Form 10-Q
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

For the Quarterly Period Ended

September 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 October 31, 2011, the number of shares of the Registrant’s common stock outstanding was approximately 93.5 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 $6.5 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 nine months ended September 30, 2011 and September 30, 2010

     1   
 

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

     2   
 

Consolidated Statements of Cash Flows for the nine months ended September 30, 2011 and September 30, 2010

     3   
 

Consolidated Statements of Equity and Comprehensive Income for the nine months ended September 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

     29   

Item 3.

 

Quantitative and Qualitative Disclosures about Market Risk

     44   

Item 4.

 

Controls and Procedures

     45   
  PART II. OTHER INFORMATION   

Item 1.

 

Legal Proceedings

     46   

Item 1A.

 

Risk Factors

     46   

Item 2.

 

Unregistered Sales of Equity Securities and Use of Proceeds

     62   

Item 6.

 

Exhibits

     63   
  Signature      64   

 

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 September 30,     Nine months ended September 30,  
              2011                          2010                          2011                          2010             

Net operating revenues

  $ 1,807,869      $ 1,649,557      $ 5,119,896      $ 4,791,126   

Operating expenses and charges:

       

Patient care costs

    1,189,638        1,144,474        3,466,860        3,334,099   

General and administrative

    182,638        148,041        498,033        421,422   

Depreciation and amortization

    67,558        58,325        193,641        173,820   

Provision for uncollectible accounts

    51,942        43,761        143,247        127,451   

Equity investment income

    (2,619     (1,789     (6,555     (6,968

Goodwill impairment charge

    —          —          24,000        —     
 

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses and charges

    1,489,157        1,392,812        4,319,226        4,049,824   
 

 

 

   

 

 

   

 

 

   

 

 

 

Operating income

    318,712        256,745        800,670        741,302   

Debt expense

    (60,848     (39,490     (179,340     (127,728

Debt redemption charges

    —          —          —          (4,127

Other income

    798        759        2,195        2,328   
 

 

 

   

 

 

   

 

 

   

 

 

 

Income from continuing operations before income taxes

    258,662        218,014        623,525        611,775   

Income tax expense

    94,204        75,038        224,034        220,189   
 

 

 

   

 

 

   

 

 

   

 

 

 

Income from continuing operations

    164,458        142,976        399,491        391,586   

Discontinued operations:

       

Income (loss) from operations of discontinued operations, net of tax

    1,076        (95     1,460        188   

Loss on disposal of discontinued operations, net of tax

    (3,688     —          (3,688     —     
 

 

 

   

 

 

   

 

 

   

 

 

 

Net income.

    161,846        142,881        397,263        391,774   

Less: Net income attributable to noncontrolling interests

    (26,485     (23,494     (67,385     (55,111
 

 

 

   

 

 

   

 

 

   

 

 

 

Net income attributable to DaVita Inc.

  $ 135,361      $ 119,387      $ 329,878      $ 336,663   
 

 

 

   

 

 

   

 

 

   

 

 

 

Earnings per share:

       

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

  $ 1.48      $ 1.16      $ 3.50      $ 3.27   
 

 

 

   

 

 

   

 

 

   

 

 

 

Basic net income per share attributable to DaVita Inc.

  $ 1.45      $ 1.16      $ 3.47      $ 3.27   
 

 

 

   

 

 

   

 

 

   

 

 

 

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

  $ 1.45      $ 1.15      $ 3.43      $ 3.22   
 

 

 

   

 

 

   

 

 

   

 

 

 

Diluted net income per share attributable to DaVita Inc.

  $ 1.42      $ 1.15      $ 3.40      $ 3.22   
 

 

 

   

 

 

   

 

 

   

 

 

 

Weighted average shares for earnings per share:

       

Basic

      93,441,620          102,608,844          95,053,339          102,989,010   
 

 

 

   

 

 

   

 

 

   

 

 

 

Diluted

    95,171,225        104,022,458        97,057,773        104,408,939   
 

 

 

   

 

 

   

 

 

   

 

 

 

Amounts attributable to DaVita Inc.:

       

Income from continuing operations

  $ 138,192      $ 119,482      $ 332,325      $ 336,475   

Discontinued operations

    (2,831     (95     (2,447     188   
 

 

 

   

 

 

   

 

 

   

 

 

 

Net income

  $ 135,361      $ 119,387      $ 329,878      $ 336,663   
 

 

 

   

 

 

   

 

 

   

 

 

 

See notes to condensed consolidated financial statements.

 

1


Table of Contents

DAVITA INC.

CONSOLIDATED BALANCE SHEETS

(unaudited)

(dollars in thousands, except per share data)

 

     September 30,
2011
    December 31,
2010
 
ASSETS     

Cash and cash equivalents

   $ 541,206      $ 860,117   

Short-term investments

     24,661        23,003   

Accounts receivable, less allowance of $231,666 and $235,629

     1,165,010        1,048,976   

Inventories

     73,293        76,008   

Other receivables

     242,218        304,366   

Other current assets

     67,454        43,994   

Income tax receivables

     —          40,330   

Deferred income taxes

     256,325        226,060   
  

 

 

   

 

 

 

Total current assets

     2,370,167        2,622,854   

Property and equipment, net

     1,335,789        1,170,808   

Amortizable intangibles, net

     159,789        162,635   

Equity investments

     30,340        25,918   

Long-term investments

     8,857        8,848   

Other long-term assets

     31,761        32,054   

Goodwill

     4,769,965        4,091,307   
  

 

 

   

 

 

 
   $ 8,706,668      $ 8,114,424   
  

 

 

   

 

 

 
LIABILITIES AND EQUITY     

Accounts payable

   $ 259,459      $ 181,033   

Other liabilities

     363,176        342,943   

Accrued compensation and benefits

     461,988        325,477   

Current portion of long-term debt

     82,497        74,892   

Income tax payable

     38,800        —     
  

 

 

   

 

 

 

Total current liabilities

     1,205,920        924,345   

Long-term debt

     4,417,468        4,233,850   

Other long-term liabilities

     134,075        89,290   

Alliance and product supply agreement, net

     22,370        25,317   

Deferred income taxes

     393,540        421,436   
  

 

 

   

 

 

 

Total liabilities

     6,173,373        5,694,238   

Commitments and contingencies

    

Noncontrolling interests subject to put provisions

     450,903        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; 93,442,783 and 96,001,535 shares outstanding)

     135        135   

Additional paid-in capital

     611,833        620,546   

Retained earnings

     3,047,695        2,717,817   

Treasury stock, at cost (41,419,500 and 38,860,748 shares)

     (1,639,554     (1,360,579

Accumulated other comprehensive (loss) income

     (20,856     503   
  

 

 

   

 

 

 

Total DaVita Inc. shareholders’ equity

       1,999,253          1,978,422   

Noncontrolling interests not subject to put provisions

     83,139        58,712   
  

 

 

   

 

 

 

Total equity

     2,082,392        2,037,134   
  

 

 

   

 

 

 
   $ 8,706,668      $ 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)

 

     Nine months ended
September 30,
 
     2011     2010  

Cash flows from operating activities:

    

Net income

   $ 397,263      $ 391,774   

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

    

Depreciation and amortization

     194,328        174,307   

Stock-based compensation expense

     36,392        33,492   

Tax benefits from stock award exercises

     35,096        15,755   

Excess tax benefits from stock award exercises

     (19,640     (2,079

Deferred income taxes

     38,377        61,499   

Equity investment income, net

     238        (3,048

Loss on disposal of assets and other non-cash charges

     16,398        5,650   

Goodwill impairment charge

     24,000        —     

Debt redemption charges

     —          4,127   

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

    

