITA INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (continued)

(unaudited)

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

 

Scheduled maturities of long-term debt at June 30, 2011 were as follows:

 

2011 (remainder of the year)

     40,429   

2012

     69,293   

2013

     119,805   

2014

     169,296   

2015

     669,993   

2016

     1,663,655   

Thereafter

     1,561,220   

During the first six months of 2011, the Company made mandatory principal payments totaling $25,000 on the Term Loan A and $8,750 on the Term Loan B.

In January 2011, the Company entered into several interest rate swap agreements as a means of hedging its exposure to and volatility from variable-based interest rate changes as part of its overall risk management strategy. These agreements are not held for trading or speculative purposes, and have the economic effect of converting the LIBOR variable component of the Company’s interest rate to a fixed rate. These swap agreements are designated as cash flow hedges, and as a result, hedge-effective gains or losses resulting from changes in the fair values of these swaps are reported in other comprehensive income until such time as each specific swap tranche is realized, at which time the amounts are reclassified into net income. Net amounts paid or received for each specific swap tranche that have settled have been reflected as adjustments to debt expense. In addition, in January 2011, the Company entered into several interest rate cap agreements that have the economic effect of capping the Company’s maximum exposure to LIBOR variable interest rate changes on specific portions of the Company’s Term Loan B debt, as described below. These cap agreements are also designated as cash flow hedges and as a result changes in the fair values of these cap agreements are reported in other comprehensive income. The amortization of the original cap premium is recognized as a component of debt expense on a straight line basis over the term on the cap agreements. The swap and cap agreements do not contain credit-risk contingent features.

As of June 30, 2011, the Company maintained a total of nine interest rate swap agreements with amortizing notional amounts totaling $975,000. These agreements had the economic effect of modifying the LIBOR variable component of the Company’s interest rate on an equivalent amount of the Company’s Term Loan A to fixed rates ranging from 1.59% to 1.64%, resulting in an overall weighted average effective interest rate of 4.36%, including the Term Loan A margin of 2.75%. The swap agreements expire by September 30, 2014 and require monthly interest payments. The Company estimates that approximately $12,300 of existing unrealized pre-tax losses in other comprehensive income at June 30, 2011 will be reclassified into income over the next twelve months.

As of June 30, 2011, the Company maintained five interest rate cap agreements with notional amounts totaling $1,250,000. These agreements have the economic effect of capping the LIBOR variable component of the Company’s interest rate at a maximum of 4.00% on an equivalent amount of the Company’s Term Loan B debt. The cap agreements expire on September 30, 2014.

 

8


Table of Contents

DAVITA INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (continued)

(unaudited)

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

 

The following table summarizes the Company’s derivative instruments as of June 30, 2011 and December 31, 2010:

 

    

June 30, 2011

    

December 31, 2010

 

Derivatives designated as hedging

instruments

  

Balance sheet
location

   Fair value     

Balance sheet
location

   Fair value  

Interest rate swap agreements

   Other long-term liabilities    $     14,247       Other long-term liabilities    $     —     
     

 

 

       

 

 

 

Interest rate cap agreements

   Other long-term assets    $ 5,374       Other long-term assets    $ —     
     

 

 

       

 

 

 

The following table summarizes the effects of the Company’s interest rate swap and cap agreements for the six months ended June 30, 2011 and 2010:

 

     Amount of gains (losses) recognized in
OCI on interest rate swap agreements
   

Location of
(losses) gains
reclassified
from
accumulated
OCI into income

   Amount of gains (losses) reclassified
from accumulated OCI into income
 
     Three months ended
June 30,
    Six months ended
June 30,
       Three months ended
June 30,
    Six months ended
June 30,
 

Derivatives designated as cash
flow hedges

   2011     2010     2011     2010        2011     2010     2011     2010  

Interest rate swap agreements

   $ (16,790   $ 68      $ (19,991   $ (215   Debt expense    $ (3,490   $ (3,572   $ (5,744   $ (7,151

Interest rate cap agreements

     (4,221     —          (7,784     —        Debt expense      (897     —          (1,495     —     

Tax benefit (expense)

     8,173        (27     10,804        83           1,706        1,389        2,816        2,781   
  

 

 

   

 

 

   

 

 

   

 

 

      

 

 

   

 

 

   

 

 

   

 

 

 

Total

   $ (12,838   $ 41      $ (16,971   $ (132      $ (2,681   $ (2,183   $ (4,423   $ (4,370
  

 

 

   

 

 

   

 

 

   

 

 

      

 

 

   

 

 

   

 

 

   

 

 

 

Total comprehensive income for the three and six months ended June 30, 2011 was $110,555 and $223,127, respectively, including a decrease to other comprehensive income due to unrealized valuation losses on interest rate swaps and caps of $10,157 and $12,548, net of tax, respectively, net of amounts reclassified into income, and an increase to other comprehensive income for unrealized valuation gains on investments, and the amounts reclassified into income of $47 and $258, net of tax, respectively.

Total comprehensive income for the three and six months ended June 30, 2010 was $125,752 and $252,980, respectively, including an increase to other comprehensive income for amounts reclassified into income, net of unrealized valuation loss on interest rate swaps of $2,224 and $4,238, net of tax, respectively, and a decrease to other comprehensive income for unrealized valuation gains on investments, and the amounts reclassified into income of $365 and $151, net of tax, respectively.

As of June 30, 2011, the Company’s interest rates were economically fixed on primarily all of its total debt.

As a result of the swap agreements, the Company’s overall weighted average effective interest rate on the Senior Secured Credit Facilities was 4.68%, based upon the current margins in effect of 2.75% for the Term loan A and 3.00% for the Term Loan B, as of June 30, 2011.

The Company’s overall weighted average effective interest rate during the second quarter of 2011 was 5.33% and as of June 30, 2011 was 5.34%.

 

9


Table of Contents

DAVITA INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (continued)

(unaudited)

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

 

As of June 30, 2011, the Company had undrawn revolving credit facilities totaling $250,000 of which approximately $45,789 was committed for outstanding letters of credit.

5. Contingencies

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

Inquiries by the Federal Government

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

Eastern District of Texas Matter: In February 2007, the Company received a request for information from the Office of Inspector General, U.S. Department of Health and Human Services, or OIG, for records relating to EPO claims submitted to Medicare. In August 2007, the Company received a subpoena from the OIG seeking similar documents. The requested documents relate to services provided from 2001 to 2004 by a number of the Company’s centers. The request and subpoena were sent from the OIG’s offices in Houston and Dallas, Texas. The Company cooperated with the inquiry and has produced all previously requested records to date. The Company was contacted by the U.S. Attorney’s Office for the Eastern District of Texas, which stated that this is a civil inquiry related to EPO claims. On July 6, 2009, the United States District Court for the Eastern District of Texas lifted the seal on the civil qui tam complaint related to these allegations and the Company was subsequently served with a complaint by the relator. The government did not intervene and is not actively pursuing this matter. The relator is pursuing the claims independently and the parties are engaged in active litigation. The Company believes that there is some overlap between this issue and the ongoing review of EPO utilization in the Eastern District of Missouri matter described above.

Northern District of Georgia Matter: In December 2008, the Company received a subpoena for documents from the OIG relating to the pharmaceutical products Zemplar, Hectorol, Venofer, Ferrlecit and EPO, as well as

 

10


Table of Contents

DAVITA INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (continued)

(unaudited)

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

 

other related matters. The subpoena covers the period from January 2003 to the present. The Company has been in contact with the U.S. Attorney’s Office for the Northern District of Georgia and the U.S. Department of Justice in Washington, DC, since November 2008 relating to this matter, and was advised that this is a civil inquiry. On June 17, 2009, the Company learned that the allegations underlying this inquiry were made as part of a civil qui tam complaint filed by individuals and brought pursuant to the federal False Claims Act. On April 1, 2011, the United States District Court for the Northern District of Georgia ordered the case to be unsealed. At that time, the Department of Justice and U.S. Attorney’s Office filed a notice of declination stating that the United States would not be intervening and not pursuing the relators’ allegation in litigation. On July 25, 2011, the relators filed their amended complaint in the United States District Court for the Northern District of Georgia and have indicated that they will independently pursue the case.

Dallas Matter: In May 2010, the Company received a subpoena from the OIG’s office in Dallas, Texas. The subpoena covers the period from January 1, 2005 to the present, and seeks production of a wide range of documents relating to the Company’s operations, including documents related to, among other things, financial relationships with physicians and joint ventures. The general subject matter of the investigation appears to overlap with the Eastern District of Missouri Matter described above. The Company met with representatives of the government to discuss the scope of the subpoena and the production of responsive documents. The Company has been advised that this is a civil investigation. The Company is cooperating with the inquiry and is producing the requested records.

Colorado Matter: The Company has learned that the U.S. Attorney’s Office for the District of Colorado has opened a grand jury investigation that encompasses certain activities of the Company. The Company understands that the investigation is at a very preliminary stage, and while its precise scope is unclear, it appears to overlap, at least in part, with the Eastern District of Missouri and OIG Dallas matters described above and previously disclosed by the Company. The Company intends to cooperate with the investigation.

Except as otherwise described above, to the Company’s knowledge, no proceedings have been initiated against the Company at this time in connection with any of the inquiries by the federal government as set forth above. Although the Company cannot predict whether or when proceedings might be initiated or when these matters may be resolved, it is not unusual for investigations such as these to continue for a considerable period of time. Responding to the subpoenas or inquiries will continue to require management’s attention and significant legal expense. Any negative findings could result in substantial financial penalties against the Company, exclusion from future participation in the Medicare and Medicaid programs and, to the extent criminal proceedings may be initiated against the Company as indicated above, possible criminal penalties. At this time, the Company cannot predict the ultimate outcome of these inquiries, or the potential outcome of the relators claims, or the potential range of damages, if any.

Other

The Company has received several notices of claims from commercial payors and other third parties related to historical billing practices and claims against DVA Renal Healthcare (formerly known as Gambro Healthcare), a subsidiary of the Company, related to historical Gambro Healthcare billing practices and other matters covered by its 2004 settlement agreement with the Department of Justice and certain agencies of the U.S. government. At least one commercial payor has filed an arbitration demand against the Company, as described below, and additional commercial payors have threatened litigation. The Company intends to defend against these claims vigorously; however, the Company may not be successful and these claims may lead to litigation and any such litigation may be resolved unfavorably. At this time, the Company cannot predict the ultimate outcome of this matter or the potential range of damages, if any.

