Form 10-Q
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

For the Quarterly Period Ended March 31, 2013

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission File Number: 1-14106

 

 

DAVITA HEALTHCARE PARTNERS INC.

 

 

2000 16th 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 April 30, 2013, the number of shares of the Registrant’s common stock outstanding was approximately 105.8 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 $12.5 billion.

 

 

 


Table of Contents

DAVITA HEALTHCARE PARTNERS INC.

INDEX

 

         Page No.  
    PART I. FINANCIAL INFORMATION       
Item 1.   Condensed Consolidated Financial Statements:   
  Consolidated Statements of Income for the three months ended March 31, 2013 and March 31, 2012      1   
  Consolidated Statements of Comprehensive Income for the three months ended March 31, 2013 and March 31, 2012      2   
  Consolidated Balance Sheets as of March 31, 2013 and December 31, 2012      3   
  Consolidated Statements of Cash Flows for the three months ended March 31, 2013 and March 31, 2012      4   
  Consolidated Statements of Equity for the three months ended March 31, 2013 and for the year ended December 31, 2012      5   
  Notes to Condensed Consolidated Financial Statements      6   
Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations      33   
Item 3.   Quantitative and Qualitative Disclosures about Market Risk      51   
Item 4.   Controls and Procedures      53   
  PART II. OTHER INFORMATION   
Item 1.   Legal Proceedings      54   
Item 1A.   Risk Factors      54   
Item 2.   Unregistered Sales of Equity Securities and Use of Proceeds      86   
Item 6.   Exhibits      87   
  Signature      88   

 

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

 

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Table of Contents

DAVITA HEALTHCARE PARTNERS INC.

CONSOLIDATED STATEMENTS OF INCOME

(unaudited)

(dollars in thousands, except per share data)

 

     Three months ended
March 31,
 
     2013     2012  

Patient service revenues

   $ 1,979,873      $ 1,765,482   

Less: Provision for uncollectible accounts

     (70,057     (53,008
  

 

 

   

 

 

 

Net patient service revenues

     1,909,816        1,712,474   

HCP capitated revenues

     746,071        —     

Other revenues

     173,695        137,059   
  

 

 

   

 

 

 

Total net revenues

     2,829,582        1,849,533   
  

 

 

   

 

 

 

Operating expenses and charges:

    

Patient care costs

     1,953,929        1,249,395   

General and administrative

     291,372        205,401   

Depreciation and amortization

     125,909        75,381   

Provision for uncollectible accounts

     878        1,106   

Equity investment income

     (9,367     (2,632

Loss contingency reserve

     300,000        —     
  

 

 

   

 

 

 

Total operating expenses and charges

     2,662,721        1,528,651   
  

 

 

   

 

 

 

Operating income

     166,861        320,882   

Debt expense

     (105,817     (61,381

Other income

     598        1,039   
  

 

 

   

 

 

 

Income from continuing operations before income taxes

     61,642        260,540   

Income tax expense

     15,144        95,556   
  

 

 

   

 

 

 

Income from continuing operations

     46,498        164,984   

Discontinued operations:

    

Loss from operations of discontinued operations, net of tax

     (139     (101

Gain on disposal of discontinued operations, net of tax

     13,375        —     
  

 

 

   

 

 

 

Net income

     59,734        164,883   

Less: Net income attributable to noncontrolling interests

     (29,570     (24,763
  

 

 

   

 

 

 

Net income attributable to DaVita HealthCare Partners Inc.

   $ 30,164      $ 140,120   
  

 

 

   

 

 

 

Earnings per share:

    

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

   $ 0.16      $ 1.50   
  

 

 

   

 

 

 

Basic net income per share attributable to DaVita HealthCare Partners Inc.

   $ 0.29      $ 1.49   
  

 

 

   

 

 

 

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

   $ 0.16      $ 1.46   
  

 

 

   

 

 

 

Diluted net income per share attributable to DaVita HealthCare Partners Inc.

   $ 0.28      $ 1.46   
  

 

 

   

 

 

 

Weighted average shares for earnings per share:

    

Basic

     104,484,476        93,769,092   
  

 

 

   

 

 

 

Diluted

     107,063,633        95,729,105   
  

 

 

   

 

 

 

Amounts attributable to DaVita HealthCare Partners Inc.:

    

Income from continuing operations

   $ 16,915      $ 140,220   

Discontinued operations

     13,249        (100
  

 

 

   

 

 

 

Net income

   $ 30,164      $ 140,120   
  

 

 

   

 

 

 

See notes to condensed consolidated financial statements.

 

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Table of Contents

DAVITA HEALTHCARE PARTNERS INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(unaudited)

(dollars in thousands, except per share data)

 

     Three months ended
March 31,
 
     2013     2012  

Net income

   $ 59,734      $ 164,883   
  

 

 

   

 

 

 

Other comprehensive (loss) income, net of tax:

    

Unrealized losses on interest rate swap and cap agreements:

    

Unrealized losses on interest rate swap and cap agreements

     (2,369     (2,261

Less: Reclassifications of net swap and cap agreements realized losses into net income

     2,507        2,520   

Unrealized gains on investments:

    

Unrealized gains on investments

     618        1,146   

Less: Reclassification of net investment realized gains into net income

     (94     (75

Foreign currency translation adjustments

     (2,106     (619
  

 

 

   

 

 

 

Other comprehensive (loss) income

     (1,444     711   
  

 

 

   

 

 

 

Total comprehensive income

     58,290        165,594   

Less: Comprehensive income attributable to the noncontrolling interests

     (29,570     (24,763
  

 

 

   

 

 

 

Comprehensive income attributable to DaVita HealthCare Partners Inc.

   $ 28,720      $ 140,831   
  

 

 

   

 

 

 

See notes to condensed consolidated financial statements.

 

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Table of Contents

DAVITA HEALTHCARE PARTNERS INC.

CONSOLIDATED BALANCE SHEETS

(unaudited)

(dollars in thousands, except per share data)

 

     March 31,
2013
    December 31,
2012
 

ASSETS

    

Cash and cash equivalents

   $ 699,671      $ 533,748   

Short-term investments

     7,142        7,138   

Accounts receivable, less allowance of $239,669 and $245,122

     1,516,642        1,424,303   

Inventories

     76,582        78,126   

Other receivables

     298,871        265,671   

Other current assets

     150,432        201,572   

Income tax receivable

     —         55,454   

Deferred income taxes

     441,828        315,782   
  

 

 

   

 

 

 

Total current assets

     3,191,168        2,881,794   

Property and equipment, net of accumulated depreciation of $1,546,266 and $1,522,183

     1,915,453        1,872,370   

Intangibles, net of accumulated amortization of $349,332 and $304,323

     2,104,044        2,128,118   

Equity investments

     37,520        35,150   

Long-term investments

     63,451        59,341   

Other long-term assets

     86,806        79,854   

Goodwill

     9,015,035        8,947,736   
  

 

 

   

 

 

 
   $ 16,413,477      $ 16,004,363   
  

 

 

   

 

 

 

LIABILITIES AND EQUITY

    

Accounts payable

   $ 330,247      $ 414,143   

Other liabilities

     565,262        563,365   

Accrued compensation and benefits

     565,206        566,911   

Medical payables

     298,322        238,964   

Loss contingency reserve

     300,000        —    

Current portion of long-term debt

     228,219        227,791   

Income tax payable

     37,983        —    
  

 

 

   

 

 

 

Total current liabilities

     2,325,239        2,011,174   

Long-term debt

     8,277,259        8,326,534   

Other long-term liabilities

     497,708        443,743   

Alliance and product supply agreement, net

     13,325        14,657   

Deferred income taxes

     737,521        710,638   
  

 

 

   

 

 

 

Total liabilities

     11,851,052        11,506,746   

Commitments and contingencies

    

Noncontrolling interests subject to put provisions

     605,894        580,692   

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; 105,702,448 and 105,498,575 shares outstanding)

     135        135   

Additional paid-in capital

     1,208,315        1,208,800   

Retained earnings

     3,761,999        3,731,835   

Treasury stock, at cost (29,159,835 and 29,363,708 shares)

     (1,154,266     (1,162,336

Accumulated other comprehensive loss

     (16,741     (15,297
  

 

 

   

 

 

 

Total DaVita HealthCare Partners Inc. shareholders’ equity

     3,799,442        3,763,137   

Noncontrolling interests not subject to put provisions

     157,089        153,788   
  

 

 

   

 

 

 

Total equity

     3,956,531        3,916,925   
  

 

 

   

 

 

 
   $ 16,413,477      $ 16,004,363   
  

 

 

   

 

 

 

See notes to condensed consolidated financial statements.

 

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Table of Contents

DAVITA HEALTHCARE PARTNERS INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)

(dollars in thousands)

 

     Three months ended
March 31,
 
     2013     2012  

Cash flows from operating activities:

    

Net income

   $ 59,734      $ 164,883   

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

    

Loss contingency reserve

     300,000        —     

Depreciation and amortization

     125,756        75,975   

Stock-based compensation expense

     16,021        12,550   

Tax benefits from stock award exercises

     9,368        10,890   

Excess tax benefits from stock award exercises

     (6,957     (6,101

Deferred income taxes

     (111,331     (13,335

Equity investment income, net

     (2,486     483   

Other non-cash charges and (gain) loss on disposal of assets

     (11,396     7,125   

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

    

Accounts receivable

     (92,339     (71,706

Inventories

     2,162        4,851   

Other receivables and other current assets

     (32,281     56,452   

Other long-term assets

     (9,865     3,742   

Accounts payable

     (83,896     (20,624

Accrued compensation and benefits

     (3,790     41,623   

Other current liabilities

     79,277        17,462   

Income taxes

     93,401        43,072   

Other long-term liabilities

     47,829        4,532   
  

 

 

   

 

 

 

Net cash provided by operating activities

     379,207        331,874   
  

 

 

   

 

 

 

Cash flows from investing activities:

    

Additions of property and equipment, net

     (116,724     (112,459

Acquisitions

     (91,498     (132,699

Proceeds from asset and business sales

     62,357        825   

Purchase of investments available for sale

     (1,212     (489

Purchase of investments held-to-maturity

     (4     (3,212

Proceeds from sale of investments available for sale

     1,091        6,791   

Proceeds from maturities of investments held-to-maturity

     —          7,551   

Purchase of intangible assets

     (137     —     

Distributions received on equity investments

     116        2   
  

 

 

   

 

 

 

Net cash used in investing activities

     (146,011     (233,690
  

 

 

   

 

 

 

Cash flows from financing activities:

    

Borrowings

     16,797,510        8,634,603   

Payments on long-term debt

     (16,860,949     (8,658,001

Interest rate cap premiums and other deferred financing costs

     (248     3   

Distributions to noncontrolling interests

     (34,926     (26,405

Stock award exercises and other share issuances, net

     5,833        1,663   

Excess tax benefits from stock award exercises

     6,957        6,101   

Contributions from noncontrolling interests

     14,257        3,651   

Proceeds from sales of additional noncontrolling interests

     4,174        100   

Purchases from noncontrolling interests

     —          (4,372
  

 

 

   

 

 

 

Net cash used in financing activities

     (67,392     (42,657

Effect of exchange rate changes on cash and cash equivalents

     119        11  
  

 

 

   

 

 

 

Net increase in cash and cash equivalents

     165,923        55,538   

Cash and cash equivalents at beginning of period

     533,748        393,752   
  

 

 

   

 

 

 

Cash and cash equivalents at end of period

   $ 699,671      $ 449,290   
  

 

 

   

 

 

 

See notes to condensed consolidated financial statements.

 

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DAVITA HEALTHCARE PARTNERS INC.