Accounts receivable

     (61,483     21,680   

Inventories

     11,767        3,041   

Other receivables and other current assets

     81,737        16,596   

Other long-term assets

     2,408        187   

Accounts payable

     56,652        95,350   

Accrued compensation and benefits

     121,631        72,501   

Other current liabilities

     (8,733     (118,305

Income taxes

     88,454        (55,703

Other long-term liabilities

     14,502        2,308   
  

 

 

   

 

 

 

Net cash provided by operating activities

     1,029,387        719,132   
  

 

 

   

 

 

 

Cash flows from investing activities:

    

Additions of property and equipment, net

     (251,879     (169,376

Acquisitions

     (927,124     (137,643

Proceeds from asset sales

     51,623        18,471   

Purchase of investments available for sale

     (2,118     (955

Purchase of investments held-to-maturity

     (29,740     (23,540

Proceeds from sale of investments available for sale

     1,149        900   

Proceeds from maturities of investments held-to-maturity

     29,747        26,916   

Purchase of equity investments and other assets

     (5,005     (436

Distributions received on equity investments

     340       350   
  

 

 

   

 

 

 

Net cash used in investing activities

     (1,133,007     (285,313
  

 

 

   

 

 

 

Cash flows from financing activities:

    

Borrowings

     27,506,051        14,736,519   

Payments on long-term debt

     (27,350,513     (15,006,754

Interest rate cap premiums and other deferred financing costs

     (17,863     (46

Debt call premium

     —          (3,314

Purchase of treasury stock

     (323,348     (148,669

Distributions to noncontrolling interests

     (67,408     (61,112

Stock award exercises and other share issuances, net

     9,886        39,416   

Excess tax benefits from stock award exercises

     19,640        2,079   

Contributions from noncontrolling interests

     14,779        5,365   

Proceeds from sales of additional noncontrolling interests

     2,675        3,205   

Purchases from noncontrolling interests

     (9,190     (5,402
  

 

 

   

 

 

 

Net cash used in financing activities

     (215,291     (438,713
  

 

 

   

 

 

 

Net decrease in cash and cash equivalents

     (318,911     (4,894

Cash and cash equivalents at beginning of period

     860,117        539,459   
  

 

 

   

 

 

 

Cash and cash equivalents at end of period

   $ 541,206      $ 534,565   
  

 

 

   

 

 

 

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

    42,662              329,878              329,878        24,723      $ 397,263   

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

                  (27,839     (27,839       (27,839

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

                  7,124        7,124          7,124   

Unrealized loss on investments, net of tax

                  (587     (587       (587

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

                  (57     (57       (57
                     

 

 

 

Total comprehensive income

                      $ 375,904   
                     

 

 

 

Stock purchase shares issued

          1,998          84        2,938          4,936       

Stock unit shares issued

          (2,640       72        2,640           

Stock options and SSARs exercised

          (33,352       1,080        38,795          5,443       

Stock-based compensation expense

          36,392                36,392       

Excess tax benefits from stock awards exercised

          19,640                19,640       

Distributions to noncontrolling interests

    (43,071                     (24,337  

Contributions from noncontrolling interests

    9,688                        5,091     

Sales and assumptions of additional noncontrolling interests

    34,673            238                238        21,054     

Purchases from noncontrolling interests

    (1,041         (6,049             (6,049     (2,100  

Changes in fair value of noncontrolling interests

    24,940            (24,940             (24,940    

Other adjustments

                      (4  

Purchase of treasury stock

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

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

Balance at September 30, 2011

  $ 450,903        134,862      $ 135      $ 611,833      $ 3,047,695        (41,420   $ (1,639,554   $ (20,856   $ 1,999,253      $ 83,139     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

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 nine months ended September 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 (increase) decrease in noncontrolling interest redemption rights in excess of fair value, by the weighted average number of common shares and vested stock units outstanding. Diluted net income per share includes the dilutive effect of outstanding stock-settled stock appreciation rights, stock options and unvested stock units (under the treasury stock method).

 

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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)

 

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

 

     Three months ended
September 30,
    Nine months ended
September 30,
 
     2011     2010     2011     2010  

Basic:

        

Income from continuing operations attributable to DaVita Inc.

   $ 138,192      $ 119,482      $ 332,325      $ 336,475   

(Increase) decrease in noncontrolling interest redemption rights in excess of fair value

     (17     26        103        (45
  

 

 

   

 

 

   

 

 

   

 

 

 

Income from continuing operations for basic earnings per share calculation

   $ 138,175      $ 119,508      $ 332,428      $ 336,430   

Discontinued operations attributable to DaVita Inc.

     (2,831     (95     (2,447     188   
  

 

 

   

 

 

   

 

 

   

 

 

 

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

   $ 135,344      $ 119,413      $ 329,981      $ 336,618   
  

 

 

   

 

 

   

 

 

   

 

 

 

Weighted average shares outstanding during the period

     93,439        102,602        95,050        102,982   

Vested stock units

     3        7        3        7   
  

 

 

   

 

 

   

 

 

   

 

 

 

Weighted average shares for basic earnings per share calculation

     93,442        102,609        95,053        102,989   
  

 

 

   

 

 

   

 

 

   

 

 

 

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

   $ 1.48      $ 1.16      $ 3.50      $ 3.27   
  

 

 

   

 

 

   

 

 

   

 

 

 

Basic net income per share attributable to DaVita Inc.

   $ 1.45      $ 1.16      $ 3.47      $ 3.27   
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted:

        

Income from continuing operations attributable to DaVita Inc.

   $ 138,192      $ 119,482      $ 332,325      $ 336,475   

(Increase) decrease in noncontrolling interest redemption rights in excess of fair value

     (17     26        103        (45
  

 

 

   

 

 

   

 

 

   

 

 

 

Income from continuing operations for diluted earnings per share calculation

   $ 138,175      $ 119,508      $ 332,428      $ 336,430   

Discontinued operations attributable to DaVita Inc.

     (2,831     (95     (2,447     188   
  

 

 

   

 

 

   

 

 

   

 

 

 

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

   $ 135,344      $ 119,413      $ 329,981      $ 336,618   
  

 

 

   

 

 

   

 

 

   

 

 

 

Weighted average shares outstanding during the period

     93,439        102,602        95,050        102,982   

Vested stock units

     3        7        3        7   

Assumed incremental shares from stock plans

     1,729        1,413        2,005        1,420   
  

 

 

   

 

 

   

 

 

   

 

 

 

Weighted average shares for diluted earnings per share calculation

     95,171        104,022        97,058        104,409   
  

 

 

   

 

 

   

 

 

   

 

 

 

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

   $ 1.45      $ 1.15      $ 3.43      $ 3.22   
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted net income per share attributable to DaVita Inc.

   $ 1.42      $ 1.15      $ 3.40      $ 3.22   
  

 

 

   

 

 

   

 

 

   

 

 

 

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

     2,834        1,804        1,777        1,368   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

(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.

 

6


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DAVITA INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (continued)

(unaudited)

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

 

3. Stock-based compensation and other common stock transactions

Stock-based compensation recognized in a period represents the amortization during that period of the estimated grant-date fair value of current and prior stock-based awards over their vesting terms, adjusted for expected forfeitures. Shares issued upon exercise of stock awards are generally issued from shares in treasury. The Company has used the Black-Scholes-Merton valuation model for estimating the grant-date fair value of stock-settled stock appreciation rights granted in all periods. During the nine months ended September 30, 2011, the Company granted 2,453 stock-settled stock appreciation rights with a grant-date fair value of $55,281 and a weighted-average expected life of approximately 4.2 years, and also granted 143 stock units with a grant-date fair value of $12,264 and a weighted-average expected life of approximately 3.2 years.