 

11


Table of Contents

DAVITA INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (continued)

(unaudited)

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

 

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

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

In August 2005, Blue Cross/Blue Shield of Louisiana filed a complaint in the United States District Court for the Western District of Louisiana against Gambro AB, the Company’s subsidiary, DVA Renal Healthcare (formerly known as Gambro Healthcare) and related entities. The plaintiff sought to bring its claims as a class action on behalf of itself and all entities that paid any of the defendants for health care goods and services from on or about January 1991 through at least December 2004. The complaint alleged, among other things, damages resulting from facts and circumstances underlying Gambro Healthcare’s 2004 settlement agreement with the Department of Justice and certain agencies of the U.S. government. In March 2006, the case was dismissed and the plaintiff was compelled to seek arbitration to resolve the matter. In November 2006, the plaintiff filed a demand for class arbitration against the Company and DVA Renal Healthcare. In February 2011, the arbitration panel denied plaintiff’s request to certify a class. The Company intends to vigorously defend against plaintiff’s remaining individual claims and any appeal that may be filed. At this time, the Company cannot predict the ultimate outcome of this matter or the potential range of damages, if any.

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

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

 

12


Table of Contents

DAVITA INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (continued)

(unaudited)

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

 

6. Investments in debt and equity securities

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

The Company’s investments consist of the following:

 

     June 30, 2011      December 31, 2010  
     Held to
maturity
     Available
for sale
     Total      Held to
maturity
     Available
for sale
     Total  

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

   $   21,814       $ —         $ 21,814       $ 21,803       $ —         $ 21,803   

Investments in mutual funds

     —           11,283         11,283         —           10,048         10,048   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
   $ 21,814       $   11,283       $   33,097       $   21,803       $   10,048       $   31,851   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Short-term investments

   $ 21,814       $ 1,200       $ 23,014       $ 21,803       $ 1,200       $ 23,003   

Long-term investments

     —           10,083         10,083         —           8,848         8,848   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
   $ 21,814       $ 11,283       $ 33,097       $ 21,803       $ 10,048       $ 31,851   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

The cost of the certificates of deposit, money market funds and U.S. treasury notes at June 30, 2011 and December 31, 2010 approximates their fair value. As of June 30, 2011 and December 31, 2010, the available for sale investments included $1,247 and $824, of gross pre-tax unrealized gains, respectively. During the six months ended June 30, 2011, the Company recorded gross pre-tax unrealized gains of $516, or $315 after tax, in other comprehensive income associated with changes in the fair value of these investments. During the six months ended June 30, 2011, the Company sold equity securities in mutual funds for net proceeds of $1,149, and recognized a pre-tax gain of $93, or $57 after tax, that was previously recorded in other comprehensive income. During the six months ended June 30, 2010, the Company sold investments in mutual funds for net proceeds of $900, and recognized a pre-tax loss of $22, or $14 after tax, that was previously recorded in other comprehensive income.

As of June 30, 2011, investments totaling $18,542 classified as held to maturity are investments used to maintain certain capital requirements of the special needs plans of VillageHealth, which is a wholly-owned subsidiary of the Company. As of December 31, 2009, the Company discontinued the VillageHealth special needs plans and is in process of paying out all incurred claims. The Company also expects to liquidate its investments that are currently held to maintain certain capital requirements as soon as the various state regulatory agencies approve the release of these investments. The investments in mutual funds classified as available for sale are held within a trust to fund existing obligations associated with several of the Company’s non-qualified deferred compensation plans.

7. Fair value of financial instruments

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

 

13


Table of Contents

DAVITA INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (continued)

(unaudited)

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

 

The following table summarizes the Company’s assets, liabilities and temporary equity measured at fair value on a recurring basis as of June 30, 2011:

 

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

Assets

           

Available for sale securities

   $ 11,283       $   11,283       $ —         $ —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Interest rate cap agreements

   $ 5,374       $ —         $ 5,374       $ —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Liabilities

           

Interest rate swap agreements

   $ 14,247       $ —         $   14,247       $ —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Temporary equity

           

Noncontrolling interests subject to put provisions

   $   416,504       $ —         $ —         $   416,504   
  

 

 

    

 

 

    

 

 

    

 

 

 

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

The interest rate swap and cap agreements are recorded at fair value based upon valuation models and a variety of techniques as reported by various broker dealers that are based upon relevant observable market inputs such as current interest rates, forward yield curves, and other credit and liquidity market conditions. The Company does not believe the ultimate amount that could be realized upon settlement of these interest rate swap and cap agreements would be materially different than the fair values as currently reported. See Note 4 to the condensed consolidated financial statements for further discussion.

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

The Company has other financial instruments in addition to the above that consist primarily of cash, accounts receivable, accounts payable, other accrued liabilities, and debt. The balances of the non-debt financial instruments are presented in the condensed consolidated financial statements at June 30, 2011 at their approximate fair values due to the short-term nature of their settlements. The carrying amount of the Company’s Senior Secured Credit Facilities totaled $2,708,608 as of June 30, 2011 and the fair value was $2,711,114 based upon quoted market prices. The fair value of the Company’s senior notes was approximately $1,561,625 at June 30, 2011, based upon quoted market prices, as compared to the carrying amount of $1,550,000.

8. Noncontrolling interests subject to put provisions and other commitments

The Company has potential obligations to purchase the noncontrolling interests held by third parties in several of its joint ventures and non-wholly-owned subsidiaries. These obligations are in the form of put provisions and are exercisable at the third-party owners’ discretion within specified periods as outlined in each specific put provision. If these put provisions were exercised, the Company would be required to purchase the third-party owners’ noncontrolling interests at either the appraised fair market value or a predetermined multiple

 

14


Table of Contents

DAVITA INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (continued)

(unaudited)

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

 

of earnings or cash flow attributable to the noncontrolling interests put to the Company, which is intended to approximate fair value. The methodology the Company uses to estimate the fair values of noncontrolling interests subject to put provisions assumes either the higher of a liquidation value of net assets or an average multiple of earnings, based on historical earnings, patient mix and other performance indicators, as well as other factors. The estimated fair values of the noncontrolling interests subject to put provisions can fluctuate and the implicit multiple of earnings at which these noncontrolling interests obligations may be settled will vary significantly depending upon market conditions including potential purchasers’ access to the capital markets, which can impact the level of competition for dialysis and non-dialysis related businesses, the economic performance of these businesses and the restricted marketability of the third-party owners’ noncontrolling interests. The amount of noncontrolling interests subject to put provisions that contractually employ a predetermined multiple of earnings rather than fair value are immaterial.

Additionally, the Company has certain other potential commitments to provide operating capital to several dialysis centers that are wholly-owned by third parties or centers in which the Company owns a minority equity investment as well as to physician-owned vascular access clinics that the Company operates under management and administrative services agreements of approximately $2,100.

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

9. Income taxes

As of June 30, 2011, the Company’s total liability for unrecognized tax benefits relating to tax positions that do not meet the more-likely-than-not threshold is $8,892, all of which would impact the Company’s effective tax rate if recognized. This balance represents an increase of $754 from the December 31, 2010 balance of $8,138 due to the addition of 2011 liabilities.

The Company recognizes accrued interest and penalties related to unrecognized tax benefits in its income tax expense. At June 30, 2011 and December 31, 2010, the Company had approximately $3,886 and $3,177, respectively, accrued for interest and penalties related to unrecognized tax benefits, net of federal tax benefits.

10. Acquisitions

On February 4, 2011, the Company entered into a definitive agreement to acquire all of the outstanding equity securities of CDSI I Holding Company, Inc., the parent company of dialysis provider DSI Renal, Inc. (DSI), in cash for approximately $689,200, subject to among other things, adjustments for certain items such as working capital, the purchase of noncontrolling interests, capital assets and acquisitions expenditures. DSI currently operates approximately 106 outpatient dialysis centers serving approximately 8,000 patients. The transaction is subject to approval by the Federal Trade Commission (FTC) including Hart-Scott-Rodino antitrust clearance. The FTC has determined that the Company will be required to divest approximately 30 outpatient dialysis centers as a condition of the transaction. The Company still expects the transaction to close in the third quarter of 2011.

During the first six months of 2011, the Company acquired 35 dialysis centers for an aggregate purchase cost of $151,379, which includes deferred purchase price and assumption of liabilities totaling $183.

 

15


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DAVITA INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (continued)

(unaudited)

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

 

The initial purchase cost allocations for acquired businesses are recorded at fair values based upon the best information available to management and are finalized when identified pre-acquisition contingencies have been resolved and other information arranged to be obtained has been received, but in no case in excess of one year from the acquisition date.

The aggregate purchase cost allocations for dialysis businesses were as follows:

 

      Six months ended
June 30, 2011
 

Tangible assets, principally leasehold improvements and equipment

   $ 14,453   

Amortizable intangible assets

     6,151   

Goodwill

     160,579   

Noncontrolling interests assumed

     (29,741

Liabilities assumed

     (63
  

 

 

 

Aggregate purchase cost

   $ 151,379   
  

 

 

 

Amortizable intangible assets acquired during the first six months of 2011 had weighted average estimated useful lives of ten years. All of the goodwill acquired during the first six months of 2011 was associated with the dialysis and related lab services business. The total amount of goodwill deductible for tax purposes associated with these acquisitions was approximately $135,000.

11. Segment reporting

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

The Company’s operating segment financial information is prepared on an internal management reporting basis that the Chief Executive Officer uses to allocate resources and analyze the performance of operating segments. For internal management reporting, segment operations include direct segment operating expenses with the exception of stock-based compensation expense and equity investment income. In addition, beginning in 2011, the ancillary services and strategic initiatives segment operations also include an allocation of corporate general and administrative expenses.