CONSOLIDATED STATEMENTS OF EQUITY

(unaudited)

(dollars and shares in thousands)

 

    Non-
controlling
interests
subject to
put
provisions
    DaVita HealthCare Partners Inc. Shareholders’ Equity     Non-
controlling
interests
not
subject to
put
provisions
 
      Common stock     Additional
paid-in
capital
    Retained
earnings
    Treasury stock     Accumulated
other
comprehensive
income (loss)
    Total    

Balance at December 31, 2011

  $ 478,216        134,862      $ 135      $ 596,300      $ 3,195,818        (41,221   $ (1,631,694   $ (19,484   $ 2,141,075      $ 127,050   

Comprehensive income:

                   

Net income

    66,456              536,017              536,017        38,764   

Other comprehensive income

                  4,187        4,187     

Stock purchase shares issued

          4,311          101        4,011          8,322     

Stock unit shares issued

          (8,303       210        8,303         

Stock options and SSARs exercised

          (83,558       2,166        85,733          2,175     

Stock-based compensation expense

          45,384                45,384     

Excess tax benefits from stock awards exercised

          62,036                62,036     

Issuance of common stock associated with the HCP acquisition

          684,161          9,380        371,311          1,055,472     

Assumption of noncontrolling interests associated with the HCP acquisition

                      29,850   

Distributions to noncontrolling interests

    (70,133                     (43,371

Contributions from noncontrolling interests

    26,371                        11,024   

Sales and assumptions of additional noncontrolling interests

    20,124            1,064                1,064        2,432   

Purchases from noncontrolling interests

    (5,229         (20,694             (20,694     (838

Changes in fair value of noncontrolling interests

    71,901            (71,901             (71,901  

Held for sale reclassification

    (7,014                  

Purchase accounting adjustments

                      (11,123
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at December 31, 2012

  $ 580,692        134,862      $ 135      $ 1,208,800      $ 3,731,835        (29,364   $ (1,162,336   $ (15,297   $ 3,763,137      $ 153,788   

Comprehensive income:

                   

Net income

    18,643              30,164              30,164        10,927   

Other comprehensive income

                  (1,444     (1,444  

Stock unit shares issued

          (1,085       27        1,085         

Stock-settled SARs exercised

          (6,985       177        6,985         

Stock-based compensation expense

          16,021                16,021     

Excess tax benefits from stock awards exercised

          6,957                6,957     

Distributions to noncontrolling interests

    (19,822                     (15,104

Contributions from noncontrolling interests

    8,281                        5,976   

Sales and assumptions of additional noncontrolling interests

    4,030            (809             (809     988   

Expiration of put option

    (889         375                375        514   

Changes in fair value of noncontrolling interests

    14,959            (14,959             (14,959  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at March 31, 2013

  $ 605,894        134,862      $ 135      $ 1,208,315      $ 3,761,999        (29,160   $ (1,154,266   $ (16,741   $ 3,799,442      $ 157,089   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

See notes to condensed consolidated financial statements.

 

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Table of Contents

DAVITA HEALTHCARE PARTNERS 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 HealthCare Partners 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 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 the accrual of an estimated loss contingency reserve and its impact on the Company’s income taxes, revenue recognition and accounts receivable, impairments of long-lived assets, fair value estimates, accounting for income taxes, variable compensation accruals, consolidation of variable interest entities, purchase accounting valuation estimates, stock-based compensation and medical liability claims. The results of operations for the three months ended March 31, 2013 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, 2012. Prior year balances and amounts have been reclassified to conform to the current year presentation and retrospectively revised to reflect purchase accounting entries. 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 the Company, net of any (increase) decrease in noncontrolling interests 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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DAVITA HEALTHCARE PARTNERS 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
March 31,
 
     2013     2012  

Basic:

    

Income from continuing operations attributable to DaVita HealthCare Partners Inc.

   $ 16,915      $ 140,220   

Discontinued operations attributable to DaVita HealthCare Partners Inc.

     13,249        (100
  

 

 

   

 

 

 

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

   $ 30,164      $ 140,120   
  

 

 

   

 

 

 

Weighted average shares outstanding during the period

     105,578        93,766   

Vested stock units

     3        3   

Contingently returnable shares held in escrow for the DaVita HealthCare Partners merger

     (1,097     —     
  

 

 

   

 

 

 

Weighted average shares for basic earnings per share calculation

     104,484        93,769   
  

 

 

   

 

 

 

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

   $ 0.16      $ 1.50   
  

 

 

   

 

 

 

Basic income from discontinued operations per share attributable to DaVita HealthCare Partners Inc.

   $ 0.13      $ (0.01
  

 

 

   

 

 

 

Basic net income per share attributable to DaVita HealthCare Partners Inc.

   $ 0.29      $ 1.49   
  

 

 

   

 

 

 

Diluted:

    

Income from continuing operations attributable to DaVita HealthCare Partners Inc.

   $ 16,915      $ 140,220   

Discontinued operations attributable to DaVita HealthCare Partners Inc.

     13,249        (100
  

 

 

   

 

 

 

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

   $ 30,164      $ 140,120   
  

 

 

   

 

 

 

Weighted average shares outstanding during the period

     105,578        93,766   

Vested stock units

     3        3   

Assumed incremental shares from stock plans

     1,483        1,960   
  

 

 

   

 

 

 

Weighted average shares for diluted earnings per share calculation

     107,064        95,729   
  

 

 

   

 

 

 

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

   $ 0.16      $ 1.46   
  

 

 

   

 

 

 

Diluted income from discontinued operations per share attributable to DaVita HealthCare Partners Inc.

   $ 0.12      $ —     
  

 

 

   

 

 

 

Diluted net income per share attributable to DaVita HealthCare Partners Inc.

   $ 0.28      $ 1.46   
  

 

 

   

 

 

 

Anti-dilutive stock-settled awards excluded from calculation (1)

     1,093        2,309   
  

 

 

   

 

 

 

 

(1) 

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

 

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DAVITA HEALTHCARE PARTNERS 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

The Company’s stock-based compensation awards are measured at their estimated fair values on the date of grant if settled in shares, or at their estimated fair values at the end of each reporting period if settled in cash. The value of stock-based awards so measured is recognized as compensation expense on a cumulative straight-line basis over the vesting terms of the awards, adjusted for expected forfeitures.

During the three months ended March 31, 2013, the Company granted 1,330 stock-settled stock appreciation rights with an aggregate grant-date fair value of $36,024 and a weighted-average expected life of approximately 4.3 years, and also granted 10 stock units with an aggregate grant-date fair value of $1,163 and a weighted-average expected life of approximately 2.7 years.

For the three months ended March 31, 2013 and 2012, the Company recognized $16,021 and $12,550, 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 March 31, 2013 and 2012 was $6,088 and $4,723, respectively. As of March 31, 2013, there was $123,372 of total estimated unrecognized compensation cost related to unvested 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.

The Company did not receive any cash proceeds from stock option exercises for the first quarter of 2013. During the three months ended March 31, 2012, the Company received $1,391 in cash proceeds from stock option exercises. In addition, for the three months ended March 31, 2013 and 2012 the Company received $9,368 and $10,890, respectively, in actual tax benefits upon the exercise of stock awards.

4. Accounts receivable

Accounts receivable are reduced by an allowance for doubtful accounts. In evaluating the ultimate collectability of the Company’s accounts receivable, the Company analyzes its historical cash collection experience and trends for each of its government payors and commercial payors to estimate the adequacy of the allowance for doubtful accounts and the amount of the provision for uncollectible accounts. Management regularly updates its analysis based upon the most recent information available to determine its current provision for uncollectible accounts and the adequacy of its allowance for doubtful accounts. For receivables associated with dialysis patient services covered by government payors, primarily Medicare, the Company receives 80% of the payment directly from Medicare as established under the governments bundled payment system and determines an appropriate allowance for doubtful accounts and provision for uncollectible accounts on the remaining balance due depending upon the Company’s estimate of the amounts ultimately collectible from other secondary coverage sources or from the patients. For receivables associated with services to patients covered by commercial payors that are either based upon contractual terms or for non-contracted health plan coverage, the Company provides an allowance for doubtful accounts by recording a provision for uncollectible accounts based upon its historical collection experience, potential inefficiencies in its billing processes and for which collectability is determined to be unlikely. Approximately 3% of the Company’s net accounts receivable are associated with patient pay and it is the Company’s policy with respect to its dialysis operations to reserve 100% of these outstanding accounts receivable balances when the amounts due are outstanding for more than four months.

 

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DAVITA HEALTHCARE PARTNERS INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(continued)

(unaudited)

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

 

During the three months ended March 31, 2013, the Company’s allowance for doubtful accounts decreased by approximately $5,453. This was primarily due to continued higher non-covered Medicare write-offs during the period in the Company’s U.S. dialysis business. There were no unusual transactions impacting the allowance for doubtful accounts.

5. Goodwill

Changes in the value of goodwill by reportable segments were as follows:

 

     Three months ended March 31, 2013  
     U.S. dialysis and
related lab services
    HCP      Other-ancillary
services and
strategic initiatives
    Consolidated total  

Balance at January 1, 2013

   $ 5,309,152      $ 3,501,557       $ 137,027      $ 8,947,736   

Acquisitions

     56,338        9,511         4,022        69,871   

Divestitures

     (1,234     —           —          (1,234

Other adjustments

     12        163         (1,513     (1,338
  

 

 

   

 

 

    

 

 

   

 

 

 

Balance at March 31, 2013

   $ 5,364,268      $ 3,511,231       $ 139,536      $ 9,015,035   
  

 

 

   

 

 

    

 

 

   

 

 

 

 

     Year ended December 31, 2012  
     U.S. dialysis and
related lab services
    HCP     Other-ancillary
services and
strategic initiatives
    Consolidated total  

Balance at January 1, 2012

   $ 4,865,864      $ —        $ 81,112      $ 4,946,976   

Acquisitions

     443,997        3,518,790        88,611        4,051,398   

Divestitures

     (709     —          —          (709

Held for sale

     —          —          (31,853     (31,853

Other adjustments

     —          —          (843     (843
  

 

 

   

 

 

   

 

 

   

 

 

 

Balance at December 31, 2012 as previously reported

   $ 5,309,152      $ 3,518,790      $ 137,027      $ 8,964,969   

HCP purchase accounting adjustments

     —          (17,233     —          (17,233
  

 

 

   

 

 

   

 

 

   

 

 

 

Balance at December 31, 2012 as adjusted

   $ 5,309,152      $ 3,501,557      $ 137,027      $ 8,947,736   
  

 

 

   

 

 

   

 

 

   

 

 

 

Each of the Company’s operating segments described in Note 13 to these condensed consolidated financial statements represents an individual reporting unit for goodwill impairment testing purposes, except that HCP is comprised of four reporting units, our direct primary care segment is comprised of two reporting units and each sovereign jurisdiction within our international operations segment is considered a separate reporting unit.

Within the U.S. dialysis and related lab services operating segment, the Company considers each of its dialysis centers to constitute an individual business for which discrete financial information is available. However, since these dialysis centers have similar operating and economic characteristics, and since resource allocation and significant investment decisions concerning these businesses are highly centralized and the benefits broadly distributed, the Company has aggregated these centers and deemed them to constitute a single reporting unit.

 

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DAVITA HEALTHCARE PARTNERS INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(continued)

(unaudited)

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

 

The Company has applied a similar aggregation to the HCP practice management operations in each region, to the vascular access service centers in its vascular access services reporting unit, and to the physician practices in its physician services reporting unit. For the Company’s additional operating segments, no component below the level of the operating segment is considered a discrete business and therefore these operating segments directly constitute individual reporting units.