For the nine months ended September 30, 2011 and 2010, the Company recognized $36,392 and $33,492, respectively, in stock-based compensation expense for stock appreciation rights, stock units and discounted employee stock plan purchases, which are primarily included in general and administrative expenses. The estimated tax benefits recorded for stock-based compensation through September 30, 2011 and 2010 was $13,766 and $12,690, respectively. As of September 30, 2011, there was $100,337 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 nine months ended September 30, 2011 and 2010, the Company received $5,443 and $36,819, respectively, in cash proceeds from stock option exercises and $35,096 and $15,755, respectively, in actual tax benefits upon the exercise of stock awards.

During the first nine months of 2011, the Company repurchased a total of 3,795 shares of its common stock for $323,348, or an average price of $85.21 per share. During the third quarter of 2011, the Company repurchased 85 shares of its common stock for $7,261, or an average price of $85.83 per share. The Company has not repurchased any additional shares of its common stock from October 1, 2011 through October 31, 2011. Therefore, the Company’s remaining board authorization for share repurchases as of October 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,

 

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DAVITA INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (continued)

(unaudited)

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

 

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:

 

     September 30,
2011
    December 31,
2010
 

Senior Secured Credit Facilities:

    

Term Loan A

   $ 962,500      $ 1,000,000   

Term Loan A-2

     200,000        —     

Term Loan B

     1,736,875        1,750,000   

Senior notes

     1,550,000        1,550,000   

Acquisition obligations and other notes payable

     27,343        9,049   

Capital lease obligations

     31,505        8,074   
  

 

 

   

 

 

 

Total debt principal outstanding

     4,508,223        4,317,123   

Discount on long-term debt

     (8,258     (8,381
  

 

 

   

 

 

 
     4,499,965        4,308,742   

Less current portion

     (82,497     (74,892
  

 

 

   

 

 

 
   $     4,417,468      $     4,233,850   
  

 

 

   

 

 

 

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

 

2011 (remainder of the year)

     28,198   

2012

     74,680   

2013

     124,386   

2014

     175,436   

2015

     674,138   

2016

     1,856,900   

Thereafter

     1,574,485   

On August 26, 2011, the Company entered into an Increase Joinder Agreement under its existing Senior Secured Credit Agreement. Pursuant to the Increase Joinder Agreement, the Company increased the revolving credit facility by $100,000, to a total of $350,000, and entered into an additional $200,000 Term Loan A-2. The new Term Loan A-2 requires quarterly principal payments of $500 beginning on the last day of December 2011, and bears interest at LIBOR (floor of 1.00%) plus an interest rate margin of 3.50% subject to a rating based step-down to 3.25%. The Term Loan A-2 matures in October 2016.

During the first nine months of 2011, the Company made mandatory principal payments under its Senior Secured Credit Facilities totaling $37,500 on the Term Loan A and $13,125 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

 

8


Table of Contents

DAVITA INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (continued)

(unaudited)

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

 

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 September 30, 2011, the Company maintained a total of nine interest rate swap agreements with amortizing notional amounts totaling $962,500. These agreements had the economic effect of modifying the LIBOR variable component of the Company’s interest rate on an equivalent amount of the Company’s Term Loan A to fixed rates ranging from 1.59% to 1.64%, resulting in an overall weighted average effective interest rate of 4.11%, including the Term Loan A margin of 2.50%. The swap agreements expire by September 30, 2014 and require monthly interest payments. The Company estimates that approximately $10,800 of existing unrealized pre-tax losses in other comprehensive income at September 30, 2011 will be reclassified into income over the next twelve months.

As of September 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.

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

 

     September 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
   $     24,629       Other long-
term liabilities
   $     —     
     

 

 

       

 

 

 

Interest rate cap agreements

   Other long-
term assets
   $ 1,492       Other long-
term assets
   $ —     
     

 

 

       

 

 

 

 

9


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 effects of the Company’s interest rate swap and cap agreements for the nine months ended September 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
September 30,
    Nine months ended
September 30,
      Three months ended
September 30,
    Nine months ended
September 30,
 

Derivatives designated as cash
flow hedges

     2011           2010           2011           2010             2011           2010           2011           2010     

Interest rate swap agreements

  $ (13,907   $ (3   $ (33,897   $ (217   Debt expense   $ (3,525   $ (1,942   $ (9,268   $ (9,093

Interest rate cap agreements

    (3,882     —          (11,666     —        Debt expense     (897     —          (2,392     —     

Tax benefit

    6,920        1        17,724        83          1,720        756        4,536        3,536   
 

 

 

   

 

 

   

 

 

   

 

 

     

 

 

   

 

 

   

 

 

   

 

 

 

Total

  $ (10,869   $ (2   $ (27,839   $ (134     $ (2,702   $ (1,186   $ (7,124   $ (5,557
 

 

 

   

 

 

   

 

 

   

 

 

     

 

 

   

 

 

   

 

 

   

 

 

 

Total comprehensive income for the three and nine months ended September 30, 2011 was $152,777 and $375,904, respectively, including a decrease to other comprehensive income due to unrealized valuation losses on interest rate swaps and caps of $8,167 and $20,715, net of tax, respectively, net of amounts reclassified into income, and a decrease to other comprehensive income for unrealized valuation losses on investments, and the amounts reclassified into income of $902 and $644, net of tax, respectively.

Total comprehensive income for the three and nine months ended September 30, 2010 was $144,461 and $397,441, respectively, including an increase to other comprehensive income for amounts reclassified into income, net of unrealized valuation loss on interest rate swaps of $1,184 and $5,423, net of tax, respectively, and an increase to other comprehensive income for unrealized valuation gains on investments, and the amounts reclassified into income of $396 and $244, net of tax, respectively.

As of September 30, 2011, interest rates on our Term Loan A-2 and Term Loan B debt are set at their interest rate floors. Interest rates on our senior notes and Term Loan A are economically fixed, while rates on $1,250,000 of our Term Loan B are subject to interest rate caps.

As a result of the swap agreements, the Company’s overall weighted average effective interest rate on the Senior Secured Credit Facilities was 4.61%, based upon the current margins in effect of 2.50% for the Term loan A, 3.50% for the Term Loan A-2 and 3.00% for the Term Loan B, as of September 30, 2011.

The Company’s overall weighted average effective interest rate during the third quarter of 2011 was 5.30% and as of September 30, 2011 was 5.27%.

As of September 30, 2011, the Company had undrawn revolving credit facilities totaling $350,000 of which approximately $42,811 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

 

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DAVITA INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (continued)

(unaudited)

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

 

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 and Certain Related Civil Proceedings

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

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

Vainer Private Civil Suit: In December 2008, the Company received a subpoena for documents from the OIG relating to the pharmaceutical products Zemplar, Hectorol, Venofer, Ferrlecit and EPO, as well as other related matters. The subpoena covers the period from January 2003 to the present. The Company was in contact

 

11


Table of Contents

DAVITA INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (continued)

(unaudited)

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

 

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 was a civil inquiry. On June 17, 2009, the Company learned that the allegations underlying this inquiry were made as part of a civil complaint filed by individuals and brought pursuant to the qui tam provisions of the federal False Claims Act. On April 1, 2011, the United States District Court for the Northern District of Georgia ordered the case to be unsealed. At that time, the Department of Justice and U.S. Attorney’s Office filed a notice of declination stating that the United States would not be intervening and not pursuing the relators’ allegation in litigation. On July 25, 2011, the relators, Daniel Barbir and Dr. Alon Vainer, filed their amended complaint in the United States District Court for the Northern District of Georgia, purportedly on behalf of the federal government. The allegations in the complaint relate to the Company’s drug administration practices for Vitamin D and iron agents for a period from 2003 through 2010. The complaint seeks monetary damages and civil penalties as well as costs and expenses. The Company is vigorously defending this matter and intends to continue to do so. The Company can make no assurances as to the time or resources that will be needed to devote to this litigation or its final outcome.