 

16


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DAVITA INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (continued)

(unaudited)

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

 

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

 

     Three months ended June 30,     Six months ended June 30,  
     2011     2010     2011     2010  

Segment revenues:

        

Dialysis and related lab services (1)

        

External sources

   $ 1,588,774      $ 1,494,049      $ 3,091,312      $ 2,969,982   

Intersegment revenues

     2,019        2,172        4,226        4,684   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total dialysis and related lab services

     1,590,793        1,496,221        3,095,538        2,974,666   
  

 

 

   

 

 

   

 

 

   

 

 

 

Other – Ancillary services and strategic initiatives

        

External sources (2)

   $ 122,756      $ 92,858      $ 226,174      $ 176,343   

Intersegment revenues

     531        —          2,828       —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Total ancillary services and strategic initiatives

     123,287        92,858        229,002        176,343   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total segment revenues

     1,714,080        1,589,079        3,324,540        3,151,009   

Elimination of intersegment revenues

     (2,551     (2,172     (7,053     (4,684
  

 

 

   

 

 

   

 

 

   

 

 

 

Consolidated revenues

   $ 1,711,529      $ 1,586,907      $ 3,317,487      $ 3,146,325   
  

 

 

   

 

 

   

 

 

   

 

 

 

Segment operating margin (loss): (3)

        

Dialysis and related lab services

   $ 282,812      $ 253,672      $ 532,980      $ 505,790   

Other – Ancillary services and strategic initiatives

     (24,841     (1,974     (31,259     (3,539
  

 

 

   

 

 

   

 

 

   

 

 

 

Total segment margin

     257,971        251,698        501,721        502,251   

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

        

Stock-based compensation

     (13,342     (12,167     (23,058     (22,399

Equity investment income

     2,417        2,834        3,936        5,179   
  

 

 

   

 

 

   

 

 

   

 

 

 

Consolidated operating income

     247,046        242,365        482,599        485,031   

Debt expense

     (59,897     (43,655     (118,492     (88,238

Debt redemption charges

     —          (4,127     —          (4,127

Other income

     556        739        1,397        1,570   
  

 

 

   

 

 

   

 

 

   

 

 

 

Consolidated income before income taxes

   $ 187,705      $ 195,322      $ 365,504      $ 394,236   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

 

(1) 

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

(2) 

Revenues from external sources in 2010 that were previously eliminated within the ancillary services and strategic initiatives segment have now been reported as a component of revenue from external sources to conform to current year presentations.

(3) 

Certain costs previously reported in the ancillary services and strategic initiatives have been reclassified to the dialysis and related lab services to conform to the current year presentation.

 

17


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DAVITA INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (continued)

(unaudited)

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

 

Depreciation and amortization expense for the dialysis and related lab services for the three and six months ended June 30, 2011 was $62,820 and $123,167, respectively, and were $1,650 and $3,340, respectively, for the ancillary services and strategic initiatives.

Depreciation and amortization expense for the dialysis and related lab services for the three and six months ended June 30, 2010 was $56,714 and $112,532, respectively, and were $1,639 and $3,289, respectively, for the ancillary services and strategic initiatives.

Summary of assets by segment is as follows:

 

     June 30,
2011
     December 31,
2010
 
Segment assets      

Dialysis and related lab services

   $ 7,946,706       $ 7,862,882   

Other – Ancillary services and strategic initiatives

     215,909         225,624   

Equity investments

     30,106         25,918   
  

 

 

    

 

 

 

Consolidated assets

   $ 8,192,721       $ 8,114,424   
  

 

 

    

 

 

 

For the three and six months ended June 30, 2011, the total amount of expenditures for property and equipment for the dialysis and related lab services were $92,565 and $159,683, respectively, and were $1,902 and $3,466, respectively, for the ancillary services and strategic initiatives.

For the three and six months ended June 30, 2010, the total amount of expenditures for property and equipment for the dialysis and related lab services were $55,280 and $100,315, respectively, and were $1,485 and $1,822, respectively, for the ancillary services and strategic initiatives.

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

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

 

     Three months ended
June 30,
    Six months ended
June 30,
 
     2011     2010     2011     2010  

Net income attributable to DaVita Inc.

   $ 100,015      $ 107,853      $ 194,517      $ 217,276   
  

 

 

   

 

 

   

 

 

   

 

 

 

Increase (decrease) in paid-in capital for sales of noncontrolling interests in three and four joint ventures for the three and six months ended June 30, 2011, respectively, and two and three joint ventures for the three and six months ended June 30, 2010, respectively

     142        (228     169        (176

Decrease in paid-in capital for the purchase of noncontrolling interests in three and four joint ventures for the three and six months ended June 30, 2011, respectively, and three and four joint ventures for the three and six months ended June 30, 2010, respectively

     (5,187     (992     (5,801     (779
  

 

 

   

 

 

   

 

 

   

 

 

 

Net transfer to noncontrolling interests

     (5,045     (1,220     (5,632     (955
  

 

 

   

 

 

   

 

 

   

 

 

 

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

   $ 94,970      $ 106,633      $ 188,885      $ 216,321   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

18


Table of Contents

DAVITA INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (continued)

(unaudited)

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

 

13. Variable interest entities

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

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

Total assets of these consolidated operating VIEs were approximately $6,000 and their liabilities to unrelated third parties were approximately $5,000 at June 30, 2011.

The Company also sponsors certain deferred compensation plans whose trusts qualify as VIEs, and as their primary beneficiary, the Company consolidates each of these plans. The assets of these plans are recorded in short-term or long-term investments with matching offsetting liabilities in accrued compensation and benefits and other long-term liabilities. See Note 6 for disclosures of the assets of these consolidated non-qualified deferred compensation plans.

14. Goodwill

In the second quarter of 2011, the Company determined that circumstances indicated it was more likely than not that the fair value of one of the Company’s ancillary businesses, HomeChoice Partners (HCP), which provides infusion therapy services, was less than its carrying amount. The primary factor informing the Company’s conclusion was the recent decline in the operating performance of HCP caused mainly by rapid expansion. This led management to scale back significantly its current plans for HCP’s future growth initiatives and to update HCP’s forecasts and current operating budgets accordingly. These revisions reduced the current and expected future cash flows that the Company believes market participants would use currently in determining the fair value of the HCP business. As a result, the Company has estimated that the carrying amount of its goodwill related to HCP exceeds its implied fair value by $24,000, resulting in a pre-tax goodwill impairment charge of that amount. As of June 30, 2011, after giving effect to this impairment charge, the Company has approximately $31,900 of remaining goodwill recorded related to HCP. The Company is in the process of finalizing its estimates of the fair values used to determine the amount of the goodwill impairment charge and, depending upon the outcome of that analysis, an additional goodwill impairment charge could result. However, management does not believe that such an amount, if any, would be material.

15. Significant new accounting standards

In July 2011, the Financial Accounting Standards Board (FASB) issued ASU No. 2011-07, Health Care Entities-Presentation and Disclosure of Patient Service Revenue, Provision for Bad Debts, and the Allowance for Doubtful Accounts. This standard amends the current presentation and disclosure requirements for Health Care

 

19


Table of Contents

DAVITA INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (continued)

(unaudited)

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

 

Entities that recognize significant amounts of patient service revenue at the time the services are rendered without assessing the patient’s ability to pay. This standard requires health care entities to reclassify the provision for bad debts from an operating expense to a deduction from patient service revenues. In addition, this standard requires more disclosure on the policies for recognizing revenue, assessing bad debts, as well as quantitative and qualitative information regarding changes in the allowance for doubtful accounts. This standard is applied retrospectively to all prior periods presented and is effective during interim and annual periods beginning after December 15, 2011. The adoption of this standard will not have a material impact on the Company’s consolidated financial statements.

In June 2011, the FASB issued Accounting Standard Update (ASU) No. 2011-05, Comprehensive Income—Presentation of Comprehensive Income. This standard amends the current presentation requirements for comprehensive income by eliminating the presentation of the components of other comprehensive income within the statement of equity. This standard allows two options on how to present the various components of comprehensive income. These options are either to report the components of comprehensive income separately on the income statement or to present total other comprehensive income and the components of other comprehensive income in a separate statement. This standard does not change the items that must be reported in other comprehensive income or when an item must be reclassified into net income. This standard is applied retrospectively and is effective for fiscal years and interim periods within those years beginning after December 15, 2011. Early adoption is permitted. The adoption of this standard will not have a material impact on the Company’s consolidated financial statements.

In May 2011, the FASB issued ASU No. 2011-04, Fair Value Measurement. This standard amends the current fair value measurement and disclosure requirements to improve comparability between U.S. GAAP and International Financial Reporting Standards (IFRS). The intent of this standard is to update the disclosures that describe several of the requirements in U.S. GAAP for measuring fair value and to enhance disclosures about fair value measurements which will improve consistency between U.S. GAAP and IFRS. This standard does not change the application of the requirements on fair value measurements and disclosures. This standard is applied prospectively and is effective during interim and annual periods beginning after December 15, 2011. The adoption of this standard will not have a material impact on the Company’s consolidated financial statements.

16. Condensed consolidating financial statements

The following information is presented in accordance with Rule 3-10 of Regulation S-X. The operating and investing activities of the separate legal entities included in the consolidated financial statements are fully interdependent and integrated. Revenues and operating expenses of the separate legal entities include intercompany charges for management and other services. The senior notes were issued by the Company on October 20, 2010, and are guaranteed by substantially all of the Company’s direct and indirect domestic wholly-owned subsidiaries. Each of the guarantor subsidiaries has guaranteed the notes on a joint and several, full and unconditional basis. Non-wholly-owned subsidiaries, certain wholly-owned subsidiaries, foreign subsidiaries, joint venture partnerships and other third parties are not guarantors of these obligations.

 

20


Table of Contents

DAVITA INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (continued)

(unaudited)

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

 

Condensed Consolidating Statements of Income

 

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

For the three months ended June 30, 2011

          

Net operating revenues

   $ 115,230      $ 1,403,016      $ 360,062      $ (166,779   $ 1,711,529   

Operating expenses

     73,466        1,240,527        317,269        (166,779     1,464,483   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating income

     41,764        162,489        42,793        —          247,046   

Debt (expense)

     (60,440     (56,920     (383     57,846        (59,897

Other income

     58,106        183        113        (57,846     556   

Income tax expense

     15,772        48,532        2,736        —          67,040   

Equity earnings in subsidiaries

     76,357        43,110        —          (119,467     —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income

     100,015        100,330        39,787        (119,467     120,665   

Less: Net income attributable to noncontrolling interests

     —          —          —          (20,650     (20,650
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income attributable to DaVita Inc.