During the first quarter of 2013, the Company did not record any goodwill impairment charges and, as of March 31, 2013, none of the goodwill associated with the Company’s various reporting units was considered at risk of impairment. Since the date of the Company’s last annual goodwill impairment test, there have been no material developments, events, changes in operating performance or other changes in circumstances that would cause management to believe it is more likely than not that the fair value of any of its reporting units would be less than its carrying amount.

6. Long-term debt

Long-term debt was comprised of the following:

 

     March 31,
2013
    December 31,
2012
 

Senior Secured Credit Facilities:

    

Term Loan A

   $ 875,000      $ 900,000   

Term Loan A-3

     1,333,125        1,350,000   

Term Loan B

     1,710,625        1,715,000   

Term Loan B-2

     1,645,875        1,650,000   

Senior notes

     2,800,000        2,800,000   

Acquisition obligations and other notes payable

     52,206        64,276   

Capital lease obligations

     109,221        96,594   
  

 

 

   

 

 

 

Total debt principal outstanding

     8,526,052        8,575,870   

Discount on long-term debt

     (20,574     (21,545
  

 

 

   

 

 

 
     8,505,478        8,554,325   

Less current portion

     (228,219     (227,791
  

 

 

   

 

 

 
   $ 8,277,259      $ 8,326,534   
  

 

 

   

 

 

 

Scheduled maturities of long-term debt at March 31, 2013 were as follows:

 

2013

     162,723   

2014

     264,212   

2015

     842,548   

2016

     1,892,176   

2017

     908,853   

2018

     801,824   

Thereafter

     3,653,716   

During the first three months of 2013, the Company made mandatory principal payments under its Senior Secured Credit Facilities totaling $25,000 on the Term Loan A, $16,875 on the Term Loan A-3, $4,375 on the Term Loan B and $4,125 on the Term Loan B-2.

 

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DAVITA HEALTHCARE PARTNERS INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(continued)

(unaudited)

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

 

The Company has 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 interest rate risk management strategy. These agreements are not held for trading or speculative purposes and have the economic effect of converting the LIBOR variable component of the Company’s interest rate to a fixed rate. These swap agreements are designated as cash flow hedges, and as a result, hedge-effective gains or losses resulting from changes in the fair values of these swaps are reported in other comprehensive income until such time as each specific swap tranche is realized, at which time the amounts are reclassified into net income. Net amounts paid or received for each specific swap tranche that have settled have been reflected as adjustments to debt expense. In addition, the Company has 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 and Term Loan B-2 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 of the cap agreements. The swap and cap agreements do not contain credit-risk contingent features.

In March 2013, the Company entered into several new interest rate swap agreements. As of March 31, 2013, the amortizing notional amounts of these swap agreements totaled $1,333,125. These agreements have 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-3 to fixed rates ranging from 0.49% to 0.52%, resulting in an overall weighted average effective interest rate of 3.01%, including the Term Loan A-3 margin of 2.50%. The swap agreements expire by September 30, 2016 and require monthly interest payments. During the three months ended March 31, 2013 the Company accrued net charges of $45 from these swaps which are included in debt expense. As of March 31, 2013, the total fair value of these swap agreements was a liability of $384. The Company estimates that approximately $2,734 of existing unrealized pre-tax losses in other comprehensive income at March 31, 2013 will be reclassified into income in 2013.

In addition, in March 2013, the Company entered into several interest rate forward swap agreements with amortizing notional amounts totaling $600,000. These forward swap agreements will be effective September 30, 2014 and will have the economic effect of modifying the LIBOR variable component of the Company’s interest rate on an equivalent amount of the Company’s outstanding debt to fixed rates ranging from 0.72% to 0.75%. These swap agreements expire on September 30, 2016 and will require quarterly interest payments beginning in October 2014. Any unrealized gains or losses resulting from changes in the fair value of these swaps will be recorded in other comprehensive income. As of March 31, 2013, the total fair value of these swap agreements was a liability of $344.

During March 2013, the Company entered into several interest rate cap agreements with notional amounts totaling $1,250,000 on the Company’s Term Loan B debt and $1,485,000 on the Company’s Term Loan B-2 debt. These agreements have the economic effect of capping the LIBOR variable component of the Company’s interest rate at a maximum of 2.50% on an equivalent amount of the Company’s Term Loan B and Term Loan B-2 debt. The cap agreements expire on September 30, 2016. As of March 31, 2013, the total fair value of these cap agreements was an asset of $5,626. During the three months ended March 31, 2013, the Company recorded a loss of $2,910 in other comprehensive income due to a decrease in the unrealized fair value of these cap agreements.

As of March 31, 2013, the Company also maintains a total of nine other interest rate swap agreements with amortizing notional amounts totaling $875,000. These agreements had the economic effect of modifying the

 

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DAVITA HEALTHCARE PARTNERS INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(continued)

(unaudited)

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

 

LIBOR variable component of the Company’s interest rate on an equivalent amount of our Term Loan A to fixed rates ranging from 1.59% to 1.64%, resulting in an overall weighted average effective interest rate of 4.11%, including the Term Loan A margin of 2.50%. The swap agreements expire by September 30, 2014 and require monthly interest payments. During the three months ended March 31, 2013, the Company accrued net charges of $3,162 from these swaps which are included in debt expense. As of March 31, 2013, the total fair value of these swap agreements was a liability of $16,023. The Company estimates that approximately $8,943 of existing unrealized pre-tax losses in other comprehensive income at March 31, 2013 will be reclassified into income in 2013.

As of March 31, 2013, the Company also maintains 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 our interest rate at a maximum of 4.00% on an equivalent amount of our Term Loan B debt. However, as a result of the new interest rate cap agreements that were entered into in March 2013, as described above, these interest rate cap agreements became ineffective cash flow hedges and as a result any changes in the fair value associated with these interest rate cap agreements will be charged to income. During the three months ended March 31, 2013, the Company accrued net charges of $897 from these caps which are included in debt expense. The cap agreements expire on September 30, 2014. As of March 31, 2013, the total fair value of these cap agreements was an asset of $63. During the three months ended March 31, 2013, the Company recorded a loss of $3 in other comprehensive income due to a decrease in the unrealized fair value of these cap agreements.

The following table summarizes the Company’s derivative instruments as of March 31, 2013 and December 31, 2012:

 

    

March 31, 2013

    

December 31, 2012

 

Derivatives designated as hedging

instruments

  

Balance sheet
location

   Fair value     

Balance sheet
location

   Fair value  

Interest rate swap agreements

   Other long-term liabilities    $ 16,751       Other long-term liabilities    $ 18,994   
     

 

 

       

 

 

 

Interest rate cap agreements

   Other long-term assets    $ 5,689       Other long-term assets    $ 65   
     

 

 

       

 

 

 

The following table summarizes the effects of the Company’s interest rate swap and cap agreements for the three months ended March 31, 2013 and 2012:

 

     Amount of gains
(losses) recognized in
OCI on interest rate  swap
and cap agreements
    Location of gains
(losses) reclassified
from accumulated
OCI into income
   Amount of gains
(losses) reclassified
from accumulated
OCI into  income
 
     Three months ended
March 31,
       Three months ended
March 31,
 

Derivatives designated as cash flow hedges

   2013     2012        2013     2012  

Interest rate swap agreements

   $ (964   $ (3,276   Debt expense    $ (3,207   $ (3,225

Interest rate cap agreements

     (2,913     (424   Debt expense      (897     (897

Tax benefit

     1,508        1,439           1,597        1,602   
  

 

 

   

 

 

      

 

 

   

 

 

 

Total

   $ (2,369   $ (2,261      $ (2,507   $ (2,520
  

 

 

   

 

 

      

 

 

   

 

 

 

 

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DAVITA HEALTHCARE PARTNERS INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(continued)

(unaudited)

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

 

As of March 31, 2013, interest rates on the Company’s Term Loan B and Term Loan B-2 debt are effectively fixed because of an embedded LIBOR floor which is higher than actual LIBOR as of such date. Furthermore, interest rates on $1,250,000 of the Company’s Term Loan B and $1,485,000 of the Company’s Term Loan B-2 are subject to interest rate caps if LIBOR should rise above 2.50%. Interest rates on the Company’s senior notes are fixed by their terms. The LIBOR variable component of the Company’s interest rates on the Company’s Term Loan A and the Term Loan A-3 are economically fixed as a result of interests rate swaps.

As a result of embedded LIBOR floors in some of the Company’s debt agreements and the swap and cap agreements, the Company’s overall weighted average effective interest rate on the Senior Secured Credit Facilities was 4.09%, based upon the current margins in effect of 2.50% for both the Term Loan A and for the Term Loan A-3, and 3.00% for both the Term Loan B and for the Term Loan B-2, as of March 31, 2013. Effective April 2, 2013, the interest rate margin on the Term Loan A increased to 2.75%

The Company’s overall weighted average effective interest rate during the first quarter of 2013 was 4.76% and as of March 31, 2013 was 4.79%.

As of March 31, 2013, the Company had undrawn revolving credit facilities totaling $350,000 of which approximately $114,456 was committed for outstanding letters of credit.

7. Contingencies

The majority of the Company’s revenues are from government programs and may be subject to adjustment as a result of: (i) examination by government agencies or contractors, for which the resolution of any matters raised may take extended periods of time to finalize; (ii) differing interpretations of government regulations by different Medicare contractors or regulatory authorities; (iii) differing opinions regarding a patient’s medical diagnosis or the medical necessity of services provided; and (iv) 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

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 covered the period from January 2003 to December 2008. The Company was in contact with the U.S. Attorney’s Office for the Northern District of Georgia and the U.S. Department of Justice in Washington, DC since November 2008 relating to this matter, and was advised that this 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 U.S. 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 U.S. 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 U.S. 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 the Company’s dialysis operations for Vitamin D and iron

 

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DAVITA HEALTHCARE PARTNERS INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(continued)

(unaudited)

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

 

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 civil subpoena covers the period from January 1, 2005 to May 2010, and seeks production of a wide range of documents relating to the Company’s dialysis operations, including documents related to, among other things, financial relationships with physicians and joint ventures, and whether those relationships and joint ventures comply with the federal anti-kickback statute and the False Claims Act. The Company has been advised by the attorneys conducting this civil investigation that they believe that some or all of the Company’s joint ventures do not comply with the anti-kickback statute and the False Claims Act. The Company disagrees that its joint venture structure generally, which the Company believes is widely used in the dialysis industry and other segments of the healthcare industry substantially in the form that the Company uses it, violates the federal anti-kickback statute or the False Claims Act. As to individual transactions, the Company made significant effort to ensure that its joint venture structures and process complied with the rules, but the Company is talking with the government about addressing its concerns. The focus of this investigation overlaps substantially with the 2011 U.S. Attorney Physician Relationship Investigation described below. The Company is engaged in good faith discussions with the attorneys from the United States Attorney’s Office for the District of Colorado, the Civil Division of the United States Department of Justice and the Office of the Inspector General in an effort to find a mutually acceptable resolution to this matter and the 2011 U.S. Attorney Physician Relationship Investigation. Discussions have advanced to a point where the Company believes it is appropriate to accrue an estimated loss contingency reserve of $300,000 in the first quarter of 2013 in connection with an offer to settle the related civil, administrative and criminal matters. However, the discussions are ongoing, and until concluded, there can be no certainty about the timing or likelihood of a definitive resolution or the scope of any potential restrictions that may be agreed upon in connection with a settlement. As these discussions proceed and additional information becomes available to us, the amount of the estimated loss contingency reserve may need to be increased or decreased to reflect this new information. This matter will continue to require management’s attention and significant legal expense, and the Company can make no assurances as to the 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 investigating certain activities of its dialysis business in connection with information being provided to a grand jury. This investigation relates to the Company’s relationships with physicians, including its joint ventures, and whether those relationships and joint ventures comply with the federal anti-kickback statute, and overlaps substantially, with the 2010 U.S. Attorney Physician Relationship Investigation described above. The Company has received a number of subpoenas for documents covering the period from January 2006 to November 2012, and the Company has produced documents in response to those subpoenas and other requests. In addition, certain current and former members of the Board, executives and other teammates have received subpoenas to testify before the grand jury. It is possible that criminal proceedings may be initiated against the Company in connection with this investigation. As noted above, the Company is engaged in good faith discussions in an effort to find a mutually acceptable resolution of both this matter and the 2010 U.S. Attorney Physician Relationship Investigation. As also noted above, the discussions are ongoing, and until concluded, there can be no certainty about the timing or likelihood of a definitive resolution. This matter will continue to require management’s attention and significant legal expense, and the Company can make no assurances as to the final outcome.