2010 U.S. Attorney Physician Relationship Investigation: In May 2010, the Company received a subpoena from the OIG’s office in Dallas, Texas. The subpoena covers the period from January 1, 2005 to 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 inquiry appears to overlap with the 2005 U.S. Attorney Investigation 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. The Company can make no assurances as to the time or resources that will be needed to devote to this litigation or its final outcome.

2011 U.S. Attorney Physician Relationship Investigation: In August 2011, the Company announced it had learned that the U.S. Attorney’s Office for the District of Colorado would be looking into certain activities of the Company in connection with information being provided to a grand jury. The Company announced further, that it understood that this investigation was at a very preliminary stage, and while its precise scope was unclear, it appeared to overlap, at least in part, with the 2005 U.S. Attorney Investigation and 2010 U.S. Attorney Physician Relationship Investigation described above. Subsequent to the Company’s announcement of this 2011 U.S. Attorney Physician Relationship Investigation, it received a subpoena for documents which substantially overlaps with the subpoena in the 2010 U.S. Attorney Physician Relationship Investigation described above. The Company is cooperating with the government and is producing the requested records. The Company can make no assurances as to the time or resources that will be needed to devote to this litigation or its final outcome.

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

Except for the private civil complaints filed by the relators as described above, to the Company’s knowledge, no proceedings have been initiated against the Company at this time in connection with any of the inquiries by the federal government. Although the Company cannot predict whether or when proceedings might be initiated or when these matters may be resolved, it is not unusual for inquiries such as these to continue for a

 

12


Table of Contents

DAVITA INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (continued)

(unaudited)

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

 

considerable period of time. Responding to the subpoenas or inquiries and defending the Company in the relator proceedings will continue to require management’s attention and significant legal expense. Any negative findings in the inquiries or relator proceedings could result in substantial financial penalties or awards against the Company, exclusion from future participation in the Medicare and Medicaid programs and, to the extent criminal proceedings may be initiated against the Company, possible criminal penalties. At this time, the Company cannot predict the ultimate outcome of these inquiries, or the potential outcome of the relators claims, or the potential range of damages, if any.

Other

The Company has received several notices of claims from commercial payors and other third parties related to historical billing practices and claims against DVA Renal Healthcare (formerly known as Gambro Healthcare), a subsidiary of the Company, related to historical Gambro Healthcare billing practices and other matters covered by its 2004 settlement agreement with the Department of Justice and certain agencies of the U.S. government. At least one commercial payor has filed an arbitration demand against the Company, which has now been dismissed as described below. 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.

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

 

13


Table of Contents

DAVITA INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (continued)

(unaudited)

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

 

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. On September 11, 2011, the arbitration panel entered a final award dismissing all claims with prejudice.

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, which fully resolves this matter for an amount that did 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.

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:

 

     September 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

   $   21,811       $ —         $ 21,811       $ 21,803       $ —         $ 21,803   

Investments in mutual funds and warrants

     —           11,707         11,707         —           10,048         10,048   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
   $ 21,811       $   11,707       $   33,518       $   21,803       $   10,048       $   31,851   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Short-term investments

   $ 21,811       $ 2,850       $ 24,661       $ 21,803       $ 1,200       $ 23,003   

Long-term investments

     —           8,857         8,857         —           8,848         8,848   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
   $ 21,811       $ 11,707       $ 33,518       $ 21,803       $ 10,048       $ 31,851   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

The cost of the certificates of deposit, money market funds and U.S. treasury notes at September 30, 2011 and December 31, 2010 approximates their fair value. As of September 30, 2011, the available for sale investments include $229 of gross pre-tax loss, and as of December 31, 2010, the available for sale investments included $824 of gross pre-tax unrealized gains. During the nine months ended September 30, 2011, the Company recorded gross pre-tax unrealized losses of $960, or $587 after tax, in other comprehensive income

 

14


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DAVITA INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (continued)

(unaudited)

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

 

associated with changes in the fair value of these investments. During the nine months ended September 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 nine months ended September 30, 2010, the Company sold investments in mutual funds for net proceeds of $900, and recognized a pre-tax loss of $22, or $13 after tax, that was previously recorded in other comprehensive income.

In addition, the available for sale securities include the estimated fair value of vested warrants to purchase NxStage Medical Inc. (NxStage) common stock totaling $1,650 based on their estimated fair value at September 30, 2011. Under the terms of the NxStage Service Provider Agreement effective July 22, 2010, the Company may, in lieu of a cash rebate, vest in warrants to purchase NxStage common stock based on achieving certain System One home patient growth targets by June 30, 2011, 2012 and 2013. The warrants are exercisable for up to a cumulative total of 5,500,000 shares of common stock at an initial exercise price of $14.22 per share. For the nine months ended September 30, 2011, the Company earned warrants to purchase 250,000 shares of NxStage common stock.

As of September 30, 2011, investments totaling $18,544 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.

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

   $ 11,707       $   10,057       $ —         $ 1,650   
  

 

 

    

 

 

    

 

 

    

 

 

 

Interest rate cap agreements

   $ 1,492       $ —         $ 1,492       $ —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Liabilities

           

Interest rate swap agreements

   $ 24,629       $ —         $   24,629       $ —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Temporary equity

           

Noncontrolling interests subject to put provisions

   $ 450,903       $ —         $ —         $   450,903   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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 available for sale securities represent investments in various open-ended registered investment companies, or mutual funds, and are recorded at fair value based upon quoted prices reported by each mutual fund. The available for sale securities also include the estimated fair value of vested NxStage common stock warrants based upon their estimated fair value. 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 provisions.

The Company has other financial instruments in addition to the above that consist primarily of cash, accounts receivable, accounts payable, other accrued liabilities, and debt. The balances of the non-debt financial instruments are presented in the condensed consolidated financial statements at September 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 $2,891,117 as of September 30, 2011 and the fair value was $2,867,569 based upon quoted market prices. The fair value of the Company’s senior notes was approximately $1,484,125 at September 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 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.

 

16


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DAVITA INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (continued)

(unaudited)

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

 

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 September 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 $9,804, all of which would impact the Company’s effective tax rate if recognized. This balance represents an increase of $1,666 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 September 30, 2011 and December 31, 2010, the Company had approximately $3,641 and $3,177, respectively, accrued for interest and penalties related to unrecognized tax benefits, net of federal tax benefits.

10. Acquisitions

On September 2, 2011, the Company completed its acquisition of all of the outstanding common stock of CDSI I Holding Company, Inc., the parent company of dialysis provider DSI Renal Inc., (DSI), pursuant to an agreement and plan of merger for approximately $724,219 in net cash, plus the assumption of certain liabilities totaling approximately $6,541, subject to certain post-closing adjustments. DSI had 113 outpatient dialysis centers that provide services to approximately 8,000 patients in 23 states. The Company also incurred approximately $9,000 in transaction and integration costs during the third quarter of 2011 associated with this acquisition that are included in general and administrative expenses in the condensed consolidated statements of income.