   $ 100,015      $ 100,330      $ 39,787      $ (140,117   $ 100,015   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

21


Table of Contents

DAVITA INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (continued)

(unaudited)

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

 

Condensed Consolidating Statements of Income

 

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

For the three months ended June 30, 2010

          

Net operating revenues

   $ 109,757      $ 1,269,975      $ 327,680      $ (120,505   $ 1,586,907   

Operating expenses

     66,242        1,131,797        267,008        (120,505     1,344,542   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating income

     43,515        138,178        60,672        —          242,365   

Debt (expense)

     (48,103     (41,171     (344     41,836        (47,782

Other income

     41,885        (16     706        (41,836     739   

Income tax expense

     14,835        54,507        2,087        —          71,429   

Equity earnings in subsidiaries

     85,391        42,387        —          (127,778     —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income

     107,853        84,871        58,947        (127,778     123,893   

Less: Net income attributable to noncontrolling interests

     —          —          —          (16,040     (16,040
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income attributable to DaVita Inc.

   $ 107,853      $ 84,871      $ 58,947      $ (143,818   $ 107,853   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

For the six months ended June 30, 2011

          

Net operating revenues

   $ 218,503      $ 2,732,336      $ 686,407      $ (319,759   $ 3,317,487   

Operating expenses

     139,840        2,416,616        598,191        (319,759     2,834,888   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating income

     78,663        315,720        88,216        —          482,599   

Debt (expense)

     (119,305     (111,060     (563     112,436        (118,492

Other income

     112,973        498        362        (112,436     1,397   

Income tax expense

     28,932        98,382        2,773        —          130,087   

Equity earnings in subsidiaries

     151,118        68,977        —          (220,095     —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income

     194,517        175,753        85,242        (220,095     235,417   

Less: Net income attributable to noncontrolling interests

     —          —          —          (40,900     (40,900
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income attributable to DaVita Inc.

   $ 194,517      $ 175,753      $ 85,242      $ (260,995   $ 194,517   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

For the six months ended June 30, 2010

          

Net operating revenues

   $ 213,425      $ 2,539,446      $ 629,458      $ (236,004   $ 3,146,325   

Operating expenses

     126,277        2,246,801        524,220        (236,004     2,661,294   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating income

     87,148        292,645        105,238        —          485,031   

Debt (expense)

     (92,801     (83,933     (717     85,086        (92,365

Other income

     85,140        659        857        (85,086     1,570   

Income tax expense

     31,795        109,717        3,831        —          145,343   

Equity earnings in subsidiaries

     169,584        69,080        —          (238,664     —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income

     217,276        168,734        101,547        (238,664     248,893   

Less: Net income attributable to noncontrolling interests

     —          —          —          (31,617     (31,617
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income attributable to DaVita Inc.

   $ 217,276      $ 168,734      $ 101,547      $ (270,281   $ 217,276   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

22


Table of Contents

DAVITA INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (continued)

(unaudited)

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

 

Condensed Consolidating Balance Sheets

 

As of June 30, 2011

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

Cash and cash equivalents

   $ 710,073       $ —         $ 19,752       $ —        $ 729,825   

Accounts receivable, net

     —           957,339         174,712         —          1,132,051   

Other current assets

     8,130         595,461         47,897         —          651,488   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total current assets

     718,203         1,552,800         242,361         —          2,513,364   

Property and equipment, net

     47,406         901,360         274,896         —          1,223,662   

Amortizable intangibles, net

     54,274         94,633         3,949         —          152,856   

Investments in subsidiaries

     6,355,021         658,679         —           (7,013,700     —     

Intercompany receivables

     —           699,230         176,874         (876,104     —     

Other long-term assets and investments

     15,561         58,621         1,271         —          75,453   

Goodwill

     —           3,775,610         451,776         —          4,227,386   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total assets

   $ 7,190,465       $ 7,740,933       $ 1,151,127       $ (7,889,804   $ 8,192,721   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Current liabilities

   $ 98,226       $ 868,672       $ 68,713       $ —        $ 1,035,611   

Intercompany payables

     751,949         —           124,155         (876,104     —     

Long-term debt and other long-term liabilities

     4,190,850         574,544         29,086         —          4,794,480   

Noncontrolling interests subject to put provisions

     268,581         —           —           147,923        416,504   

Total DaVita Inc. shareholders’ equity

     1,880,859         6,297,717         715,983         (7,013,700     1,880,859   

Noncontrolling interest not subject to put provisions

     —           —           213,190         (147,923     65,267   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total equity

     1,880,859         6,297,717         929,173         (7,161,623     1,946,126   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total liabilities and equity

   $ 7,190,465       $ 7,740,933       $ 1,151,127       $ (7,889,804   $ 8,192,721   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

As of December 31, 2010

                                 

Cash and cash equivalents

   $ 856,803       $ —         $ 3,314       $ —        $ 860,117   

Accounts receivable, net

     —           895,955         153,021         —          1,048,976   

Other current assets

     11,231         653,670         48,860         —          713,761   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total current assets

     868,034         1,549,625         205,195         —          2,622,854   

Property and equipment, net

     30,409         888,927         251,472         —          1,170,808   

Amortizable intangibles, net

     58,967         98,795         4,873         —          162,635   

Investments in subsidiaries

     6,154,398         555,579         —           (6,709,977     —     

Intercompany receivables

     —           516,286         208,030         (724,316     —     

Other long-term assets and investments

     8,951         56,996         873         —          66,820   

Goodwill

     —           3,731,983         359,324         —          4,091,307   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total assets

   $ 7,120,759       $ 7,398,191       $ 1,029,767       $ (7,434,293   $ 8,114,424   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Current liabilities

   $ 61,384       $ 786,114       $ 76,847       $ —        $ 924,345   

Intercompany payables

     611,919         —           112,397         (724,316     —     

Long-term debt and other long-term liabilities

     4,210,703         539,620         19,570         —          4,769,893   

Noncontrolling interests subject to put provisions

     258,331         —           —           124,721        383,052   

Total DaVita Inc. shareholders’ equity

     1,978,422         6,072,457         637,520         (6,709,977     1,978,422   

Noncontrolling interest not subject to put provisions

     —           —           183,433         (124,721     58,712   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total equity

     1,978,422         6,072,457         820,953         (6,834,698     2,037,134   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total liabilities and equity

   $ 7,120,759       $ 7,398,191       $ 1,029,767       $ (7,434,293   $ 8,114,424   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

 

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Table of Contents

DAVITA INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (continued)

(unaudited)

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

 

Condensed Consolidating Statements of Cash Flows

 

For the six months ended June 30, 2011   DaVita Inc.     Guarantor
subsidiaries
    Non-Guarantor
subsidiaries
    Consolidating
adjustments
    Consolidated
total
 

Cash flows from operating activities:

         

Net income

  $ 194,517      $ 175,753      $ 85,242      $ (220,095   $ 235,417   

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

    (98,306     157,151        19,836        220,095        298,776   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net cash provided by operating activities

    96,211        332,904        105,078        —          534,193   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cash flows from investing activities:

         

Additions of property and equipment, net

    (19,269     (89,010     (46,650     —          (154,929

Acquisitions

    —          (151,196     —          —          (151,196

Proceeds from asset sales

    —          2,954        —          —          2,954   

Proceeds from investment sales and other items

    (725     340        (5,000     —          (5,385
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net cash used in investing activities

    (19,994     (236,912     (51,650     —          (308,556
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cash flows from financing activities:

         

Long-term debt and related financing costs, net

    (55,558     1,694        8,625        —          (45,239

Intercompany borrowing

    96,785        (91,103     (5,682     —          —     

Other items

    (264,174     (6,583     (39,933     —          (310,690
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net cash used in financing activities

    (222,947     (95,992     (36,990     —          (355,929
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net (decrease) increase in cash and cash equivalents

    (146,730     —          16,438        —          (130,292

Cash and cash equivalents at beginning of period

    856,803        —          3,314        —          860,117   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cash and cash equivalents at end of period

  $ 710,073      $ —        $ 19,752      $ —        $ 729,825   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

For the six months ended June 30, 2010

                             

Cash flows from operating activities:

         

Net income

  $ 217,276      $ 168,734      $ 101,547      $ (238,664   $ 248,893   

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

    (168,264     220,262        18,211        238,664        308,873   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net cash provided by operating activities

    49,012        388,996        119,758        —          557,766   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cash flows from investing activities:

         

Additions of property and equipment, net

    (5,624     (81,227     (12,500     —          (99,351

Acquisitions

    —          (91,701     —          —          (91,701

Proceeds from asset sales

    —          17,681        —          —          17,681   

Proceeds from investment sales and other items

    114        3,454        —          —          3,568   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net cash used in investing activities

    (5,510     (151,793     (12,500     —          (169,803
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cash flows from financing activities:

         

Long-term debt and related financing costs, net

    (248,533     522        (3,957     —          (251,968

Intercompany borrowing

    308,193        (236,113     (72,080     —          —     

Other items

    (64,288     (1,612     (34,838     —          (100,738
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net cash used in financing activities

    (4,628     (237,203     (110,875     —          (352,706
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net increase (decrease) in cash and cash equivalents

    38,874        —          (3,617     —          35,257   

Cash and cash equivalents at beginning of period

    534,550        —          4,909        —          539,459   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cash and cash equivalents at end of period

  $ 573,424      $ —        $ 1,292      $ —        $ 574,716   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

24


Table of Contents

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

Forward-looking statements

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

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

Results of operations

We operate principally as a dialysis and related lab services business but also operate other ancillary services and strategic initiatives. These ancillary services and strategic initiatives consist of pharmacy services, infusion therapy services, disease management services, vascular access services, ESRD clinical research programs and physician services. The dialysis and related lab services business qualifies as a separately reportable segment and all of the other ancillary services and strategic initiatives segments have been combined and disclosed in the other segments category.