 

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DAVITA HEALTHCARE PARTNERS INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(continued)

(unaudited)

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

 

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. Subsequent to the Company’s announcement of this 2011 U.S. Attorney Medicaid Investigation, the Company received a request for documents in connection with the inquiry by the U.S. Attorney’s Office for the Eastern District of New York. The request relates to payments for infusion drugs covered by Medicaid composite payments 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 is cooperating with the government and is producing the requested documents.

Turner-Hooks Private Civil Suit: In January 2013, the Company was served with a civil complaint filed by a former patient, Laura Turner-Hooks, and brought pursuant to the qui tam provisions of the federal False Claims Act purportedly on behalf of the federal government. On November 13, 2012, the U.S. District Court for the Eastern District of Michigan 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 U.S. would not be intervening and not pursuing the relator’s allegation in litigation. The relator’s complaint, originally filed in July 2011, stated that she was a patient at a single dialysis facility in Michigan and that the Company allegedly violated the federal False Claims Act by providing treatments at the facility that failed to comply with the standard of care required under federal healthcare programs. The complaint asked the court to order the Company to cease committing the alleged violations and seeks monetary damages and civil penalties as well as costs and expenses. On March 29, 2013, the Company filed a motion to dismiss the case, arguing that the allegations were meritless. After reviewing the Company’s motion, on April 29, 2013, the U.S. District Court dismissed the case with prejudice as to the relator. There was no finding of wrongdoing by the Company, nor was the Company assessed or required to pay, any fines, penalties or other amounts in connection with the relator’s complaint or dismissal of the case.

Swoben Private Civil Suit: In April 2013, the Company’s Health Care Partners (HCP) subsidiary was served with a civil complaint filed by a former employee of SCAN Health Plan (SCAN), a health maintenance organization (HMO). On July 13, 2009, pursuant to the qui tam provisions of the federal False Claims Act and the California False Claims Act, James M. Swoben, as relator, filed a qui tam action in the United States District Court for the Central District of California purportedly on behalf of the United States of America and the State of California against SCAN, and certain other defendants whose identities were under seal. The allegations in the complaint relate to alleged overpayments received from government healthcare programs. In or about August 2012, SCAN entered into a settlement agreement with the United States of America and the State of California. The United States and the State of California partially intervened in the action for the purpose of settlement with and dismissal of the action against SCAN. In or about November 2011, the relator filed his Third Amended Complaint under seal alleging violations of the federal False Claims Act and the California False Claims Act, which named additional defendants, including HCP and certain health insurance companies that are referred to collectively in the complaint as the HMOs. The allegations in the complaint relate to patient diagnosis coding. The complaint seeks monetary damages and civil penalties as well as costs and expenses. The Company believes and is in the process of evaluating the extent to which it might have indemnification from the sellers in connection with the Company’s merger with HCP on November 1, 2012 for all or a portion of any liabilities it might incur related to this matter. The Company intends to vigorously defend this action.

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

 

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DAVITA HEALTHCARE PARTNERS INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(continued)

(unaudited)

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

 

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 considerable period of time through the various phases of document and witness requests and on-going discussions with regulators. 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 (except as described above), 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. The Company has received no further indication that any of these claims are active, and some of them may be barred by applicable statutes of limitations. To the extent any of these claims might proceed, the Company intends to defend against them 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 these matters 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 appealed that decision. In January 2013, the Court of Appeals affirmed the trial court’s decision on some claims, but remanded the case to the trial court for clarification of its decision on one of the claims. 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 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 by our dialysis business, 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 ESRD dialysis providers in Nevada and that 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 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

 

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DAVITA HEALTHCARE PARTNERS INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(continued)

(unaudited)

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

 

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.

8. Investments in debt and equity securities

Based on the Company’s intentions and strategy involving investments in debt 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, including those of mutual funds, as well as other debt securities, are classified as available for sale and recorded at fair value.

The Company’s investments in securities consist of the following:

 

     March 31, 2013      December 31, 2012  
     Held to
maturity
     Available
for sale
     Total      Held to
maturity
     Available
for sale
     Total  

Certificates of deposit and money market funds due within one year

   $ 5,942       $ —         $ 5,942       $ 5,938       $ —         $ 5,938   

Investments in mutual funds

     —           16,317         16,317         —           15,185         15,185   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
   $ 5,942       $ 16,317       $ 22,259       $ 5,938       $ 15,185       $ 21,123   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Short-term investments

   $ 5,942       $ 1,200       $ 7,142       $ 5,938       $ 1,200       $ 7,138   

Long-term investments

     —           15,117         15,117         —           13,985         13,985   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
   $ 5,942       $ 16,317       $ 22,259       $ 5,938       $ 15,185       $ 21,123   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

The cost of the certificates of deposit and money market funds at March 31, 2013 approximates their fair value. As of March 31, 2013 and December 31, 2012, the available for sale investments include $3,002 and $2,146 of gross pre-tax unrealized gains, respectively. During the three months ended March 31, 2013, the Company recorded gross pre-tax unrealized gains of $1,011, or $618 after tax, in other comprehensive income associated with changes in the fair value of these investments. During the three months ended March 31, 2013, the Company sold investments in mutual funds for net proceeds of $1,091 and recognized a pre-tax gain of $155, or $94 after-tax, which was previously recorded in other comprehensive income. During the three months ended March 31, 2012, the Company sold investments in mutual funds for net proceeds of $6,791, and recognized a pre-tax gain of $123, or $75 after tax, that was previously recorded in other comprehensive income.

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.

9. 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, temporary equity and commitments. The Company also has classified certain assets, liabilities and temporary equity that are measured at fair value into the appropriate fair value hierarchy levels as defined by FASB.

 

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DAVITA HEALTHCARE PARTNERS INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(continued)

(unaudited)

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

 

The following table summarizes the Company’s assets, liabilities and temporary equity measured at fair value on a recurring basis as of March 31, 2013:

 

     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

   $ 16,317       $ 16,317       $ —         $ —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Interest rate cap agreements

   $ 5,689       $ —         $ 5,689       $ —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Funds on deposit with third parties

   $ 72,303       $ 15,548       $ 56,755       $ —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Liabilities

           

Interest rate swap agreements

   $ 16,751       $ —         $ 16,751       $ —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Contingent earn-out obligations

   $ 294,079       $ —         $ —         $ 294,079   
  

 

 

    

 

 

    

 

 

    

 

 

 

Temporary equity

           

Noncontrolling interests subject to put provisions

   $ 605,894       $ —         $ —         $ 605,894   
  

 

 

    

 

 

    

 

 

    

 

 

 

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. See Note 8 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 utilizing the income approach and commonly accepted valuation techniques that use inputs from closing prices for similar assets and liabilities in active markets as well as other relevant observable market inputs at quoted intervals such as current interest rates, forward yield curves, implied volatility and credit default swap pricing. 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 from the fair values as currently reported. See Note 6 to the condensed consolidated financial statements for further discussion.

The funds on deposit with third parties represent funds held with various third parties as required by regulation or contract and invested by those parties in various investments, which are measured at estimated fair value based primarily on quoted close or bid market prices of the same or similar assets.

The estimated fair value measurements of contingent earn-out obligations are primarily based on unobservable inputs including projected EBITDA of acquired businesses, estimated probabilities of achieving gross margin of certain medical procedures and the estimated probability of earn-out payments being made using an option pricing technique and a simulation model for expected EBITDA. In addition, a probability-adjusted model was used to estimate the fair values of the quality results amounts. The estimated fair value of these contingent earn-out obligations will be remeasured as of each reporting date and could fluctuate based upon any significant changes in key assumptions, such as changes in the Company credit risk-adjusted rate that is used to discount obligations to present value.

See Note 10 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.

 

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DAVITA HEALTHCARE PARTNERS INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(continued)

(unaudited)

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

 

Other financial instruments consist primarily of cash, accounts receivable, life insurance contracts, accounts payable, other accrued liabilities, and debt. The balances of the non-debt financial instruments are presented in the condensed consolidated financial statements at March 31, 2013 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 $5,564,625 as of March 31, 2013, and the fair value was $5,598,190 based upon quoted market prices. The fair value of the Company’s senior notes was approximately $2,965,243 at March 31, 2013, based upon quoted market prices, as compared to the carrying amount of $2,800,000.

10. 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, non-owned and minority-owned entities 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 $3,000.

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 rather than sale of these entities would be valued below the related noncontrolling interests carrying balances in the condensed consolidated balance sheet.

11. Income taxes

As of March 31, 2013, the Company’s total liability for unrecognized tax benefits relating to tax positions that do not meet the more-likely-than-not threshold is $67,131, of which $41,291 would impact the Company’s effective tax rate if recognized. This balance represents a decrease of $415 from the December 31, 2012 balance of $67,546 due to the reduction of 2012 liabilities.

The Company recognizes accrued interest and penalties related to unrecognized tax benefits in its income tax expense. At March 31, 2013 and December 31, 2012, the Company had approximately $12,425 and $12,073, respectively, accrued for interest and penalties related to unrecognized tax benefits, net of federal tax benefits.

 

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Table of Contents

DAVITA HEALTHCARE PARTNERS INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(continued)

(unaudited)

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

 

12. Acquisitions and discontinued operations

Dialysis and other acquisitions

During the first three months of 2013, the Company acquired dialysis businesses and one other business consisting of eight dialysis centers located in the U.S. and one hospice care business for a total of $91,498 in cash and deferred purchase price obligations totaling $3,514. The assets and liabilities for all acquisitions were recorded at their estimated fair values at the dates of the acquisitions and are included in the Company’s condensed consolidated financial statements and operating results from the designated effective dates of the acquisitions.

The following table summarizes the assets acquired in these transactions and recognized at their acquisition dates at estimated fair values:

 

     Three months ended
March 31, 2013
 

Tangible assets, principally leasehold improvements and equipment

   $ 3,874   

Intangible and other long-term assets

     21,267   

Goodwill

     69,871   
  

 

 

 
   $ 95,012   
  

 

 

 

Amortizable intangible assets acquired during the first three months of 2013 had weighted-average estimated useful lives of 10.3 years. The total amount of goodwill deductible for tax purposes associated with these acquisitions is approximately $69,871.

HCP acquisition

The initial allocations of the purchase price at the time of the acquisition of HCP on November 1, 2012 were recorded at the estimated fair values of assets acquired and liabilities assumed based upon the best information available to management at that time and will be finalized when certain information arranged to be obtained has been received. Certain income tax amounts are pending issuance of final tax refunds and the evaluation and quantification of certain pre-acquisition tax contingencies. Valuation of medical claims reserves and certain noncontrolling interest amounts are pending final issuance and acceptance of third party actuarial reports.