The initial purchase price allocation for the DSI acquisition is recorded at estimated fair values based upon the best information available to management and will be finalized when certain information arranged to be obtained has been received. In particular, certain income tax amounts and the fair values of certain intangible and fixed assets are pending issuance of the final tax returns and valuation reports.

The following table summarizes the assets acquired and liabilities assumed in the transaction and recognized at the acquisition date at their estimated fair values, as well as the estimated fair value of the noncontrolling interests in DSI at that date:

 

Current assets

   $ 163,634   

Property and equipment

     67,451   

Amortizable intangible and other long-term assets

     6,523   

Goodwill

     495,474   

Long-term deferred income taxes

     79,420   

Current liabilities assumed

     (48,081

Other long-term liabilities

     (10,561

Noncontrolling interests

     (23,100
  

 

 

 
   $ 730,760   
  

 

 

 

 

17


Table of Contents

DAVITA INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (continued)

(unaudited)

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

 

Of the goodwill recognized in this acquisition, approximately $262,000 is expected to be deductible for tax purposes over the next 15 years.

The noncontrolling interests acquired as part of the acquisition are stated at fair value based on a predetermined multiple of earnings based upon implied multiples used for the acquisition of DSI.

The operating results of DSI are included in the Company’s condensed consolidated financial statements effective September 1, 2011.

Other dialysis acquisitions

During the first nine months of 2011, the Company acquired other dialysis businesses consisting of 44 centers for a total of $202,905 in cash and deferred purchase price obligations totaling $10,335. The assets and liabilities for all acquisitions were recorded at their estimated fair market values at the dates of the acquisitions and are included in the Company’s financial statements and operating results from the designated effective dates of the acquisitions.

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

 

     Nine months  ended
September 30, 2011
 

Tangible assets, principally leasehold improvements and equipment

   $ 17,355   

Amortizable intangible assets

     11,325   

Goodwill

     215,682   

Liabilities assumed

     (244

Noncontrolling interests assumed

     (30,878
  

 

 

 
   $ 213,240   
  

 

 

 

Amortizable intangible assets acquired during the first nine months of 2011 had weighted-average estimated useful lives of 8.5 years. The total amount of goodwill deductible for tax purposes associated with these 2011 other dialysis acquisitions is approximately $188 million.

Discontinued operations

Pursuant to a consent order issued by the Federal Trade Commission on September 2, 2011, the Company agreed to divest a total of 30 outpatient dialysis centers and several home-based dialysis programs in order to complete the acquisition of DSI. In conjunction with the consent order, on September 30, 2011, the Company completed the sale of 28 outpatient dialysis centers to Dialysis Newco, Inc., (Dialysis Newco), a portfolio company of Frazier Healthcare VI, L.P. and New Enterprise Associates 13, Limited Partnership pursuant to an asset purchase agreement dated August 26, 2011. Effective October 31, 2011, the Company also completed the sale of two additional outpatient dialysis centers to Dialysis Newco that were previously pending state regulatory approval. The Company anticipates receiving total cash consideration of approximately $83,600 for all of the outpatient dialysis centers that were divested. At September 30, 2011, there was $19,981 of assets valued at fair value that

 

18


Table of Contents

DAVITA INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (continued)

(unaudited)

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

 

were held for sale associated with the two outpatient dialysis centers that were sold effective October 31, 2011. These assets are included in other current assets on the consolidated balance sheet. As part of this transaction, Dialysis Newco assumed specific liabilities related to the centers it acquired. All other liabilities were retained by the Company. The Company recorded a loss of approximately $3,668, net of tax, during the three months ended September 30, 2011 related to the divestiture of its historical DaVita centers.

The operating results of the historical DaVita divested centers are reflected as discontinued operations for all periods presented. In addition, the operating results for the DSI centers divested and to be divested are reflected as discontinued operations in the consolidated financial statements beginning September 1, 2011.

The results from discontinued operations related to the dialysis and related lab services segment were as follows:

 

     September 30, 2011      September 30, 2010  
     Three months      Nine months      Three months     Nine months  

Net operating revenues

   $ 9,281       $   14,741       $   2,092      $   6,848   

Income (loss) before income taxes

     1,640         2,281         (154     321   

Income tax expense (benefit)

     564         821         (59     133   
  

 

 

    

 

 

    

 

 

   

 

 

 

Income (loss) from discontinued operations

   $   1,076       $ 1,460       $ (95   $ 188   
  

 

 

    

 

 

    

 

 

   

 

 

 

Net assets of discontinued operations related to the dialysis and related lab services segment sold at September 30, 2011 were as follows:

 

Current assets

   $ 52,949   

Property and equipment, net

     5,183   

Goodwill

     7,999   

Liabilities and noncontrolling interests

     (836
  

 

 

 

Net assets from discontinued operations

   $ 65,295   
  

 

 

 

Pro forma financial information

The following summary, prepared on a pro forma basis, combines the results of operations as if the acquisitions and divestitures in 2011 had been consummated as of the beginning of 2010, after including the impact of certain adjustments such as amortization of intangibles and income tax effects.

 

     Nine months ended September 30,  
            2011                    2010         
     (unaudited)  

Pro forma net revenues

   $ 5,353,067       $ 5,117,128   

Pro forma income from continuing operations attributable to DaVita Inc.

     357,885         365,774   

Pro forma net income attributable to DaVita Inc.

     355,438         365,962   

Pro forma diluted income from continuing operations per share attributable to DaVita Inc.

     3.68         3.50   

Pro forma diluted net income per share attributable to DaVita Inc.

     3.66         3.51   

 

19


Table of Contents

DAVITA INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (continued)

(unaudited)

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

 

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.

 

20


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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 September 30,     Nine months ended September 30,  
             2011                     2010                     2011                     2010          

Segment revenues:

        

Dialysis and related lab services (1)

        

External sources

   $ 1,672,218      $ 1,549,100      $ 4,758,070      $ 4,514,325   

Intersegment revenues

     2,938        2,182        7,164        6,866   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total dialysis and related lab services

     1,675,156        1,551,282        4,765,234        4,521,191   
  

 

 

   

 

 

   

 

 

   

 

 

 

Other – Ancillary services and strategic initiatives

        

External sources (2)

   $ 135,651      $ 100,458      $ 361,825      $ 276,801   

Intersegment revenues

     1,333        —          4,161       —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Total ancillary services and strategic initiatives

     136,984        100,458        365,986        276,801   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total segment revenues

     1,812,140        1,651,740        5,131,220        4,797,992   

Elimination of intersegment revenues

     (4,271     (2,183     (11,324     (6,866
  

 

 

   

 

 

   

 

 

   

 

 

 

Consolidated revenues

   $ 1,807,869      $ 1,649,557      $ 5,119,896      $ 4,791,126   
  

 

 

   

 

 

   

 

 

   

 

 

 

Segment operating margin (loss): (3)

        

Dialysis and related lab services

   $ 327,698      $ 265,768      $ 860,036      $ 771,084   

Other – Ancillary services and strategic initiatives

     1,728        281        (29,529     (3,258
  

 

 

   

 

 

   

 

 

   

 

 

 

Total segment margin

     329,426        266,049        830,507        767,826   

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

        

Stock-based compensation

     (13,333     (11,093     (36,392     (33,492

Equity investment income

     2,619        1,789        6,555        6,968   
  

 

 

   

 

 

   

 

 

   

 

 

 

Consolidated operating income

     318,712        256,745        800,670        741,302   

Debt expense

     (60,848     (39,490     (179,340     (127,728

Debt redemption charges

     —          —          —          (4,127

Other income

     798        759        2,195        2,328   
  

 

 

   

 

 

   

 

 

   

 

 

 

Consolidated income from continuing operations before income taxes

   $ 258,662      $ 218,014      $ 623,525      $ 611,775   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

(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.