 

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Table of Contents

Our consolidated operating results for the second quarter of 2011 compared with the prior sequential quarter and the same quarter of 2010 as well as the six months ended June 30, 2011 compared to the same periods in 2010 were as follows:

 

     Three months ended     Six months ended  
     June 30, 2011     March 31, 2011     June 30, 2010     June 30, 2011     June 30, 2010  
     (dollar amounts rounded to nearest million)  

Net operating revenues

   $ 1,712        100   $ 1,606        100   $ 1,587        100   $ 3,317        100   $ 3,146        100
  

 

 

     

 

 

     

 

 

     

 

 

     

 

 

   

Operating expenses and charges:

                    

Patient care costs

     1,165        68     1,116        69     1,111        70     2,281        69     2,193        70

General and administrative

     164        10     152        9     136        9     315        10     273        9

Depreciation and amortization

     64        4     62        4     58        4     127        4     116        4

Provision for uncollectible accounts

     49        3     42        3     42        3     92        3     84        3

Goodwill impairment charge

     24        1     —          —          —          —          24        1     —          —     

Equity investment income

     (2     —          (2     —          (3     —          (4     —          (5     —     
  

 

 

     

 

 

     

 

 

     

 

 

     

 

 

   

Total operating expenses and charges

     1, 464        85     1,370        85     1,345        85     2,835        85     2,661        85
  

 

 

     

 

 

     

 

 

     

 

 

     

 

 

   

Operating income

   $ 247        15   $ 236        15   $ 242        15   $ 483        15   $ 485        15
  

 

 

     

 

 

     

 

 

     

 

 

     

 

 

   

The following table summarizes consolidated net operating revenues:

 

     Three months ended     Six months ended  
     June 30,
2011
    March 31,
2011
    June 30,
2010
    June 30,
2011
    June 30,
2010
 
     (dollar amounts rounded to nearest million)  

Dialysis and related lab services

   $ 1,591      $ 1,505      $ 1,496      $ 3,096      $ 2,975   

Other – Ancillary Services and Strategic Initiatives

     123        106        93        229        176   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total segment revenues

     1,714        1,611        1,589        3,325        3,151   

Elimination of intersegment revenues

     (2     (5     (2     (8     (5
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Consolidated net operating revenues

   $ 1,712      $ 1,606      $ 1,587      $ 3,317      $ 3,146   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

The following table summarizes consolidated operating income:

 

     Three months ended     Six months ended  
     June  30,
2011
    March 31,
2011
    June 30,
2010
    June  30,
2011
    June 30,
2010
 
     (dollar amounts rounded to nearest million)  

Dialysis and related lab services

   $ 283      $ 250      $ 254      $ 533      $ 506   

Other – Ancillary Services and Strategic Initiatives

     (25     (6     (2     (31     (4
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total segment operating income

     258        244        252        502        502   

Reconciling items:

          

Stock-based compensation

     (13     (10     (12     (23     (22

Equity investment income

     2        2        3        4        5   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Consolidated operating income

     247        236        242        483        485   

Reconciliation of non-GAAP measure:

          

Add: Goodwill impairment charge

     24        —          —          24        —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Non-GAAP consolidated operating income (1)

   $ 271      $ 236      $ 242      $ 507      $ 485   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

26


Table of Contents

 

(1) 

For the three and six months ended June 30, 2011, we have excluded a non-cash goodwill impairment charge from operating expenses and operating income because management believes that this presentation enhances a user’s understanding of our normal consolidated operating income by excluding a non-cash goodwill impairment charge that resulted from a decrease in the implied fair value of goodwill below its carrying amount associated with HomeChoice Partners (HCP), which provides infusion therapy services, during the second quarter of 2011 and is therefore more meaningful and comparable to our prior period results and more indicative of our normal consolidated operating income.

Consolidated net operating revenues

Consolidated net operating revenues for the second quarter of 2011 increased by approximately $106 million, or approximately 6.6%, as compared to the first quarter of 2011. The increase in consolidated net operating revenues was primarily due to an increase in dialysis and related lab services net revenues of approximately $86 million, principally due to an increase in the number of treatments as a result of one additional treatment day in the second quarter of 2011 and as a result of additional treatments from non-acquired growth and acquisitions. Consolidated net operating revenues also increased due to an increase of approximately $6 in the average dialysis revenue per treatment, as described below.

Consolidated net operating revenues for the second quarter of 2011 increased by approximately $125 million, or approximately 7.9%, as compared to the second quarter of 2010. The increase in consolidated net operating revenues was primarily due to an increase in dialysis and related lab services net revenues of approximately $95 million, principally due to strong volume growth from additional treatments as a result of non-acquired treatment growth in existing and new centers and growth through acquisitions, partially offset by a decrease of approximately $3 in the average dialysis revenue per treatment, as described below. The increase in consolidated net revenues was also due to an increase of approximately $30 million in the ancillary services and strategic initiatives net revenues primarily from growth in our pharmacy services.

Consolidated net operating revenues for the six months ended June 30, 2011 increased by approximately $171 million, or approximately 5.4%, as compared to the same period in 2010. The increase in consolidated net operating revenues was primarily due to an increase in dialysis and related lab services net revenues of approximately $121 million, principally due to strong volume growth from additional treatments as a result of non-acquired treatment growth in existing and new centers and growth through acquisitions, partially offset by a decrease of approximately $10 in the average dialysis revenue per treatment as a result of the same factors, as described for the second quarter of 2011 as compared to the same quarter of 2010. The increase in consolidated net revenues was also due to an increase of approximately $53 million in the ancillary services and strategic initiatives net revenues primarily from growth in our pharmacy services.

Consolidated operating income

Consolidated operating income for the second quarter of 2011, excluding the $24 million HCP goodwill impairment charge, would have increased by approximately $35 million, or approximately 14.8%, as compared to the first quarter of 2011. This increase in consolidated operating income was primarily due to an increase in the dialysis and related lab services net revenues, principally due to an increase in the number of treatments as a result of one additional treatment day in the second quarter of 2011 and an increase of approximately $6 in the average dialysis revenue per treatment as discussed below. Consolidated operating income also benefited from improvements in productivity but was negatively impacted by higher labor and benefit costs, the timing of certain other operating costs and a decline in the intensities of physician-prescribed pharmaceuticals.

Consolidated operating income for the second quarter of 2011, excluding the $24 million HCP goodwill impairment charge, would have increased by approximately $29 million, or approximately 12.0%, as compared to the second quarter of 2010. The increase in consolidated operating income was primarily due to strong volume growth from additional treatments as a result of non-acquired growth in existing and new centers and growth

 

27


Table of Contents

through acquisitions, partially offset by a decline in the average dialysis revenue per treatment of approximately $3, as described below. Consolidated operating income also increased as a result of lower pharmaceutical costs and cost control initiatives, but was negatively impacted by higher labor and related payroll costs, additional benefit costs, a decline in productivity, an increase in professional fees in conjunction with acquisition-related transactions and for compliance and international initiatives, as well as a decline in the intensities of physician-prescribed pharmaceuticals.

Consolidated operating income for the six months ended June 30, 2011, excluding the $24 million HCP goodwill impairment charge, would have increased by approximately $22 million, or approximately 4.5%, as compared to the same period in 2010. The increase in consolidated operating income was primarily due to strong volume growth from additional treatments as a result of non-acquired growth in existing and new centers and growth through acquisitions, partially offset by a decline in the average dialysis revenue per treatment of approximately $10, as described below. Consolidated operating income was also impacted by the same additional factors as discussed for the second quarter of 2011, as compared to the second quarter of 2010.

Operating segments

Dialysis and related lab services

 

     Three months ended      Six months ended  
     June 30,
2011
     March 31,
2011
     June 30,
2010
     June 30,
2011
     June 30,
2010
 
     (dollar amounts rounded to nearest million, except per treatment data)  

Revenues

   $ 1,591       $ 1,505       $ 1,496       $ 3,096       $ 2,975   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Segment operating income

   $ 283       $ 250       $ 254       $ 533       $ 506   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Dialysis treatments

     4,777,817         4,602,375         4,462,565         9,380,191         8,756,685   

Average dialysis treatments per treatment day

     61,254         59,771         57,212         60,517         56,495   

Average dialysis revenue per treatment (including lab services)

   $ 332       $ 326       $ 335       $ 329       $ 339   

Net operating revenues

Dialysis and related lab services’ net operating revenues for the second quarter of 2011 increased by approximately $86 million, or approximately 5.7%, as compared to the first quarter of 2011. The increase in net operating revenues was primarily due to an increase in the number of treatments as a result of one additional treatment day in the second quarter of 2011 and from non-acquired treatment growth in existing and new centers and from growth through acquisitions, totaling approximately 3.8%. The increase was also due to an increase in our average dialysis revenue per treatment of approximately $6, or approximately 1.8%. The increase in the average dialysis revenue per treatment was primarily due to an increase in our Medicare reimbursement rates as a result of corrections to the transition adjustment factor under the new single bundled payment system, an increase in some of our commercial payment rates and a slight improvement in the commercial payor mix, partially offset by a decline in the intensities of physician-prescribed pharmaceuticals.

Dialysis and related lab services’ net operating revenues increased by approximately $95 million, or 6.4%, in the second quarter of 2011, as compared to the second quarter of 2010. The increase in net operating revenues in the second quarter of 2011 was principally due to an increase in the number of treatments of approximately 7.1%, partially offset by a decrease in the average dialysis revenue per treatment of approximately $3, or approximately 0.7%. The increase in the number of treatments was primarily attributable to non-acquired treatment growth at existing and new centers and growth through acquisitions. The decrease in the average dialysis revenue per treatment was primarily due to a decline in our Medicare reimbursement rates as a result of

 

28


Table of Contents

operating in the new single bundled payment system, a decline in the commercial payor mix, and a decline in the intensities of physician-prescribed pharmaceuticals, partially offset by an increase in some of our commercial payment rates.

Dialysis and related lab services’ net operating revenues increased by approximately $121 million, or 4.1%, for the six months ended June 30, 2011, as compared to the same period in 2010. The increase in net operating revenues in the first six months of 2011 was principally due to an increase in the number of treatments of approximately 7.1%, partially offset by a decrease in the average dialysis revenue per treatment of approximately $10, or approximately 2.8%. The increase in the number of treatments was primarily attributable to non-acquired treatment growth at existing and new centers and growth through acquisitions. The decrease in the average dialysis revenue per treatment was primarily due to the same factors as described for the second quarter of 2011 as compared to the second quarter of 2010.