The following is a summary of HCP’s purchase accounting adjustments recorded in the first quarter of 2013 applied retrospectively to the December 31, 2012 balance sheet and primarily relates to adjustments to medical claims reserves and noncontrolling interests:

 

     Adjustments to the
December 31, 2012
balance sheet
 

Accounts receivable

   $ 3,000   

Medical payables

   $ 7,000   

Noncontrolling interest

   $ 11,123   

Goodwill

   $ (17,233

Deferred income taxes

   $ (3,890

 

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Table of Contents

DAVITA HEALTHCARE PARTNERS INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(continued)

(unaudited)

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

 

Discontinued operations

Divestiture of HomeChoice Partners, Inc.

On February 1, 2013, the Company completed the sale of HomeChoice Partners Inc. (HomeChoice) to BioScrip, Inc. pursuant to a stock purchase agreement dated December 12, 2012 for $70,000 in cash, subject to various post-closing adjustments, of which the Company receives approximately 90% of the proceeds. The stock purchase agreement also provides that as additional consideration the Company may earn up to a total of 90% of $20,000 if certain performance amounts exceed certain thresholds over the next two years. As of February 1, 2013, the Company has assigned no value to this contingent receivable and will recognize any estimated realizable value of this receivable only when it becomes probable and reasonably estimable. The Company recorded a gain of approximately $13,375, net of tax, during the three months ended March 31, 2013 related to this divestiture.

HomeChoice is a regional provider of home infusion services that provides specialized pharmacy, nursing and nutritional services to patients in their homes.

The operating results of HomeChoice have been reported as discontinued operations for all periods presented.

The results from discontinued operations related to HomeChoice were as follows:

 

     Three months ended March 31,  
     2013      2012  

Net revenues

   $ 6,351       $ 17,102   
  

 

 

    

 

 

 

Loss before income taxes

     (223      (162

Income tax benefit

     (84      (61
  

 

 

    

 

 

 

Loss from discontinued operations

   $ (139    $ (101
  

 

 

    

 

 

 

Net assets of discontinued operations related to HomeChoice as of February 1, 2013, were as follows:

 

Current assets

   $ 17,039   

Property and equipment, net

     2,963   

Long-term assets

     28   

Goodwill

     31,853   

Liabilities and noncontrolling interests

     (8,998
  

 

 

 

Net assets of discontinued operations

   $ 42,885   
  

 

 

 

Contingent earn-out obligations

As a result of HCP achieving certain financial performance targets in 2012, the Company made earn-out payments of $136,954 on April 1, 2013, to the common unit holders of HCP. In addition, HCP’s prior owners can still earn as further consideration $137,500 if HCP’s earn-out EBITDA for 2013 is equal to or greater than $600,000. As of March 31, 2013, the Company estimated the fair value of the total contingent earn-out obligation to be $260,000. After the payment for the 2012 contingent earn-out obligation, the Company has estimated the fair value of the 2013 contingent earn-out obligation to be approximately $123,000.

 

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Table of Contents

DAVITA HEALTHCARE PARTNERS INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(continued)

(unaudited)

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

 

The Company also has several other contingent earn-out obligations associated with other acquisitions that could result in the Company paying the former shareholders of those acquired companies up to $95,100 if certain EBITDA performance targets and quality margins are met over the next three years and earn-out obligations based on 20% of operating income over the next five years. As of March 31, 2013, the Company has measured the fair value of these contingent earn-out obligations to be $34,079.

Contingent earn-out obligations will subsequently be remeasured to fair value at each reporting date until the contingencies are resolved with changes in the liability due to the re-measurement recorded in earnings. See Note 9 to the condensed consolidated financial statements for further details. Of the total contingent earn-out obligations of $294,079 recognized at March 31, 2013, a total of $141,244 is included in other accrued liabilities and the remaining $152,835 is included in other long-term liabilities on our consolidated balance sheet.

13. Segment reporting

The Company primarily operates two major lines of business, the largest being its U.S. dialysis and related lab services business and the other being HCP. The Company also operates various other ancillary services and strategic initiatives.

As of March 31, 2013, the ancillary services and strategic initiatives consisted primarily of pharmacy services, disease management services, vascular access services, ESRD clinical research programs, physician services, direct primary care and the Company’s international dialysis operations. For internal management reporting the U.S. dialysis and related lab services business, HCP’s practice management operations in each region, and each of the ancillary services and strategic initiatives have been defined as separate operating segments by management since 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 chief operating decision maker for the Company’s U.S. dialysis business and its ancillary services and strategic initiatives is its Chief Executive Officer. The chief operating decision maker for the HCP business is the HCP Chief Executive Officer. The U.S. dialysis and related lab services business and the HCP business each qualify as separately reportable segments 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 the operating segments. For internal management reporting, segment operations include direct segment operating expenses but exclude (i) corporate support, which consists primarily of indirect labor, benefits and long-term incentive based compensation of departments which provide support to all of the Company’s operating lines of business, and (ii) transaction expenses for the three months ended March 31, 2012 associated with the acquisition of HCP.

 

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Table of Contents

DAVITA HEALTHCARE PARTNERS 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
March 31,
 
     2013     2012  

Segment net revenues:

    

U.S. dialysis and related lab services

    

Patient service revenues:

    

External sources

   $ 1,908,783      $ 1,762,578   

Intersegment revenues

     7,511        4,059   
  

 

 

   

 

 

 

Total dialysis and related lab services revenues

     1,916,294        1,766,637   

Less: Provision for uncollectible accounts

     (67,071     (53,008
  

 

 

   

 

 

 

Net dialysis and related lab services patient service revenues

     1,849,223        1,713,629   

Other revenues (1)

     2,895        2,885   
  

 

 

   

 

 

 

Total net dialysis and related lab services revenues

     1,852,118        1,716,514   
  

 

 

   

 

 

 

HCP

    

HCP revenues:

    

Capitated revenues

     746,071        —     

Net patient service revenues

     53,602        —     

Other revenues(2)

     4,086        —     
  

 

 

   

 

 

 

Total revenues

     803,759        —     
  

 

 

   

 

 

 

Other—Ancillary services and strategic initiatives

    

Net patient service revenues (U.S. and international)

   $ 14,502      $ 2,905   

Other external sources

     166,714        134,173   

Intersegment revenues

     2,779        2,044   
  

 

 

   

 

 

 

Total ancillary services and strategic initiatives revenues

     183,995        139,122   
  

 

 

   

 

 

 

Total net segment revenues

     2,839,872        1,855,636   

Elimination of intersegment revenues

     (10,290     (6,103
  

 

 

   

 

 

 

Consolidated net revenues

   $ 2,829,582      $ 1,849,533   
  

 

 

   

 

 

 

Segment operating margin (loss):

    

U.S. dialysis and related lab services

   $ 87,292      $ 359,090   

HCP

     110,231        —     

Other—Ancillary services and strategic initiatives

     (15,014     (18,260
  

 

 

   

 

 

 

Total segment margin

     182,509        340,830   

Reconciliation of segment operating margin to consolidated income from continuing operations before income taxes:

    

Corporate support costs

     (15,648     (13,895

Transaction expenses

     —         (6,053
  

 

 

   

 

 

 

Consolidated operating income

     166,861        320,882   

Debt expense

     (105,817     (61,381

Other income

     598        1,039   
  

 

 

   

 

 

 

Consolidated income from continuing operations before income taxes

   $ 61,642      $ 260,540   
  

 

 

   

 

 

 

 

(1) 

Includes management fees for 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.

 

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Table of Contents

DAVITA HEALTHCARE PARTNERS INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(continued)

(unaudited)

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

 

(2) 

Includes payments received for medical consulting services and management fees for providing management and administrative services to an unconsolidated joint venture that provides medical services in which the Company owns a 50% interest.

For the three months ended March 31, 2013, depreciation and amortization expense for the dialysis and related lab services, HCP and the ancillary services and strategic initiatives was $84,936, $38,017 and $2,956, respectively.

For the three months ended March 31, 2012, depreciation and amortization expense for the dialysis and related lab services and for the ancillary services and strategic initiatives was $73,727 and $1,654, respectively.

Summary of assets by segment is as follows:

 

     March 31,
2013
     December 31,
2012
 

Segment assets

     

U.S. dialysis and related lab services

   $ 9,609,466       $ 9,351,075   

HCP

     6,399,107         6,218,133   

Other—Ancillary services and strategic initiatives

     404,904         435,155   
  

 

 

    

 

 

 

Consolidated assets

   $ 16,413,477       $ 16,004,363   
  

 

 

    

 

 

 

For the three months ended March 31, 2013, the total amount of expenditures for property and equipment, excluding capital leases for U.S. dialysis and related lab services, were $102,076, $6,539 for HCP and were $8,109 for the ancillary services and strategic initiatives.

For the three months ended March 31, 2012, the total amount of expenditures for property and equipment, excluding capital leases for U.S. dialysis and related lab services, were $106,802 and were $5,657 for the ancillary services and strategic initiatives.

 

24


Table of Contents

DAVITA HEALTHCARE PARTNERS INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(continued)

(unaudited)

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

 

14. Changes in DaVita HealthCare Partners Inc.’s ownership interest in consolidated subsidiaries

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

 

     Three months ended
March 31, 2013
 
     2013     2012  

Net income attributable to DaVita HealthCare Partners Inc.

   $ 30,164      $ 140,120   
  

 

 

   

 

 

 

(Decrease) increase in paid-in capital for sales of noncontrolling interests

     (809     5   

Decrease in paid-in capital for the purchase of noncontrolling interests

     —          (897
  

 

 

   

 

 

 

Net transfer to noncontrolling interests

     (809     (892
  

 

 

   

 

 

 

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

   $ 29,355      $ 139,228   
  

 

 

   

 

 

 

15. Variable interest entities

The Company relies on the operating activities of certain entities that it does not directly own or control, but over which it has indirect influence and of which it is considered the primary beneficiary. These entities are subject to the consolidation guidance applicable to variable interest entities (VIEs).

Under U.S. GAAP, variable interest entities typically include those for which the entity’s equity is not sufficient to finance its activities without additional subordinated financial support; those for which the equity holders as a group lack the power to direct the activities that most significantly influence the entity’s economic performance, the obligation to absorb the entity’s expected losses, or the right to receive the entities expected returns; or those for which the voting rights of some investors are not proportional to their obligations to absorb the entity’s losses.

Under U.S. GAAP, the Company has determined that substantially all of the entities it is associated with that qualify as variable interest entities must be included in its consolidated financial statements. The Company manages these entities and provides operating and capital funding as necessary for the entities to accomplish their operational and strategic objectives. A number of these entities are subject to nominee share ownership or share transfer restriction agreements that effectively transfer the majority of the economic risks and rewards of their ownership to the Company. In other cases the Company’s management agreements with these entities include both financial terms and protective and participating rights to the entity’s operating, strategic and non-clinical governance decisions which transfer substantial powers over and economic responsibility for the entity to the Company. In some cases such entities are subject to broad exclusivity or noncompetition restrictions that benefit the Company. Further, in some cases the Company has contractual arrangements with its related party nominee owners that effectively indemnify these parties from the economic losses from, or entitle the Company to the economic benefits of, these entities.

 

25


Table of Contents

DAVITA HEALTHCARE PARTNERS INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(continued)

(unaudited)

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

 

The analyses upon which these consolidation determinations rest are complex, involve uncertainties, and require significant judgment on various matters, some of which could be subject to different interpretations. At March 31, 2013, these consolidated financial statements include total assets of variable interest entities of $477,771 and total liabilities and noncontrolling interests of variable interest entities to third parties of $323,627.

The Company also sponsors certain deferred compensation plans whose trusts qualify as variable interest entities 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 recorded in accrued compensation and benefits and other long-term liabilities. See Note 8 for disclosures on the assets of these consolidate non-qualified deferred compensation plans.

16. Health care costs payable

The health care costs shown in the following table include estimates for the cost of professional medical services provided by non-employed physicians and other providers, as well as inpatient and other ancillary costs for all markets, other than California, where state regulation allows for the assumption of global risk. Health care costs payable are included in medical payables.