 

21


Table of Contents

DAVITA INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (continued)

(unaudited)

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

 

(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.

Depreciation and amortization expense for the dialysis and related lab services for the three and nine months ended September 30, 2011 was $65,898 and $188,642, respectively, and was $1,660 and $4,999, respectively, for the ancillary services and strategic initiatives.

Depreciation and amortization expense for the dialysis and related lab services for the three and nine months ended September 30, 2010 was $56,698 and $168,904, respectively, and was $1,627 and $4,916, respectively, for the ancillary services and strategic initiatives.

Summary of assets by segment is as follows:

 

     September 30,
2011
     December 31,
2010
 

Segment assets

     

Dialysis and related lab services

   $ 8,450,133       $ 7,862,882   

Other – Ancillary services and strategic initiatives

     226,195         225,624   

Equity investments

     30,340         25,918   
  

 

 

    

 

 

 

Consolidated assets

   $ 8,706,668       $ 8,114,424   
  

 

 

    

 

 

 

For the three and nine months ended September 30, 2011, the total amount of expenditures for property and equipment for the dialysis and related lab services were $108,905 and $268,587, respectively, and were $3,340 and $6,806, respectively, for the ancillary services and strategic initiatives.

For the three and nine months ended September 30, 2010, the total amount of expenditures for property and equipment for the dialysis and related lab services were $67,739 and $168,054, respectively, and were $2,286 and $4,108, respectively, for the ancillary services and strategic initiatives.

As of September 30, 2011, there was $4,725,023 and $44,942 of goodwill associated with the dialysis and related lab services business and the ancillary services and strategic initiatives, respectively.

As of December 31, 2010, there was $4,022,365 and $68,942 of goodwill associated with the dialysis and related lab services business and the ancillary services and strategic initiatives, respectively.

 

22


Table of Contents

DAVITA INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (continued)

(unaudited)

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

 

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

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

 

     Three months ended
September 30,
    Nine months ended
September 30,
 
     2011     2010     2011     2010  

Net income attributable to DaVita Inc.

   $ 135,361      $ 119,387      $ 329,878      $ 336,663   
  

 

 

   

 

 

   

 

 

   

 

 

 

Increase (decrease) in paid-in capital for sales of noncontrolling interests in several joint ventures

     69        (125     238        (301

Decrease in paid-in capital for the purchase of noncontrolling interests in several joint ventures

     (248     —          (6,049     (779
  

 

 

   

 

 

   

 

 

   

 

 

 

Net transfer to noncontrolling interests

     (179     (125     (5,811     (1,080
  

 

 

   

 

 

   

 

 

   

 

 

 

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

   $ 135,182      $ 119,262      $ 324,067      $ 335,583   
  

 

 

   

 

 

   

 

 

   

 

 

 

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 September 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.

 

23


Table of Contents

DAVITA INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (continued)

(unaudited)

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

 

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 and expectations for HCP’s future growth initiatives, as well as its current and recently-opened centers, 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 September 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 September 2011, the Financial Accounting Standards Board (FASB) issued ASU No. 2011-08, Intangibles – Goodwill and Other. This standard amends the current two-step goodwill impairment test required under the existing accounting guidance. This amendment allows entities the option to first assess certain qualitative factors to ascertain whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount to determine if the two-step impairment test is necessary. If an entity concludes that certain events or circumstances prove that it is more likely than not that the fair value of a reporting unit is less than its carrying amount then an entity is required to proceed to step one of the two-step goodwill impairment test. This standard 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 July 2011, the 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 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

 

24


Table of Contents

DAVITA INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (continued)

(unaudited)

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

 

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.

 

25


Table of Contents

DAVITA INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (continued)

(unaudited)

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

 

Condensed Consolidating Statements of Income

 

For the three months ended September 30, 2011

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

Net operating revenues

  $ 116,752      $ 1,468,045      $ 397,364      $ (174,292   $ 1,807,869   

Operating expenses

    83,459        1,280,989        299,001        (174,292     1,489,157   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating income

    33,293        187,056        98,363        —         318,712   

Debt (expense)

    (61,123     (57,129     (598     58,002        (60,848

Other income

    58,073        596        131        (58,002     798   

Income tax expense

    12,303        85,110        (3,209     —         94,204   

Equity earnings in subsidiaries

    117,421        75,400        —          (192,821     —    
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income from continuing operations

    135,361        120,813        101,105        (192,821     164,458   

Discontinued operations net of (loss) gain on disposal of discontinued operations

    —         (3,431     819        —         (2,612
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income

    135,361        117,382        101,924        (192,821     161,846   

Less: Net income attributable to noncontrolling interests

    —         —         —         (26,485     (26,485
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income attributable to DaVita Inc.

  $ 135,361      $ 117,382      $ 101,924      $ (219,306   $ 135,361   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

For the three months ended September 30, 2010

                             

Net operating revenues

  $ 113,670      $ 1,318,723      $ 339,910      $ (122,746   $ 1,649,557   

Operating expenses

    63,400        1,192,045        260,113        (122,746     1,392,812   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating income

    50,270        126,678        79,797        —         256,745   

Debt (expense)

    (39,960     (36,768     (306     37,544        (39,490

Other income

    37,683        462        158        (37,544     759   

Income tax expense

    18,560        54,152        2,326        —         75,038   

Equity earnings in subsidiaries

    89,954        53,487        —         (143,441     —    
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income from continuing operations

    119,387        89,707        77,323        (143,441     142,976   

Discontinued operations

    —          (122     27        —          (95
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income

    119,387        89,585        77,350        (143,441     142,881   

Less: Net income attributable to noncontrolling interests

    —         —         —         (23,494     (23,494
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income attributable to DaVita Inc.

  $ 119,387      $ 89,585      $ 77,350      $ (166,935   $ 119,387   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

For the nine months ended September 30, 2011

                             

Net operating revenues

  $ 335,255      $ 4,195,993      $ 1,082,699      $ (494,051   $ 5,119,896   

Operating expenses

    223,299        3,693,401        896,577        (494,051     4,319,226   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating income

    111,956        502,592        186,122        —         800,670   

Debt (expense)

    (180,428     (168,189     (1,161     170,438        (179,340

Other income

    171,046        1,094        493        (170,438     2,195   

Income tax expense

    41,235        183,418        (619     —         224,034   

Equity earnings in subsidiaries

    268,539        144,377        —         (412,916     —    
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income from continuing operations

    329,878        296,456        186,073        (412,916     399,491   

Discontinued operations net of (loss) gain on disposal of discontinued operations

    —          (3,321     1,093        —          (2,228
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income

    329,878        293,135        187,166        (412,916     397,263   

Less: Net income attributable to noncontrolling interests

    —          —         —         (67,385     (67,385
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income attributable to DaVita Inc.