Operating expenses and charges

Patient care costs. Dialysis and related lab services’ patient care costs on a per treatment basis in the second quarter of 2011 remained flat compared to the first quarter of 2011. However patient care costs benefited from improvements in productivity, lower intensities of physician-prescribed pharmaceuticals and slightly lower pharmaceutical costs, offset by higher labor and benefit costs.

Dialysis and related lab services’ patient care costs on a per treatment basis decreased by approximately $9 in the second quarter of 2011 as compared to the second quarter of 2010. The decrease in the per treatment costs was primarily attributable to lower pharmaceutical costs and a decline in the intensities of physician-prescribed pharmaceuticals, partially offset by an increase in labor and related payroll costs, additional benefit costs, a decline in productivity and an increase in other operating costs of our dialysis centers.

Dialysis and related lab services’ patient care costs on a per treatment basis decreased by approximately $11 for the six months ended June 30, 2011 as compared to the same period in 2010. The decrease in the per treatment costs was primarily attributable to the same factors as discussed above for the change in the second quarter of 2011 as compared to the second quarter of 2010.

General and administrative expenses. Dialysis and related lab services’ general and administrative expenses of approximately $133 million for the second quarter of 2011 increased by approximately $8 million as compared to the first quarter of 2011. The increase was primarily due to higher labor and benefit costs and an increase in professional fees in conjunction with international initiatives.

General and administrative expenses increased by approximately $24 million and $37 million for the second quarter of 2011 and for the six months ended June 30, 2011, respectively, compared to the same periods in 2010. The increases, were primarily due to higher information technology expenditures, higher labor and benefit costs, an increase in professional fees in conjunction with acquisition-related transactions and for compliance and international initiatives and the timing of certain other expenditures. General and administrative expenses, as a percentage of dialysis and related lab services’ revenue, was 8.3% for the second quarter of 2011, 8.3% for the first quarter of 2011 and 7.3% for the second quarter of 2010.

Depreciation and amortization. Depreciation and amortization for dialysis and related lab services was approximately $63 million for the second quarter of 2011, $60 million for the first quarter of 2011 and $57 million for the second quarter of 2010. The increases in depreciation and amortization in the second quarter of 2011, as compared to both the first quarter of 2011 and the second quarter of 2010, was primarily due to growth in newly developed centers and from centers through acquisitions.

Depreciation and amortization for dialysis and related lab services was approximately $123 million for the six months ended June 30, 2011, as compared to $113 million for the same period in 2010. The increase was primarily due to the same factors, as described above.

 

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Provision for uncollectible accounts. The provision for uncollectible accounts receivable for dialysis and related lab services was 3.0% for the second quarter of 2011 and was 2.8% for the first quarter of 2011 and the second quarter of 2010. The increase in the provision for uncollectible accounts was primarily the result of an increase in our write-offs of our accounts receivable balances. We assess our level of the provision for uncollectible accounts based upon our historical cash collection experience and trends, and have and will continue to adjust the provision as necessary as a result of changes in our cash collections.

Segment operating income

Dialysis and related lab services’ operating income for the second quarter of 2011 increased by approximately $33 million, as compared to the first quarter of 2011. The increase in operating income was primarily attributable to an increase in revenue as a result of additional treatments in the second quarter of 2011, as described above, an increase in the average dialysis revenue per treatment of approximately $6, as also discussed above, improvements in productivity and a slight decline in pharmaceutical costs. However, dialysis and related lab services’ operating income was negatively impacted by higher labor and benefit costs and a decline in the intensities of physician-prescribed pharmaceuticals.

Dialysis and related lab services’ operating income for the second quarter of 2011 increased by approximately $29 million, as compared to the second quarter of 2010. The increase in operating income was primarily attributable to strong volume growth in revenue from additional treatments as a result of non-acquired treatment growth and growth through acquisitions, partially offset by a decline in the average dialysis revenue per treatment of approximately $3, as described above. Dialysis and related lab services’ also increased as a result of lower pharmaceutical costs and cost control initiatives, but was negatively impacted by higher labor costs and related payroll taxes, additional benefit costs, a decline in productivity, an increase in professional fees in conjunction with acquisition-related transactions and compliance and international initiatives and a decline in intensities of physician-prescribed pharmaceuticals.

Dialysis and related lab services’ operating income for the six months ended June 30, 2011 increased by approximately $27 million, as compared to the same period in 2010. The increase in operating income was primarily attributable to strong volume growth in revenue from additional treatments as a result of non-acquired treatment growth and growth through acquisitions, partially offset by a decline in the average dialysis revenue per treatment of approximately $10, as described above. Dialysis and related lab services was also impacted by the same additional factors discussed above for the second quarter of 2011 as compared to the second quarter of 2010.

Other – Ancillary Services and Strategic Initiatives

 

     Three months ended     Six months ended  
     June 30,
2011
    March 31,
2011
    June 30,
2010
    June 30,
2011
    June 30,
2010
 
     (dollar amounts rounded to nearest million)  

Revenues

   $ 123      $ 106      $ 93      $ 229      $ 176   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Segment operating loss

   $ (25   $ (6   $ (2   $ (31   $ (4
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net operating revenues

The ancillary services and strategic initiatives’ net operating revenues for the second quarter of 2011 increased by approximately $17 million as compared to the first quarter of 2011. The increase was primarily due to an increase in revenue in our pharmacy services due to volume growth, additional days in the second quarter of 2011 and an increase in the pharmacy’s other services revenue.

The increase in net operating revenues for the second quarter of 2011 of approximately $30 million, as compared to the second quarter of 2010, was primarily due to volume growth in our pharmacy services.

 

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The ancillary services and strategic initiatives’ net operating revenues for the six months ended June 30, 2011 increased by approximately $53 million as compared to the same period in 2010. The increase was primarily due to an increase in revenue in our pharmacy services and increases in revenues associated with our infusion therapy services and our disease management services.

Operating expenses

Ancillary services and strategic initiatives’ operating expenses for the second quarter of 2011 increased by approximately $36 million as compared to the first quarter of 2011, which includes the $24 million HCP goodwill impairment charge, as described below. Excluding this item, ancillary services and strategic initiatives adjusted operating expenses would have increased by approximately $12 million primarily due to volume growth and an increase in labor costs associated with our pharmacy services.

Ancillary services and strategic initiatives’ operating expenses for the second quarter of 2011 increased by approximately $53 million as compared to the second quarter in 2010, which includes the $24 million HCP goodwill impairment charge, as described below. Excluding this item, ancillary services and strategic initiatives adjusted operating expenses would have increased by approximately $29 million primarily due to volume growth in our pharmacy services, an increase in medical supply costs and an increase in labor and benefit costs.

Ancillary services and strategic initiatives’ operating expenses for the six months ended June 30, 2011 increased by approximately $80 million as compared to the same period in 2010, which includes the $24 million HCP goodwill impairment charge, as described below. Excluding this item, ancillary services and strategic initiatives adjusted operating expenses would have increased by approximately $56 million primarily due to the same factors as discussed for the increase in the second quarter of 2011 as compared to the second quarter of 2010.

Goodwill

In the second quarter of 2011, we determined that circumstances indicated it was more likely than not that the fair value of one of our ancillary businesses, HCP, which provides infusion therapy services, was less than its carrying amount. The primary factor informing our conclusion was the recent decline in the operating performance of HCP caused mainly by rapid expansion. This led management to scale back significantly its current plans for HCP’s future growth initiatives and to update HCP’s forecasts and current operating budgets accordingly. These revisions reduced the current and expected future cash flows that the Company believes market participants would use currently in determining the fair value or the HCP business. As a result, we have estimated that the carrying amount of goodwill related to HCP exceeds its implied fair value by $24 million, resulting in a pre-tax goodwill impairment charge of that amount. As of June 30, 2011, after giving effect to this impairment charge, we have approximately $32 million of remaining goodwill recorded related to HCP. We are in the process of finalizing our estimates of the fair values used to determine the amount of the goodwill impairment charge and, depending upon the outcome of that analysis, an additional goodwill impairment charge could result. However, management does not believe that such an amount, if any, would be material.

Segment operating results

Ancillary services and strategic initiatives’ operating losses increased by approximately $19 million in the second quarter of 2011 as compared to the first quarter of 2011, which includes the $24 million HCP goodwill impairment charge, as described below. Excluding this item, ancillary services and strategic initiatives adjusted operating losses would have decreased by approximately $5 million. The decrease was primarily due to improved operating performance in our pharmacy services as a result of an increase in revenue due to volume growth, additional days in the second quarter of 2011 and an increase in other services revenue, as well as improved operating performance in our disease management services.

 

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Ancillary services and strategic initiatives’ operating losses increased by approximately $23 million in the second quarter of 2011, as compared to the second quarter of 2010, which includes the $24 million HCP goodwill impairment charge, as described below. Excluding this item, ancillary services and strategic initiatives adjusted operating losses would have decreased by $1 million. The decrease was primarily due to improved operating performance in our disease management services and in our vascular access services, partially offset by a decrease in operating performance in some of our other strategic initiatives.

Ancillary services and strategic initiatives’ operating losses increased by approximately $27 million for the six months ended June 30, 2011, as compared to the same period in 2010, which includes the $24 million HCP goodwill impairment charge, as described below. Excluding this item, ancillary services and strategic initiatives adjusted operating losses would have increased by $3 million. The increase was primarily due to the result of deteriorations in the operating performance of our infusion therapy services, ESRD clinical research programs and in other strategic initiatives, partially offset by improvements in our vascular access services.

Corporate level charges

Stock-based compensation. Stock-based compensation of approximately $13.3 million in the second quarter of 2011 represented an increase of approximately $3.6 million as compared to the first quarter of 2011 and an increase of approximately $1.2 million as compared to the second quarter of 2010. The increases were primarily due to an increase in the aggregate quantity of grants that contributed expense to these respective periods. For the six months ended June 30, 2011, stock-based compensation increased by approximately $0.7 million as compared to the same period in 2010.