The following table shows the components of changes in the health care costs payable for the three months ended March 31, 2013:

 

     Three months
ended
March 31, 2013
 

Health care costs payable, beginning of the period

   $ 119,512   
  

 

 

 

Acquisitions and other adjustments

     19,267   
  

 

 

 

Add: Components of incurred health care costs

  

Current year

     329,374   

Prior years

     (2,145
  

 

 

 

Total incurred health care costs

     327,229   
  

 

 

 

Less: Claims paid

  

Current year

     187,950   

Prior years

     107,713   
  

 

 

 

Total claims paid

     295,663   
  

 

 

 

Health care costs payable, end of the period

   $ 170,345   
  

 

 

 

Our prior year estimates of health care costs payable decreased by $2,145 resulting from certain medical claims being settled for amounts less than originally estimated. These reductions were primarily the result of lower than expected utilization trends. When significant decreases (increases) in prior-year health care cost estimates occur that we believe significantly impact our current year operating results, we disclose that amount as favorable (unfavorable) development of prior-year’s health care cost estimates. Actual claim payments for prior year services have not been materially different from our year-end estimates.

 

26


Table of Contents

DAVITA HEALTHCARE PARTNERS INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(continued)

(unaudited)

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

 

17. Comprehensive income

On January 1, 2013, the Company adopted FASB’s ASU No. 2013-02 Comprehensive Income. This standard requires an entity to provide information about the amounts reclassified out of accumulated other comprehensive income by component. In addition, an entity is required to present, either on the face of the statement where net income is presented or in the notes, significant amounts reclassified out of accumulated other comprehensive income by the respective line items of net income but only if the amount reclassified is required under U.S. GAAP to be reclassified to net income in its entirety in the same reporting period. For other amounts that are not required under U.S. GAAP to be reclassified in their entirety to net income, an entity is required to cross reference to other disclosures required under U.S. GAAP that provide additional detail about those amounts.

 

    For the three months ended
March 31, 2013
    For the three months ended
March 31, 2012
 
    Interest
rate swap
and cap
agreements
    Investment
securities
    Foreign
currency
translation
adjustments
    Accumulated
other
comprehensive
income (loss)
    Interest
rate swap
and cap
agreements
    Investment
securities
    Foreign
currency
translation
adjustments
    Accumulated
other
comprehensive
income (loss)
 

Beginning balance

  $ (15,402   $ 1,310      $ (1,205   $ (15,297   $ (19,328   $ (156   $ —        $ (19,484
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Unrealized (losses) gains

    (3,877     1,011        (2,106     (4,972     (3,700     1,877        (619     (2,442

Related income tax benefit (expense)

    1,508        (393     —          1,115        1,439        (731     —          708   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
    (2,369     618        (2,106     (3,857     (2,261     1,146        (619     (1,734
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Reclassification from accumulated other comprehensive income into net income

    4,104        (155     —          3,949        4,122        (123     —          3,999   

Related tax

    (1,597     61        —          (1,536     (1,602     48        —          (1,554
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
    2,507        (94     —          2,413        2,520        (75     —          2,445   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance

  $ (15,264   $ 1,834      $ (3,311   $ (16,741   $ (19,069   $ 915      $ (619   $ (18,773
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

The reclassification of net swap and cap realized losses into income are recorded as debt expense in the corresponding condensed consolidated statements of income. See Note 6 to the condensed consolidated financial statements for further details.

The reclassification of net investment realized gains into income are recorded in other income in the corresponding condensed consolidated statements of income. See Note 8 to the condensed consolidated financial statements for further details.

 

27


Table of Contents

DAVITA HEALTHCARE PARTNERS INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(continued)

(unaudited)

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

 

18. 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 Company’s consolidated financial statements are fully interdependent and integrated. Revenues and operating expenses of the separate legal entities include intercompany charges for management and other administrative services. The Company’s senior notes are guaranteed by substantially all of its domestic wholly-owned subsidiaries. Each of the guarantor subsidiaries has guaranteed the notes on a joint and several basis. However, the guarantor subsidiaries can be released from their obligations in the event of a sale or other disposition of all or substantially all of the assets of such subsidiary, including by merger or consolidation or the sale of all equity interests in such subsidiary owned by the Company, if such subsidiary guarantor is designated as an unrestricted subsidiary or otherwise ceases to be a restricted subsidiary, and if such subsidiary guarantor no longer guaranties any other indebtedness of the Company. Non-wholly-owned subsidiaries, certain wholly-owned subsidiaries, foreign subsidiaries, joint ventures, partnerships, non-owned entities and third parties are not guarantors of these obligations.

Condensed Consolidating Statements of Income

 

For the three months ended March 31, 2013

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

Dialysis patient service revenues

  $ —        $ 1,452,220      $ 536,658      $ (9,005   $ 1,979,873   

Less: Provision for uncollectible accounts

    —          (63,857     (6,200     —         (70,057
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net patient service revenues

    —          1,388,363        530,458        (9,005     1,909,816   

HCP capitated revenue

    —          343,480        403,675        (1,084     746,071   

Other revenues

    135,375        375,001        17,657        (354,338     173,695   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total net revenues

    135,375        2,106,844        951,790        (364,427     2,829,582   

Operating expenses

    420,504        1,781,223        825,421        (364,427     2,662,721   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating (loss) income

    (285,129     325,621        126,369        —          166,861   

Debt (expense)

    (105,331     (94,715     (10,723     104,952        (105,817

Other income (expense)

    100,221        5,967        (638     (104,952     598   

Income tax (benefit) expense

    (136,703     138,088        13,759        —          15,144   

Equity earnings in subsidiaries

    183,700        66,077        —          (249,777     —     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income from continuing operations

    30,164        164,862        101,249        (249,777     46,498   

Discontinued operations

    —          —          13,236        —          13,236   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income

    30,164        164,862        114,485        (249,777     59,734   

Less: Net income attributable to noncontrolling interests

    —          —          —          (29,570     (29,570
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income attributable to DaVita HealthCare Partners Inc.

  $ 30,164      $ 164,862      $ 114,485      $ (279,347   $ 30,164   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

28


Table of Contents

DAVITA HEALTHCARE PARTNERS INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(continued)

(unaudited)

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

 

For the three months ended March 31, 2012

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

Dialysis patient service revenues

  $ —        $ 1,315,992      $ 463,090      $ (13,600   $ 1,765,482   

Less: Provision for uncollectible accounts

    —          (38,846     (14,162     —          (53,008
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net patient service revenues

    —          1,277,146        448,928        (13,600     1,712,474   

Other revenues

    123,593        146,965        4,153        (137,652     137,059   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total net revenues

    123,593        1,424,111        453,081        (151,252     1,849,533   

Operating expenses

    93,158        1,230,436        356,309        (151,252     1,528,651   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating income

    30,435        193,675        96,772        —          320,882   

Debt (expense)

    (62,181     (51,218     (6,366     58,384        (61,381

Other income

    58,346        632        445        (58,384     1,039   

Income tax expense

    10,773        78,112        6,671        —          95,556   

Equity earnings in subsidiaries

    124,293        59,540        —          (183,833     —     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income from continuing operations

    140,120        124,517        84,180        (183,833     164,984   

Discontinued operations

    —          —          (101     —          (101
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income

    140,120        124,517        84,079        (183,833     164,883   

Less: Net income attributable to noncontrolling interests

    —          —          —          (24,763     (24,763
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income attributable to DaVita HealthCare Partners Inc.

  $ 140,120      $ 124,517      $ 84,079      $ (208,596   $ 140,120   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

29


Table of Contents

DAVITA HEALTHCARE PARTNERS INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(continued)

(unaudited)

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

 

Condensed Consolidating Statements of Comprehensive Income

 

For the three months ended March 31, 2013

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

Net income

   $ 30,164      $ 164,862       $ 114,485       $ (249,777   $ 59,734   

Other comprehensive loss

     (1,444     —           —           —          (1,444
  

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

Total comprehensive income

     28,720        164,862         114,485         (249,777     58,290   

Less: comprehensive income attributable to the noncontrolling interests

     —          —           —           (29,570     (29,570
  

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

Comprehensive income attributable to DaVita HealthCare Partners Inc.

   $ 28,720      $ 164,862       $ 114,485       $ (279,347   $ 28,720   
  

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

For the three months ended March 31, 2012

                                

Net income

   $ 140,120      $ 124,517       $ 84,079       $ (183,833   $ 164,883   

Other comprehensive income

     711        —           —           —          711   
  

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

Total comprehensive income

     140,831        124,517         84,079         (183,833     165,594   

Less: comprehensive income attributable to the noncontrolling interests

     —          —           —           (24,763     (24,763
  

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

Comprehensive income attributable to DaVita HealthCare Partners Inc.

   $ 140,831      $ 124,517       $ 84,079       $ (208,596   $ 140,831   
  

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

 

30


Table of Contents

DAVITA HEALTHCARE PARTNERS INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(continued)

(unaudited)

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

 

Condensed Consolidating Balance Sheets

 

As of March 31, 2013

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

Cash and cash equivalents

  $ 303,829      $ 222,548      $ 173,294      $ —        $ 699,671   

Accounts receivable, net

    —          979,782        536,860        —          1,516,642   

Other current assets

    141,748        743,622        89,485        —          974,855   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total current assets

    445,577        1,945,952        799,639        —          3,191,168   

Property and equipment, net

    158,570        1,239,950        516,933        —          1,915,453   

Amortizable intangibles, net

    92,172        1,974,157        37,715        —          2,104,044   

Investments in subsidiaries

    7,739,790        1,335,279        —          (9,075,069     —     

Intercompany receivables

    4,433,541        160,955        423,295        (5,017,791     —     

Other long-term assets and investments

    59,701        71,056        57,020        —          187,777   

Goodwill

    —          7,760,863        1,254,172        —          9,015,035   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total assets

  $ 12,929,351      $ 14,488,212      $ 3,088,774        (14,092,860   $ 16,413,477   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Current liabilities

  $ 486,690      $ 1,489,523      $ 349,026      $ —        $ 2,325,239   

Intercompany payables

    —          4,161,191        856,600        (5,017,791     —     

Long-term debt and other long-term liabilities

    8,258,157        1,097,708        169,948        —          9,525,813   

Noncontrolling interests subject to put provisions

    385,062        —          —          220,832        605,894   

Total DaVita HealthCare Partners Inc. shareholders’ equity

    3,799,442        7,739,790        1,335,279        (9,075,069     3,799,442   

Noncontrolling interests not subject to put provisions

    —          —          377,921        (220,832     157,089   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total equity

    3,799,442        7,739,790        1,713,200        (9,295,901     3,956,531   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total liabilities and equity

  $ 12,929,351      $ 14,488,212      $ 3,088,774      $ (14,092,860   $ 16,413,477   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

As of December 31, 2012

                             

Cash and cash equivalents

  $ 195,037      $ 166,107      $ 172,604      $ —        $ 533,748   

Accounts receivable, net

    —          966,854        457,449        —          1,424,303   

Other current assets

    13,928        775,595        134,220        —          923,743   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total current assets

    208,965        1,908,556        764,273        —          2,881,794   

Property and equipment, net

    143,684        1,237,166        491,520        —          1,872,370   

Amortizable intangibles, net

    96,472        1,995,372        36,274        —          2,128,118   

Investments in subsidiaries

    7,444,676        1,337,414        —          (8,782,090     —     

Intercompany receivables

    4,866,059        —          423,626        (5,289,685     —     

Other long-term assets and investments

    52,787        67,000        54,558        —          174,345   

Goodwill

    —          7,705,119        1,242,617        —          8,947,736   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total assets

  $ 12,812,643      $ 14,250,627      $ 3,012,868      $ (14,071,775   $ 16,004,363   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Current liabilities