  $ 329,878      $ 293,135      $ 187,166      $ (480,301   $ 329,878   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

For the nine months ended September 30, 2010

                             

Net operating revenues

  $ 327,095      $ 3,853,970      $ 968,811      $ (358,750   $ 4,791,126   

Operating expenses

    189,677        3,435,087        783,810        (358,750     4,049,824   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating income

    137,418        418,883        185,001        —          741,302   

Debt (expense)

    (132,761     (120,701     (1,023     122,630        (131,855

Other income

    122,823        1,121        1,014        (122,630     2,328   

Income tax expense

    50,355        163,691        6,143        —          220,189   

Equity earnings in subsidiaries

    259,538        122,567        —         (382,105     —    
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income from continuing operations

    336,663        258,179        178,849        (382,105     391,586   

Discontinued operations

    —          140        48        —          188   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income

    336,663        258,319        178,897        (382,105     391,774   

Less: Net income attributable to noncontrolling interests

    —         —         —         (55,111     (55,111
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income attributable to DaVita Inc.

  $ 336,663      $ 258,319      $ 178,897      $ (437,216   $ 336,663   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

26


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 September 30, 2011

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

Cash and cash equivalents

   $ 520,652       $ —         $ 20,554       $ —        $ 541,206   

Accounts receivable, net

     —           927,783         237,227         —          1,165,010   

Other current assets

     8,040         558,907         97,004         —          663,951   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total current assets

     528,692         1,486,690         354,785         —          2,370,167   

Property and equipment, net

     60,980         922,489         352,320         —          1,335,789   

Amortizable intangibles, net

     55,934         91,891         11,964         —          159,789   

Investments in subsidiaries

     6,460,883         761,153         —           (7,222,036     —     

Intercompany receivables

     —           428,434         274,526         (702,960     —     

Other long-term assets and investments

     10,467         58,827         1,664         —          70,958   

Goodwill

     —           4,100,567         669,398         —          4,769,965   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total assets

   $ 7,116,956       $ 7,850,051       $ 1,664,657       $ (7,924,996   $ 8,706,668   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Current liabilities

   $ 179,906       $ 894,531       $ 131,483       $ —        $ 1,205,920   

Intercompany payables

     282,913         —           420,047         (702,960     —     

Long-term debt and other long-term liabilities

     4,371,613         552,023         43,817         —          4,967,453   

Noncontrolling interests subject to put provisions

     283,271         —           —           167,632        450,903   

Total DaVita Inc. shareholders’ equity

     1,999,253         6,403,497         818,539         (7,222,036     1,999,253   

Noncontrolling interest not subject to put provisions

     —           —           250,771         (167,632     83,139   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total equity

     1,999,253         6,403,497         1,069,310         (7,389,668     2,082,392   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total liabilities and equity

   $ 7,116,956       $ 7,850,051       $ 1,664,657       $ (7,924,996   $ 8,706,668   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

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   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

 

27


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 nine months ended September 30, 2011

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

Cash flows from operating activities:

          

Net income

   $ 329,878      $ 293,135      $ 187,166      $ (412,916   $ 397,263   

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

     (116,688     355,867        (19,971     412,916        632,124   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net cash provided by operating activities

     213,190        649,002        167,195        —          1,029,387   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cash flows from investing activities:

          

Additions of property and equipment, net

     (34,061     (147,392     (70,426     —          (251,879

Acquisitions

     —          (927,124     —          —          (927,124

Proceeds from asset sales

     —          51,623        —          —          51,623   

Proceeds from investment sales and other items

     (970     343        (5,000     —          (5,627
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net cash used in investing activities

     (35,031     (1,022,550     (75,426     —          (1,133,007
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cash flows from financing activities:

          

Long-term debt and related financing costs, net

     96,233        13,493        28,048        —          137,774   

Intercompany borrowing

     (316,622     366,570        (49,948     —          —     

Other items

     (293,921     (6,515     (52,629     —          (353,065
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net cash used in financing activities

     (514,310     373,548        (74,529     —          (215,291
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net decrease in cash and cash equivalents

     (336,151     —          17,240        —          (318,911

Cash and cash equivalents at beginning of period

     856,803        —          3,314        —          860,117   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cash and cash equivalents at end of period

   $ 520,652      $ —        $ 20,554      $ —        $ 541,206   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

For the nine months ended September 30, 2010

                              

Cash flows from operating activities:

          

Net income

   $ 336,663      $ 258,319      $ 178,897      $ (382,105   $ 391,774   

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

     (315,151     253,282        7,122        382,105        327,358   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net cash provided by operating activities

     21,512        511,601        186,019        —          719,132   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cash flows from investing activities:

          

Additions of property and equipment, net

     (19,797     (118,754     (30,825     —          (169,376

Acquisitions

     —          (137,643     —          —          (137,643

Proceeds from asset sales

     —          18,471        —          —          18,471   

Proceeds from investment sales and other items

     114        3,121        —          —          3,235   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net cash used in investing activities

     (19,683     (234,805     (30,825     —          (285,313
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cash flows from financing activities:

          

Long-term debt and related financing costs, net

     (270,482     706        (3,774     —          (273,550

Intercompany borrowing

     374,694        (276,205     (98,489     —          —     

Other items

     (107,174     (1,297     (56,692     —          (165,163
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net cash used in financing activities

     (2,962     (276,796     (158,955     —          (438,713
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net decrease in cash and cash equivalents

     (1,133     —          (3,761     —          (4,894

Cash and cash equivalents at beginning of period

     534,550        —          4,909        —          539,459   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cash and cash equivalents at end of period

   $ 533,417      $ —        $ 1,148      $ —        $ 534,565   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

28


Table of Contents

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

Forward-looking statements

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

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

Results of operations

We operate principally as a dialysis and related lab services business 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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The operating results of DSI are included in our operating results effective September 1, 2011. Our consolidated operating results for the third quarter of 2011 compared with the prior sequential quarter and the same quarter of 2010 as well as the nine months ended September 30, 2011 compared to the same periods in 2010 were as follows:

 

    Three months ended     Nine months ended  
    September 30,
2011
    June 30,
2011
    September 30,
2010
    September 30,
2011
    September 30,
2010
 
    (dollar amounts rounded to nearest million)  

Net operating revenues

  $ 1,808        100   $ 1,709        100   $ 1,650        100   $ 5,120        100   $ 4,791        100
 

 

 

     

 

 

     

 

 

     

 

 

     

 

 

   

Operating expenses and charges:

                   

Patient care costs

    1,190        66     1,163        68     1,144        69     3,467        68     3,334        70

General and administrative

    183        10     164        10     148        9     498        10     421        9

Depreciation and amortization

    68        4     64        4     58        4     194        4     174        4

Provision for uncollectible accounts

    52        3     49        3     44        3     143        3     127        3

Goodwill impairment charge

    —          —          24        1     —          —          24        —          —          —     

Equity investment income

    (3     —          (2     —          (2     —          (7     —          (7     —     
 

 

 

     

 

 

     

 

 

     

 

 

     

 

 

   

Total operating expenses and charges

    1, 489        82     1, 462        86     1,393        84     4,319        84     4,050        85
 

 

 

     

 

 

     

 

 

     

 

 

     

 

 

   

Operating income

  $ 319        18   $ 247        14   $ 257        16   $ 801        16   $ 741        15
 

 

 

     

 

 

     

 

 

     

 

 

     

 

 

   

The following table summarizes consolidated net operating revenues:

 

    Three months ended     Nine months ended  
    September 30,
2011
    June 30,
2011
    September 30,
2010
    September 30,
2011
    September 30,
2010
 
    (dollar amounts rounded to nearest million)  

Dialysis and related lab services

  $ 1,675      $ 1,588      $ 1,551      $ 4,765      $ 4,521   

Other – Ancillary services and strategic initiatives

    137        123        101        366        277   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total segment revenues

    1,812        1,711        1,652        5,131        4,798   

Elimination of intersegment revenues

    (4     (3     (2     (11     (7
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Consolidated net operating revenues