Other income. Other income for the second quarter of 2011 decreased by approximately $0.3 million as compared to the first quarter of 2011 and decreased by approximately $0.2 million as compared to the second quarter of 2010. For the six months ended June 30, 2011, other income decreased by approximately $0.2 million as compared to the same period in 2010.

Debt expense. Debt expense of $60 million in the second quarter of 2011 increased by approximately $1.3 million from the first quarter of 2011 and increased by $16.2 million, as compared to the second quarter of 2010. The increase in debt expense in the second quarter of 2011 as compared to the first quarter of 2011 was primarily due to higher interest rates associated with our interest rate swap agreements that went effective January 31, 2011. The increase in debt expense in the second quarter of 2011 as compared to the second quarter of 2010 was primarily due to additional borrowings under our new Senior Secured Credit Facilities that were issued on October 20, 2010 that contain significantly higher interest rates than the interest rates under our previous facility. In addition, debt expense in the second quarter of 2011 was also impacted by the amount of interest rate swaps that resulted in a higher overall weighted average effective interest rate on the Term Loan A and from the amortization of the interest rate cap premiums. However, debt expense in the second quarter of 2011 benefited from lower rates associated with the issuance of our new senior notes on October 20, 2010 and also benefited from lower outstanding principal balances on our senior notes. The overall weighted average effective interest rate for the second quarter of 2011 was 5.33%, as compared to 5.20% for the first quarter of 2011 and 4.68% for the second quarter of 2010.

For the six months ended June 30, 2011, debt expense increased by approximately $30.3 million, as compared to the same period in 2010. The increase was primarily attributable to the same factors that were discussed above for the increase in debt expense for the second quarter of 2011 as compared to the second quarter of 2010.

Equity investment income. Equity investment income was approximately $2.4 million for the second quarter of 2011, as compared to $1.5 million for the first quarter of 2011 and $2.8 million for the second quarter of 2010. The increase in equity income in the second quarter of 2011, as compared to the first quarter of 2011, was primarily due to the recognition of additional income in the second quarter of 2011. The decrease in equity income in the second quarter of 2011, as compared to the second quarter of 2010, was primarily due to a decrease

 

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in certain reimbursement rates. For the six months ended June 30, 2011, equity investment income decreased by approximately $1.2 million as compared to the same period in 2010. The decrease was primarily due to the recognition of additional revenue in one of the joint ventures during the first six months of 2010.

Noncontrolling interests

Net income attributable to noncontrolling interests. Net income attributable to noncontrolling interests was $20.7 million for the second quarter of 2011, as compared to $20.3 million for the first quarter of 2011 and $16.0 million for the second quarter of 2010. The increase in net income attributable to noncontrolling interests in the second quarter of 2011 as compared to the first quarter of 2011 was primarily due to an increase in earnings resulting from one additional treatment day in the second quarter of 2011. The increase in net income attributable to noncontrolling interests in the second quarter of 2011 as compared to the second quarter of 2010 was primarily due to an increase in the overall profitability of our joint ventures, as well as increases in the number of joint ventures. For the six months ended June 30, 2011, net income attributable to noncontrolling interests increased by approximately $9.3 million as compared to the same period in 2010. The increase was primarily due to the same factors as the increase in the second quarter of 2011 as compared to the second quarter of 2010.

Accounts receivable

Our accounts receivable balances at June 30, 2011 and March 31, 2011 were $1,132 million and $1,069 million, respectively, which represented approximately 63 days and 62 days of revenue, respectively, net of bad debt provision. The increase in DSO was primarily the result of a slight slowdown in our cash collections. Our DSO calculation is based on the current quarter’s average revenue per day. There were no significant changes during the second quarter of 2011 from the first quarter of 2011 in the amount of unreserved accounts receivable over one year old or the amounts pending approval from third-party payors.

Outlook

Outlook for 2011 and 2012. We are raising our operating income guidance for 2011 to now be in the range of $1,080 million to $1,120 million. This guidance excludes the non-cash goodwill impairment charge recorded in the second quarter of 2011. Our previous operating income guidance for 2011 was in the range of $1,040 million to $1,100 million. We are raising our operating cash flow guidance for 2011 to now be in the range of $900 million to $980 million. Our previous operating cash flow guidance for 2011 was in the range of $840 million to $940 million. We are also raising our operating income guidance for 2012 to now be in the range of $1,200 million to $1,300 million. Our previous operating income guidance for 2012 was in the range of $1,100 million to $1,200 million. The guidance above assumes the DSI acquisition closes in the third quarter of 2011. These projections and the underlying assumptions involve significant risks and uncertainties, and actual results may vary significantly from current projections. These risks, among others, include those relating to the concentration of profits generated from commercial payor plans, continued downward pressure on average realized payment rates from commercial payors, which may result in the loss of revenue or patients, a reduction in the number of patients under higher-paying commercial plans, a reduction in government payment rates under the Medicare ESRD program or other government-based programs, the impact of health care reform legislation that was enacted in the United States in March 2010, changes in pharmaceutical or anemia management practice patterns, payment policies, or pharmaceutical pricing, our ability to maintain contracts with physician medical directors, legal compliance risks, including our continued compliance with complex government regulations, investigations by various governmental entities and potential other related proceedings, continued increased competition from large and medium-sized dialysis providers that compete directly with us, our ability to complete any acquisitions, mergers or dispositions that we might be considering or announce, or integrate and successfully operate any business we may acquire and expansion of our operations and services to markets outside the United States, or to businesses outside of dialysis. See “Risk Factors” in Part II, Item 1A. in this Quarterly Report on Form 10-Q and the cautionary language contained in the forward looking statements and associated risks as discussed under “Forward-looking statements” on page 25 for more information about these and other potential risks. We undertake no obligation to update or revise these projections, whether as a result of changes in underlying factors, new information, future events or otherwise.

 

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Liquidity and capital resources

Liquidity and capital resources. Cash flow from operations during the second quarter of 2011 was $204 million, compared to $296 million during the second quarter of 2010. The decrease in operating cash flow was primarily the result of a slow-down in our cash collections, the timing of payments for certain working capital expenditures and the timing of interest payments. Non-operating cash outflows for the second quarter of 2011 included capital asset expenditures of $94 million, including $39 million for new center developments and relocations and $55 million for maintenance and information technology. We spent an additional $70 million for acquisitions. We paid distributions to noncontrolling interests of $24 million and repurchased 3.5 million shares of our common stock for $291 million. Non-operating cash outflows for the second quarter of 2010 included capital asset expenditures of $57 million, including $29 million for new center developments and relocations and $28 million for maintenance and information technology. We spent an additional $91 million for acquisitions. We paid distributions to noncontrolling interests of $19 million and we repurchased 1.6 million shares of our common stock for approximately $100 million.

During the second quarter of 2011, we acquired and opened a total of 27 dialysis centers. During the second quarter of 2010, we acquired and opened a total of 41 dialysis centers, closed one center, sold one center and discontinued administrative and management services to one third-party owned center.

Cash flow from operations for the six months ended June 30, 2011 was $534 million compared to $558 million for the six months ended June 30, 2010. The decrease in operating cash flow was primarily due to a slow-down in our cash collections and the timing of payment for certain working capital expenditures. Non-operating cash outflows for the first six months of 2011 included capital asset expenditures of $163 million, including $67 million for new center developments and relocations and $96 million for maintenance and information technology. We spent an additional $151 million for acquisitions. We paid distributions to noncontrolling interests of $46 million and we repurchased 3.7 million shares of our common stock for approximately $291 million. Non-operating cash outflows for the first six months of 2010 included capital asset expenditures of $102 million, including $52 million for new center developments and relocations and $50 million for maintenance and information technology. We spent an additional $92 million for acquisitions. We paid distributions to noncontrolling interests of $37 million and we repurchased 1.6 million shares of our common stock for approximately $100 million.

For the six months ended June 30, 2011, we acquired and opened a total of 60 dialysis centers, closed two centers, and sold one center. For the six months ended June 30, 2010, we acquired and opened a total of 63 dialysis centers, closed six centers, sold four centers, and acquired an equity investment in one additional center in which we also provide management and administrative services.

We currently expect to spend approximately $240 million for capital asset expenditures in 2011 related to routine maintenance items and information technology equipment, which includes the capital expenditures for our new corporate headquarters. We also expect to spend $150 million for new center development and relocations in 2011. These expenditures will depend upon the availability of projects and sufficient project returns.

On February 4, 2011, we entered into a definitive agreement to acquire all of the outstanding equity securities of CDSI I Holding Company, Inc., the parent company of dialysis provider DSI Renal, Inc. (DSI), in cash for approximately $689.2 million, subject to among other things, adjustments for certain items such as working capital, the purchase of noncontrolling interests, capital assets and acquisitions expenditures. DSI currently operates approximately 106 outpatient dialysis centers serving approximately 8,000 patients. The transaction is subject to approval by the Federal Trade Commission (FTC) including Hart-Scott-Rodino antitrust clearance. The FTC has determined that we will be required to divest approximately 30 outpatient dialysis centers as a condition of the transaction. We currently expect the transaction to close in the third quarter of 2011.

During the first six months of 2011, we repurchased a total of 3,710,086 shares of our common stock for $316.1 million, or an average price of $85.20 per share. As of June 30, 2011, a total of $25.5 million of share

 

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repurchases had not yet been settled in cash. In addition, we repurchased 84,600 additional shares of our common stock for $7.3 million, or an average price of $85.83 per share during the period July 1, 2011 through July 31, 2011. As a result of these transactions, our remaining board authorization for share repurchases as of July 31, 2011 is approximately $358.2 million.

During the first six months of 2011 we made mandatory principal payments under our Senior Secured Credit Facilities totaling $25 million on the Term Loan A and $8.8 million on the Term Loan B.

As of June 30, 2011, we maintained a total of nine interest rate swap agreements with amortizing notional amounts totaling $975 million. These agreements had the economic effect of modifying the LIBOR variable component of our interest rate on an equivalent amount of our Term Loan A to fixed rates ranging from 1.59% to 1.64%, resulting in an overall weighted average effective interest rate of 4.36%, including the Term Loan A margin of 2.75%. The swap agreements expire by September 30, 2014 and require monthly interest payments. During the six months ended June 30, 2011, we accrued net charges of $5.7 million from these swaps which are included in debt expense. As of June 30, 2011, the total fair value of these swap agreements was a liability of $14.2 million. We estimate that approximately $12.3 million of existing unrealized pre-tax losses in other comprehensive income at June 30, 2011 will be reclassified into income over the next twelve months.