  $ 357,476      $ 1,274,305      $ 379,393      $ —        $ 2,011,174   

Intercompany payables

    —          4,593,709        695,976        (5,289,685     —     

Long-term debt and other long-term liabilities

    8,326,266        993,331        175,975        —          9,495,572   

Noncontrolling interests subject to put provisions

    365,764        —          —          214,928        580,692   

Total DaVita HealthCare Partners Inc. shareholders’ equity

    3,763,137        7,389,282        1,392,808        (8,782,090     3,763,137   

Noncontrolling interests not subject to put provisions

    —          —          368,716        (214,928     153,788   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total equity

    3,763,137        7,389,282        1,761,524        (8,997,018     3,916,925   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total liabilities and equity

  $ 12,812,643      $ 14,250,627      $ 3,012,868      $ (14,071,775   $ 16,004,363   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

31


Table of Contents

DAVITA HEALTHCARE PARTNERS 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 three months ended March 31, 2013

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

Cash flows from operating activities:

         

Net income

  $ 30,164      $ 164,862      $ 114,485      $ (249,777   $ 59,734   

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

    105,835        11,971        (48,110     249,777        319,473   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net cash provided by operating activities

    135,999        176,833        66,375        —          379,207   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cash flows from investing activities:

         

Additions of property and equipment, net

    (19,582     (51,574     (45,568     —          (116,724

Acquisitions

    —          (81,505     (9,993     —          (91,498

Proceeds from asset and business sales

    60,650        1,707        —          —          62,357   

Purchases/proceeds from investment sales and other items

    (125     (21     —          —          (146
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net cash provided by (used in) investing activities

    40,943        (131,393     (55,561     —          (146,011
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cash flows from financing activities:

         

Long-term debt and related financing costs, net

    (50,725     (3,907     (9,055     —          (63,687

Intercompany borrowing

    (30,215     10,734        19,481        —          —     

Other items

    12,790        4,174        (20,669     —          (3,705
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net cash (used in) provided by financing activities

    (68,150     11,001        (10,243     —          (67,392
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Effect of exchange rate changes on cash

    —          —          119        —          119   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net increase in cash and cash equivalents

    108,792        56,441        690        —          165,923   

Cash and cash equivalents at beginning of period

    195,037        166,107        172,604        —          533,748   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cash and cash equivalents at end of period

  $ 303,829      $ 222,548      $ 173,294      $ —        $ 699,671   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

For the three months ended March 31, 2012

                             

Cash flows from operating activities:

         

Net income

  $ 140,120      $ 124,517      $ 84,079      $ (183,833   $ 164,883   

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

    (49,986     60,253        (27,109     183,833        166,991   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net cash provided by operating activities

    90,134        184,770        56,970        —          331,874   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cash flows from investing activities:

         

Additions of property and equipment, net

    (18,640     (58,812     (35,007     —          (112,459

Acquisitions

    —          (116,269     (16,430     —          (132,699

Proceeds from asset sales

    —          825        —          —          825   

Purchases of investments and other items

    6,302        4,341        —          —          10,643   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net cash used in investing activities

    (12,338     (169,915     (51,437     —          (233,690
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cash flows from financing activities:

         

Long-term debt and related financing costs, net

    (17,158     (10,678     4,437        —          (23,399

Intercompany borrowing

    (11,910     95        11,815        —          —     

Other items

    7,768        (4,272     (22,754     —          (19,258
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net cash used in financing activities

    (21,300     (14,855     (6,502     —          (42,657
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Effect of exchange rate changes on cash

    —          —          11        —          11   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net increase (decrease) in cash and cash equivalents

    56,496        —          (958     —          55,538   

Cash and cash equivalents at beginning of period

    365,276        —          28,476        —          393,752   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cash and cash equivalents at end of period

  $ 421,772      $ —        $ 27,518      $ —        $ 449,290   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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

Forward-looking statements

This Management’s Discussion and Analysis of Financial Condition and Results of Operations contain statements that are forward-looking statements within the meaning of the federal securities laws. 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 dialysis centers and dialysis center acquisitions, government and commercial payment rates, revenue estimating risk and the impact of our level of indebtedness on our financial performance, including earnings per share, and incorporation of HCP’s operating results into the Company’s consolidated operating results. 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 the concentration of profits generated by the continued downward pressure on average realized payment rates from, and a reduction in the number of patients under, higher-paying commercial payor plans, which may result in the loss of revenues or patients, 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 U.S. in March 2010, changes in pharmaceutical or anemia management practice patterns, payment policies, or pharmaceutical pricing, legal compliance risks, including our continued compliance with complex government regulations and current or potential investigations by various government entities and related government or private-party proceedings, including risks relating to the resolution of the 2010 and 2011 U.S. Attorney Physician Relationship Investigations, continued increased competition from large and medium-sized dialysis providers that compete directly with us, our ability to maintain contracts with physician medical directors, changing affiliation models for physicians, and the emergence of new models of care introduced by the government or private sector that may erode our patient base and reimbursement rates such as accountable care organizations (ACOs), independent practice associations (IPAs) and integrated delivery systems, or to businesses outside of dialysis and HCP’s business, our ability to complete any acquisitions, mergers or dispositions that we might be considering or announce, or to integrate and successfully operate any business we may acquire or have acquired, including HCP, or to expand our operations and services to markets outside the U.S., variability of our cash flows, risks arising from the use of accounting estimates, judgments and interpretations in our financial statements, loss of key HCP employees, potential disruption from the HCP transaction making it more difficult to maintain business and operational relationships with customers, partners, associated physicians and physician groups, hospitals and others, the risk that laws regulating the corporate practice of medicine could restrict the manner in which HCP conducts its business, the fact that HCP faces certain competitive threats that could reduce its profitability, the risk that the cost of providing services under HCP’s agreements may exceed our compensation, the risk that reductions in reimbursement rates, including Medicare Advantage rates, and future regulations may negatively impact HCP’s business, revenue and profitability, the risk that HCP may not be able to successfully establish a presence in new geographic regions or successfully address competitive threats that could reduce its profitability, the risk that a disruption in HCP’s healthcare provider networks could have an adverse effect on HCP’s operations and profitability, the risk that reductions in the quality ratings of health maintenance organization plan customers of HCP could have an adverse effect on HCP’s business, or the risk that health plans that acquire health maintenance organizations may not be willing to contract with HCP or may be willing to contract only on less favorable terms, 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.

 

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Consolidated results of operations

We primarily operate two major lines of business and, to a lesser extent, various other ancillary services and strategic initiatives, which includes our international dialysis operations. Our largest line of business is our U.S. dialysis and related lab services business, which is a leading provider of kidney dialysis services in the U.S. for patients suffering from chronic kidney failure, also known as ESRD. Our other major line of business is HealthCare Partners (HCP), which is a patient- and physician-focused integrated health care delivery and management company with nearly three decades of providing coordinated, outcomes-based medical care in a cost-effective manner.

Following is a summary of our consolidated operating results for the first quarter of 2013 compared with the prior sequential quarter and the same quarter of 2012 for reference in the discussion that follows. The operating results of HCP are included in our operating results effective November 1, 2012.

 

     Three months ended  
     March 31,
2013
    December 31,
2012
    March 31,
2012
 
     (dollar amounts rounded to nearest million)  

Net revenues:

            

Patient service revenues

   $ 1,980        $ 1,930        $ 1,766     

Less: Provision for uncollectible accounts

     (70       (68       (53  
  

 

 

     

 

 

     

 

 

   

Net patient service revenues

     1,910          1,862          1,713     

HCP capitated revenues

     746          419          —       

Other revenues

     174          197          137     
  

 

 

     

 

 

     

 

 

   

Total consolidated net revenues

     2,830        100     2,478        100     1,850        100
  

 

 

     

 

 

     

 

 

   

Operating expenses and charges:

            

Patient care costs

     1,954        69     1,703        69     1,250        68

General and administrative

     291        10     278        11     206        11

Depreciation and amortization

     126        4     109        4     75        4

Provision for uncollectible accounts

     1        —          1        —          1        —     

Equity investment income

     (9     —          (8     —          (3     —     

Loss contingency reserve and other legal settlement expenses

     300        11     7        —          —          —     
  

 

 

     

 

 

     

 

 

   

Total operating expenses and charges

     2,663        94 %(1)      2,090        84     1,529        83
  

 

 

     

 

 

     

 

 

   

Operating income

   $ 167        6   $ 388        16   $ 321        17
  

 

 

     

 

 

     

 

 

   

 

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The following table summarizes consolidated net revenues for our U.S. dialysis and related lab services segment, HCP and our other ancillary services and strategic initiatives:

 

    Three months ended  
    March 31,
2013
    December 31,
2012
    March 31,
2012
 
    (dollar amounts rounded to nearest million)  

Net revenues:

     

Dialysis and related lab services patient service revenues

  $ 1,916      $ 1,894      $ 1,767   

Less: Provision for uncollectible accounts

    (67     (66     (53
 

 

 

   

 

 

   

 

 

 

Dialysis and related lab services net patient service revenues

  $ 1,849      $ 1,828      $ 1,714   

Other revenues

    3        3        3   
 

 

 

   

 

 

   

 

 

 

Total net dialysis and related lab services revenues

    1,852        1,831        1,717   
 

 

 

   

 

 

   

 

 

 

HCP capitated revenues

    746        419        —     

HCP net patient service revenues (less provision for uncollectible accounts of $3 and $2)

    54        34        —     

Other revenues

    4        24        —     
 

 

 

   

 

 

   

 

 

 

Total net HCP revenues

    804        477        —     
 

 

 

   

 

 

   

 

 

 

Other—Ancillary services and strategic initiatives revenues

    169        173        136   

Other—Ancillary services and strategic initiatives net patient service revenues

    15        5        3   
 

 

 

   

 

 

   

 

 

 

Total net other-ancillary services and strategic initiatives revenues

    184        178        139   
 

 

 

   

 

 

   

 

 

 

Total net segment revenues

    2,840        2,486        1,856   

Elimination of intersegment revenues

    (10     (8     (6
 

 

 

   

 

 

   

 

 

 

Consolidated net revenues

  $ 2,830      $ 2,478      $ 1,850   
 

 

 

   

 

 

   

 

 

 

 

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The following table summarizes consolidated operating income and adjusted consolidated operating income:

 

     Three months ended  
     March 31,
2013
    December 31,
2012
    March 31,
2012
 
     (dollar amounts rounded to nearest million)  

Dialysis and related lab services

   $ 87      $ 362      $ 359   

HCP services

     110        67        —     

Other—Ancillary services and strategic initiatives loss

     (15     (15     (18
  

 

 

   

 

 

   

 

 

 

Total segment operating income

     182        414        341   

Reconciling items:

      

Corporate support costs

     (15     (13     (14

Transaction expenses

     —          (13     (6
  

 

 

   

 

 

   

 

 

 

Consolidated operating income

     167        388        321   

Reconciliation of non-GAAP measure:

      

Add:

      

Loss contingency reserve and other legal settlement expenses

     300        7        —     

Transaction expenses

     —          13        6   
  

 

 

   

 

 

   

 

 

 

Adjusted consolidated operating income (1)

   $ 467      $ 408      $ 327   
  

 

 

   

 

 

   

 

 

 

 

(1) 

For the three months ended March 31, 2013, we have excluded $300 million of expenses related to an estimated loss contingency reserve and for the three months ended December 31, 2012, we have excluded $7 million of expenses related to a legal settlement, from operating expenses and operating income. In addition, for the three months ended December 31, 2012 and March 31, 2012, we have excluded $13 million and $6 million, respectively, of transaction expenses associated with the acquisition of HCP from operating expenses and operating income. These are non-GAAP measures and are not intended as substitutes for the GAAP equivalent measures. We have presented these adjusted amounts because management believes that these presentations enhance a user’s understanding of our normal consolidated operating income by excluding an estimated $300 million loss contingency reserve related to the 2010 and 2011 U.S. Attorney Physician Relationship Investigations (see note 7 to the condensed consolidated financial statements), $7 million of expenses relating to a settlement we reached in the second quarter of 2012 with the U.S. District Court in the Eastern District of Texas to resolve federal program claims regarding EPO that were or could have been raised in the complaint relating to historical EPO practices dating back to 1997, and an unusual amount of transaction expenses totaling $13 million and $6 million for the three months ended December 31, 2012 and March 31, 2012, respectively, that resulted from the acquisition of HCP. These adjusted consolidated operating income amounts are therefore considered meaningful and comparable to our prior period results.