  $ 1,808      $ 1,709      $ 1,650      $ 5,120      $ 4,791   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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The following table summarizes consolidated operating income:

 

    Three months ended     Nine months ended  
    September 30,
2011
    June 30,
2011
    September 30,
2010
    September 30,
2011
    September 30,
2010
 
    (dollar amounts rounded to nearest million)  

Dialysis and related lab services

  $ 328      $ 282      $ 266      $ 860      $ 771   

Other – Ancillary services and strategic initiatives

    2        (25     —          (30     (3
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total segment operating income

    330        257        266        830        768   

Reconciling items:

         

Stock-based compensation

    (13     (13     (11     (36     (33

Equity investment income

    2        2        2        7        7   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Consolidated operating income

    319        247        257        801        741   

Reconciliation of non-GAAP measure:

         

Add: Goodwill impairment charge

    —          24        —          24        —     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Non-GAAP consolidated operating income (1)

  $ 319      $ 271      $ 257      $ 825      $ 741   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) 

For the three months ended June 30, 2011 and the nine months ended September 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 third quarter of 2011 increased by approximately $99 million, or approximately 5.8%, as compared to the second 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 $87 million, principally due to an increase in the number of treatments as a result of one additional treatment day in the third quarter of 2011 and as a result of additional treatments from non-acquired growth and acquisitions including the acquisition of DSI. Consolidated net operating revenues also increased due to an increase of approximately $2 in the average dialysis revenue per treatment, as described below.

Consolidated net operating revenues for the third quarter of 2011 increased by approximately $158 million, or approximately 9.6%, as compared to the third 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 $124 million, principally due to strong volume growth from additional treatments from non-acquired treatment growth in existing and new centers and growth through acquisitions, including the acquisition of DSI. However, the increase in the dialysis and related lab services net revenues was partially offset by a decrease of approximately $5 in the average dialysis revenue per treatment, as described below. The increase in consolidated net revenues was also due to an increase of approximately $36 million in the ancillary services and strategic initiatives net revenues primarily from growth in our pharmacy services.

Consolidated net operating revenues for the nine months ended September 30, 2011 increased by approximately $329 million, or approximately 6.9%, 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 $244 million, principally due to strong volume growth from additional treatments as a

 

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result of non-acquired treatment growth in existing and new centers and growth through acquisitions, including the acquisition of DSI. However, the increase in the dialysis and related lab services net revenues was partially offset by a decrease of approximately $8 in the average dialysis revenue per treatment and as a result of the same factors as described for the third quarter of 2011 as compared to the same quarter of 2010 as described below. The increase in consolidated net revenues was also due to an increase of approximately $89 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 third quarter of 2011 increased by approximately $72 million, or approximately 29.1%, as compared to the second quarter of 2011, which includes the $24 million HCP goodwill impairment charge. Excluding this item, consolidated operating income would have increased by approximately $48 million, 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 third quarter of 2011 and an increase of approximately $2 in the average dialysis revenue per treatment as discussed below. Consolidated operating income also benefited from lower pharmaceutical costs including a decline in the intensities of physician-prescribed pharmaceuticals, the acquisition of DSI and the timing of certain other operating expenditures, but was negatively impacted by higher labor and benefit costs, an increase in professional fees for compliance and legal initiatives and for information technology matters as well as transaction costs associated with the acquisition of DSI.

Consolidated operating income for the third quarter of 2011 increased by approximately $62 million, or approximately 24.1%, as compared to the third 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 through acquisitions, partially offset by a decline in the average dialysis revenue per treatment of approximately $5, as described below. Consolidated operating income also benefitted from lower pharmaceutical costs including a decline in the intensities of physician-prescribed pharmaceuticals, the acquisition of DSI and cost control initiatives, but was negatively impacted by higher labor and related payroll costs, additional benefit costs, higher information technology expenditures, an increase in professional fees for compliance and legal initiatives and transaction costs associated with the acquisition of DSI.

Consolidated operating income for the nine months ended September 30, 2011 increased by approximately $60 million, or approximately 8.1%, as compared to the same period in 2010 which includes the $24 million HCP goodwill impairment charge recorded in the second quarter of 2011. Excluding this item consolidated operating income would have increased by approximately $84 million, 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 $8, as described below. Consolidated operating income was also impacted by the same additional factors as discussed for the third quarter of 2011, as compared to the third quarter of 2010.

Operating segments

Dialysis and related lab services

 

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

Revenues

  $ 1,675      $ 1,588      $ 1,551      $ 4,765      $ 4,521   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Segment operating income

  $ 328      $ 282      $ 266      $ 860      $ 771   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Dialysis treatments

    5,008,094        4,769,661        4,571,219        14,372,305        13,314,251   

Average dialysis treatments per treatment day

    63,394        61,150        57,864        61,420        56,899   

Average dialysis revenue per treatment (including lab services)

  $ 334      $ 332      $ 339      $ 331      $ 339   

 

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Net operating revenues

Dialysis and related lab services’ net operating revenues for the third quarter of 2011 increased by approximately $87 million, or approximately 5.5%, as compared to the second 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 third quarter of 2011 and from non-acquired treatment growth in existing and new centers and from growth through acquisitions, totaling approximately 5.0%, which includes additional treatments associated with the acquisition of DSI. The increase was also due to an increase in our average dialysis revenue per treatment of approximately $2, or approximately 0.5%. The increase in the average dialysis revenue per treatment was primarily due to an increase in some of our commercial payment rates, partially offset by a decline in the intensities of physician-prescribed pharmaceuticals and a slight decline in the commercial payor mix.

Dialysis and related lab services’ net operating revenues increased by approximately $124 million, or 8.0%, in the third quarter of 2011, as compared to the third quarter of 2010. The increase in net operating revenues in the third quarter of 2011 was principally due to an increase in the number of treatments of approximately 9.6%, which includes additional treatments associated with the acquisition of DSI, partially offset by a decrease in the average dialysis revenue per treatment of approximately $5, or approximately 1.5%. 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 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 $244 million, or 5.4%, for the nine months ended September 30, 2011, as compared to the same period in 2010. The increase in net operating revenues in the first nine months of 2011 was principally due to an increase in the number of treatments of approximately 7.9%, which includes additional treatments associated with the acquisition of DSI, partially offset by a decrease in the average dialysis revenue per treatment of approximately $8, or approximately 2.4%. 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 third quarter of 2011 as compared to the third 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 third quarter of 2011 decreased $7 per treatment compared to the second quarter of 2011. Patient care costs benefited from lower intensities of physician-prescribed pharmaceuticals and the timing of certain other operating expenditures, partially offset by higher benefit costs.

Dialysis and related lab services’ patient care costs on a per treatment basis decreased by approximately $17 in the third quarter of 2011 as compared to the third quarter of 2010. The decrease in the per treatment costs was primarily attributable to lower pharmaceutical costs including a decline in the intensities of physician-prescribed pharmaceuticals and the timing of certain other operating expenditures, partially offset by an increase in labor and related payroll costs and additional benefit costs.

Dialysis and related lab services’ patient care costs on a per treatment basis decreased by approximately $13 for the nine months ended September 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 third quarter of 2011 as compared to the third quarter of 2010.

General and administrative expenses. Dialysis and related lab services’ general and administrative expenses of approximately $151 million for the third quarter of 2011 increased by approximately $18 million as compared

 

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to the third quarter of 2010. The increase was primarily due to higher labor and benefit costs and an increase in professional fees in conjunction with compliance and legal initiatives and for information technology matters, as well as transaction costs associated with the acquisition of DSI.