As of June 30, 2011, we maintained five interest rate cap agreements with notional amounts totaling $1.25 billion. These agreements have the economic effect of capping the LIBOR variable component of our interest rate at a maximum of 4.00% on an equivalent amount of our Term Loan B debt. The cap agreements expire on September 30, 2014. As of June 30, 2011, the total fair value of these cap agreements was an asset of $5.4 million. During the six months ended June 30, 2011, we recorded $3.8 million, net of tax, as a decrease to other comprehensive income due to unrealized valuation changes in the cap agreements, net of the amortization of the interest rate cap premiums that were reclassified into net income.

As of June 30, 2011, the interest rates were economically fixed on primarily all of our total debt.

As a result of the swap agreements, our overall weighted average effective interest rate on the Senior Secured Credit Facilities was 4.68%, based upon the current margins in effect of 2.75% for the Term Loan A and 3.00% for the Term Loan B, as of June 30, 2011.

Our overall weighted average effective interest rate during the second quarter of 2011 was 5.33% and as of June 30, 2011 was 5.34%.

As of June 30, 2011, we had undrawn revolving credit facilities totaling $250 million of which approximately $46 million was committed for outstanding letters of credit.

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

Stock-based compensation

Stock-based compensation recognized in a period represents the amortization during that period of the estimated grant-date fair value of current and prior stock-based awards over their vesting terms, adjusted for expected forfeitures. Shares issued upon exercise of stock awards are generally issued from shares in treasury. We have used the Black-Scholes-Merton valuation model for estimating the grant-date fair value of stock options and stock-settled stock appreciation rights granted in all periods. During the six months ended June 30, 2011, we granted 2.3 million stock-settled stock appreciation rights with a grant-date fair value of $51.6 million and a weighted-average expected life of approximately 4.3 years, and also granted 138,000 stock units with a grant-date fair value of $11.9 million and a weighted-average expected life of approximately 3.2 years.

 

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For the six months ended June 30, 2011 and 2010, we recognized $23.1 million and $22.4 million, respectively, in stock-based compensation expense for stock-settled stock appreciation rights, stock options, stock units and discounted employee stock plan purchases, which are primarily included in general and administrative expenses. The estimated tax benefits recorded for stock-based compensation through June 30, 2011 and 2010 was $8.8 million and $8.5 million, respectively. As of June 30, 2011, there was $110.0 million of total estimated unrecognized compensation cost related to nonvested stock-based compensation arrangements under our equity compensation and stock purchase plans. We expect to recognize this cost over a weighted average remaining period of 1.5 years.

During the six months ended June 30, 2011 and 2010, we received $5.2 million and $32.1 million, respectively, in cash proceeds from stock option exercises and $33.8 million and $12.9 million, respectively, in actual tax benefits upon the exercise of stock awards.

Medicare’s bundled payment system

On January 1, 2011 we implemented Medicare’s new payment system in which all ESRD payments are made under a single bundled payment rate that, beginning in 2012, will provide for an annual inflation adjustment based upon a market basket index, less a productivity adjustment. Also beginning in 2012, the rule provides for up to a 2% annual payment withhold that can be earned back by the facilities that meet certain defined clinical performance standards. The new payment system reimburses providers based upon a single bundled or average payment for each Medicare treatment provided. This new bundled payment amount is designed to cover all dialysis services which were historically included in the composite rate and all separately billable ESRD services such as pharmaceuticals and laboratory costs. The new bundled payment rate is adjusted for certain patient characteristics, a geographic wage index and certain other factors. The initial 2011 bundled payment rate included reductions of 2.0% and 3.1%, respectively, to conform to the provisions of The Medicare Improvements for Patients and Providers Act for 2008 (MIPPA), and to establish budget neutrality. Further, there is a 5.94% reduction tied to an expanded list of case mix adjustors which can be earned back based upon the presence of these patient characteristics and co-modalities at the time of treatment.

On April 1, 2011, CMS released an interim final rule correcting the 3.1% transition adjustment factor to properly update the number of ESRD facilities that elected to opt fully into the new Prospective Payment System (PPS). This new rule is prospective and as a result, effective April 1, 2011 we began recognizing revenues in accordance with the new rule, which resulted in an increase in Medicare revenue per treatment of approximately 3.1% in comparison to our levels recorded in the first quarter of 2011. This reduced our transition adjustment to zero for the balance of 2011 and to an aggregate of approximately 0.75% for 2011.

On July 8, 2011, CMS published the proposed ESRD Prospective Payment System (PPS) rule for 2012. The base rate may increase by 1.8% and the proposal includes additional quality measures that could result in decreased payments if a dialysis facility fails to meet the standards.

Off-balance sheet arrangements and aggregate contractual obligations

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

 

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

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

The following is a summary of these contractual obligations and commitments as of June 30, 2011 (in millions):

 

     Remainder of
2011
     1-3
years
     4-5
years
    After
5 years
     Total  

Scheduled payments under contractual obligations:

             

Long-term debt

   $ 40       $ 187       $ 837      $ 3,214       $ 4,278   

Interest payments

     50         202         202        380         834   

Interest payments on the Term Loan B (1)

     40         157         153        61         411   

Capital lease obligations

     1         2         2        11         16   

Operating leases

     122         430         354        641         1,547   

Construction of the new corporate headquarters

     45         30         —          —           75   
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 
   $ 298       $ 1,008       $ 1,548      $ 4,307       $ 7,161   
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 

Potential cash requirements under existing commitments:

             

Letters of credit

   $ 46       $ —         $ —        $ —         $ 46   

Noncontrolling interests subject to put provisions

     230         64         57        66         417   

Pay-fixed swaps potential obligations

     6         12         (4     —           14   

Operating capital advances

     2         —           —          —           2   
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 
   $ 284       $ 76       $ 53      $ 66       $ 479   
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 

 

(1) 

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

The pay-fixed swap obligations represent the estimated fair market values of our interest rate swap agreements as reported by various broker dealers that are based upon relevant observable market inputs as well as other current market conditions that existed as of June 30, 2011, and represent the estimated potential obligation that we would be required to pay based upon the estimated future settlement of each specific tranche over the term of the swap agreements, assuming no future changes in the forward yield curve. The actual amount of our obligation associated with these swaps in the future will depend upon changes in the LIBOR-based interest rates that can fluctuate significantly depending upon market conditions, and other relevant factors that can affect the fair market value of these swap agreements.

In addition to the above commitments, we are obligated to purchase a certain amount of our hemodialysis products and supplies at fixed prices through 2015 from Gambro Renal Products, Inc. in connection with the Alliance and Product Supply Agreement. Our total expenditures for the six months ended June 30, 2011 on such products were approximately 2% of our total operating costs in each year. In January 2010, we entered into an agreement with Fresenius Medical Care, or Fresenius, which committed us to purchase a certain amount of dialysis equipment, parts and supplies from them through 2013. Our total expenditures for the six months ended June 30, 2011 on such products were approximately 2% of our total operating costs.

 

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

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

Significant new accounting standards

In July 2011, the Financial Accounting Standards Board (FASB) issued ASU No. 2011-07, Health Care Entities-Presentation and Disclosure of Patient Service Revenue, Provision for Bad Debts, and the Allowance for Doubtful Accounts. This standard amends the current presentation and disclosure requirements for Health Care Entities that recognize significant amounts of patient service revenue at the time the services are rendered without assessing the patient’s ability to pay. This standard requires health care entities to reclassify the provision for bad debts from an operating expense to a deduction from patient service revenues. In addition, this standard requires more disclosure on the policies for recognizing revenue, assessing bad debts, as well as quantitative and qualitative information regarding changes in the allowance for doubtful accounts. This standard is applied retrospectively to all prior periods presented and is effective during interim and annual periods beginning after December 15, 2011. The adoption of this standard will not have a material impact on our consolidated financial statements.

In June 2011, the FASB issued Accounting Standard Update (ASU) No. 2011-05, Comprehensive Income—Presentation of Comprehensive Income. This standard amends the current presentation requirements for comprehensive income by eliminating the presentation of the components of other comprehensive income within the statement of equity. This standard allows two options on how to present the various components of comprehensive income. These options are either to report the components of comprehensive income separately on the income statement or to present total other comprehensive income and the components of other comprehensive income in a separate statement. This standard does not change the items that must be reported in other comprehensive income or when an item must be reclassified into net income. This standard is applied retrospectively and is effective for fiscal years and interim periods within those years beginning after December 15, 2011. Early adoption is permitted. The adoption of this standard will not have a material impact on our consolidated financial statements.

In May 2011, the FASB issued ASU No. 2011-04, Fair Value Measurement. This standard amends the current fair value measurement and disclosure requirements to improve comparability between U.S. GAAP and International Financial Reporting Standards (IFRS). The intent of this standard is to update the disclosures that describe several of the requirements in U.S. GAAP for measuring fair value and to enhance disclosures about fair value measurements which will improve consistency between U.S. GAAP and IFRS. This standard does not change the application of the requirements on fair value measurements and disclosures. This standard is applied prospectively and is effective during interim and annual periods beginning after December 15, 2011. The adoption of this standard will not have a material impact on our consolidated financial statements.

 

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Item 3. Quantitative and Qualitative Disclosures about Market Risk

Interest rate sensitivity

The tables below provide information about our financial instruments that are sensitive to changes in interest rates. For our debt obligations the table presents principal repayments and current weighted average interest rates on our debt obligations as of June 30, 2011. The variable rates presented reflect the weighted average LIBOR rates in effect for all debt tranches plus interest rate margins in effect as of June 30, 2011. The Term Loan A margin currently in effect is 2.75% until June 30, 2011, and along with the revolving line of credit, is then subject to adjustment depending upon changes in certain of our financial ratios including a leverage ratio. The Term Loan B currently bears interest at LIBOR (floor of 1.50%) plus an interest rate margin of 3.00% subject to a ratings based step-down to 2.75%.