Consolidated net revenues

Consolidated net revenues for the first quarter of 2013 increased by approximately $352 million, or approximately 14.2%, as compared to the fourth quarter of 2012. The increase in consolidated net revenues was primarily due to an increase of approximately $327 million associated with HCP as a result of HCP’s operations being included for the full first quarter in 2013 as compared to two months in 2012. HCP’s net revenues in the first quarter of 2013 benefited from an increase in new members and growth through acquisitions. In addition, consolidated net revenues increased as a result of an increase in the dialysis and related lab services net revenues of approximately $21 million, principally due to an increase in our average dialysis revenue per treatment of

 

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approximately $10 in the first quarter of 2013 and volume growth from additional treatments from non-acquired growth and acquisitions. However, consolidated net revenues were negatively impacted by three fewer treatment days in the first quarter of 2013.

Consolidated net revenues for the first quarter of 2013 increased by approximately $980 million, or approximately 53.0%, as compared to the first quarter of 2012. The increase in consolidated net revenues was primarily due to the acquisition of HCP which generated approximately $804 million in net revenues, an increase of $135 million in the dialysis and related lab services net revenues, primarily due to an increase in our average dialysis revenue per treatment of approximately $8 and strong volume growth from additional treatments from non-acquired treatment growth in existing and new centers, and growth through acquisitions partially offset by one and a half fewer treatment days in the first quarter of 2013. In addition, the increase in consolidated net revenues was also due to an increase of approximately $45 million in our ancillary services and strategic initiatives, primarily from growth in our pharmacy services and in our international operations.

Consolidated operating income

Consolidated operating income for the first quarter of 2013 decreased by approximately $221 million, or approximately 57.0%, as compared to the fourth quarter of 2012, including the estimated loss contingency reserve of $300 million in the first quarter of 2013 and including other legal settlement expenses of approximately $7 million and the transaction expenses of $13 million associated with acquisition of HCP in the fourth quarter of 2012. Excluding these items from the respective periods, adjusted consolidated operating income would have increased by $59 million. The increase in the adjusted consolidated operating income was primarily due to HCP’s operating results being included for the full first quarter in 2013, compared to two months in 2012. HCP’s operating results benefited from an increase in new members. In addition, adjusted consolidated operating income increased as a result of an increase in our average dialysis revenue per treatment of approximately $10, volume growth in the number of treatments, lower benefit costs and a decrease in the EPO unit costs. Adjusted consolidated operating income was negatively impacted by three fewer treatment days in the first quarter of 2013, higher labor costs and related payroll taxes and a decline in productivity.

Consolidated operating income for the first quarter of 2013 decreased by approximately $154 million, or approximately 48.0%, as compared to the first quarter of 2012 including the estimated loss contingency reserve of $300 million in the first quarter of 2013 and including transaction expenses of $6 million associated with the acquisition of HCP in the first quarter of 2012. Excluding these items from their respective periods, adjusted consolidated operating income would have increased by $140 million. The increase in adjusted operating income was primarily due to the acquisition of HCP, which generated $110 million in operating income, an increase of approximately $8 in our average dialysis revenue per treatment, strong volume growth in the number of treatments, lower professional fees for legal and compliance matters, lower transaction and integration costs associated with the acquisition of DSI and a decrease in the EPO unit costs. Adjusted consolidated operating income was negatively impacted by one and a half fewer treatment days in the first quarter of 2013, higher labor costs and related payroll taxes, a decline in productivity and a decline in the intensities of physician-prescribed pharmaceuticals.

 

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U.S. dialysis and related lab services business

Results of Operations

 

     Three months ended  
     March 31,
2013
    December 31,
2012
    March 31,
2012
 
     (dollar amounts rounded to nearest million, except
per treatment data)
 

Net revenues:

      

Dialysis and related lab services patient service revenues

   $ 1,916      $ 1,894      $ 1,767   

Less: Provision for uncollectible accounts

     (67     (66     (53
  

 

 

   

 

 

   

 

 

 

Dialysis and related lab services net patient service revenues

   $ 1,849      $ 1,828      $ 1,714   

Other revenues

     3        3        3   
  

 

 

   

 

 

   

 

 

 

Total net dialysis and related lab services revenues

   $ 1,852      $ 1,831      $ 1,717   
  

 

 

   

 

 

   

 

 

 

Operating expenses and charges:

      

Patient care costs

     1,216        1,219        1,129   

General and administrative

     167        163        158   

Depreciation and amortization

     85        83        74   

Loss contingency reserve and other legal settlement expenses

     300        7        —     

Equity investment income

     (3     (3     (3
  

 

 

   

 

 

   

 

 

 

Total operating expenses and charges

     1,765        1,469        1,358   
  

 

 

   

 

 

   

 

 

 

Operating income

   $ 87      $ 362      $ 359   
  

 

 

   

 

 

   

 

 

 

Dialysis treatments

     5,628,799        5,736,776        5,314,275   

Average dialysis treatments per treatment day

     73,579        72,161        68,132   

Average dialysis and related lab services revenue per treatment

   $ 340      $ 330      $ 332   

Net revenues

Dialysis and related lab services’ net revenues for the first quarter of 2013 increased by approximately $21 million, or approximately 1.1%, as compared to the fourth quarter of 2012. The increase in net revenues was primarily due to an increase of approximately $10 in the average dialysis revenue per treatment, primarily due to an increase in our Medicare reimbursements, an increase in some of our commercial payment rates and a slight increase in our commercial patient mix. The increase in dialysis and related lab services’ net revenues was also due to an increase in the number of treatments per day as a result of non-acquired treatment growth in existing and new centers and growth through acquisitions, partially offset by a reduction in the overall number of treatments as a result of three fewer treatment days in the quarter.

Dialysis and related lab services’ net revenues for the first quarter of 2013 increased by approximately $135 million, or approximately 7.9%, as compared to the first quarter of 2012. The increase in net revenues in the first quarter of 2013 was principally due to strong volume growth from additional treatments, even with one and a half fewer treatment days in the first quarter of 2013. Dialysis and related services’ net revenues also increased as a result of an increase in the average dialysis revenue per treatment of approximately $8. The increase in the number of treatments was primarily attributable to non-acquired treatment growth at existing and new centers

 

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and growth through acquisitions. The increase in the average dialysis revenue per treatment was primarily due to an increase in our Medicare reimbursements and an increase in some of our commercial payment rates, partially offset by a slight decline in our commercial mix and a decline in the intensities of physician-prescribed pharmaceuticals.

Under the American Taxpayer Relief Act of 2012, the sequester was postponed until March 1, 2013. However, since Congress failed to act by that date, the sequestration became effective on April 1, 2013 and as a result, our dialysis Medicare reimbursements were reduced by 2% effective at that time which represents a reduction of approximately $20 million per quarter.

Operating expenses and charges

Patient care costs. Dialysis and related lab services’ patient care costs on a per treatment basis for the first quarter of 2013 increased by approximately $4 per treatment as compared to the fourth quarter of 2012. The increase in the dialysis and related lab services’ patient care costs per treatment was primarily due to higher labor costs and related payroll taxes and a decline in productivity, partially offset by a decrease in our benefit costs and a decrease in the EPO unit cost.

Dialysis and related lab services’ patient care costs on a per treatment basis for the first quarter of 2013 increased by approximately $4 as compared to the first quarter of 2012. The increase was primarily attributable to higher labor costs and related payroll taxes, a decline in productivity and an increase in our other direct operating expenses associated with our dialysis centers, partially offset by lower pharmaceutical costs mainly from a decline in the intensities of physician prescribed pharmaceuticals and a decrease in the EPO unit cost.

General and administrative expenses. Dialysis and related lab services’ general and administrative expenses of approximately $167 million increased by approximately $4 million in the first quarter of 2013 as compared to the fourth quarter of 2012. The increase was primarily due to higher labor costs and related payroll taxes, higher long-term incentive compensation and an increase in our professional fees for legal and compliance matters, partially offset by lower benefit costs and lower costs related to leadership meetings and related travel costs.

Dialysis and related lab services’ general and administrative expenses for the first quarter of 2013 increased by approximately $9 million as compared to the first quarter of 2012. The increase was primarily due to higher labor costs and related payroll taxes, and higher long-term incentive compensation, partially offset by lower professional fees in conjunction with legal and compliance matters and lower transaction and integration costs associated with the acquisition of DSI.

Depreciation and amortization. Depreciation and amortization for dialysis and related lab services was approximately $85 million for the first quarter of 2013, $83 million for the fourth quarter of 2012 and $74 million for the first quarter of 2012. The increases in depreciation and amortization in the first quarter of 2013, as compared to both the fourth quarter of 2012 and the first quarter of 2012, was primarily due to growth in newly developed centers and from acquired centers. In addition, the increase in depreciation and amortization in the first quarter of 2013 compared to the first quarter of 2012 was also due to additional depreciation expense associated with the opening of our new corporate headquarters in August 2012.

Provision for uncollectible accounts. The provision for uncollectible accounts receivable for dialysis and related lab services was 3.5% for the first quarter of 2013, 3.5% for the fourth quarter of 2012, and 3.0% for the first quarter of 2012. The increase in the provision for uncollectible accounts in the first quarter of 2013 as compared to the first quarter of 2012 was primarily due to higher non-covered Medicare charges that continue to result in additional write-offs. We assess our level of the provision for uncollectible accounts based upon our historical cash collection experience and trends, and have and will continue to adjust the provision as necessary as a result of changes in our cash collections.

 

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Loss contingency reserve and other legal settlement expenses. We are engaged in good faith discussions with the attorneys from the United States Attorney’s Office for the District of Colorado, the Civil Division of the United States Department of Justice and the Office of the Inspector General in an effort to find a mutually acceptable resolution to the 2010 and 2011 U.S. Attorney Physician Relationship Investigations. Discussions have advanced to a point where we believe it is appropriate to accrue an estimated loss contingency reserve of $300 million in the first quarter of 2013 in connection with an offer to settle the related civil, administrative and criminal matters. However, the discussions are ongoing, and until concluded, there can be no certainty about the timing or likelihood of a definitive resolution or the scope of any potential restrictions that may be agreed upon in connection with a settlement. As these discussions proceed, and additional information becomes available to us, the amount of the estimated loss contingency reserve may need to be increased or decreased to reflect this new information. In the fourth quarter of 2012, we incurred $7.0 million of expenses relating to a settlement we reached in the second quarter of 2012 with the U.S. District Court in the Eastern District of Texas to resolve federal program claims regarding EPO that were or could have been raised in the complaint relating to historical EPO practices dating back to 1997.

Equity investment income. Equity investment income was approximately $3.3 million for the first quarter of 2013, as compared to $3.1 million for the fourth quarter of 2012 and $2.6 million for the first quarter of 2012. The increases in equity income in the first quarter of 2013, as compared to both the fourth quarter of 2012 and the first quarter of 2012 were primarily due to improvements in the operating performance of certain joint ventures.