Prepared by R.R. Donnelley Financial -- Form 10-Q period ended 03/31/2002
Table of Contents
 
UNITED STATES
 
SECURITIES AND EXCHANGE COMMISSION
 
Washington, D.C. 20549
 
FORM 10-Q
 
For the Quarter Ended March 31, 2002
 
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
 
Commission File Number: 1-4034
 
DAVITA INC.
 
21250 Hawthorne Blvd., Suite 800
Torrance, California 90503-5517
Telephone # (310) 792-2600
 
Delaware
   
51-0354549
(State of incorporation)
   
(I.R.S. employer identification no.)
 
The Registrant has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months and has been subject to such filing requirements for the past 90 days.
 
As of May 1, 2002, there were 84,058,786 shares of the Registrant’s common stock (par value $0.001) outstanding.

Table of Contents
 
DAVITA INC.
 
INDEX
 
           
Page No.
    
PART I.    FINANCIAL INFORMATION
       
Item 1.
   
Condensed Consolidated Financial Statements:
       
         
1
         
2
         
3
         
4
Item 2.
        
11
Item 3.
        
14
    
15
    
PART II.    OTHER INFORMATION
       
Item 1.
        
19
Item 4.
        
19
Item 6.
        
20
    
21
Note:  Items 2, 3, and 5 of Part II are omitted because they are not applicable.
 
 

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DAVITA INC.
 
CONSOLIDATED BALANCE SHEETS
(unaudited)
(dollars in thousands, except per share data)
 
    
March 31,
2002
     
December 31,
2001
  
ASSETS
                  
Cash and cash equivalents
   
$
31,697
 
   
$
36,711
 
Accounts receivable, less allowance of $51,807 and $52,475
   
 
344,238
 
   
 
333,546
 
Inventories
   
 
28,179
 
   
 
34,901
 
Other current assets
   
 
12,192
 
   
 
9,364
 
Deferred income taxes
   
 
58,987
 
   
 
60,142
 
    
  
Total current assets
   
 
475,293
 
   
 
474,664
 
Property and equipment, net
   
 
256,046
 
   
 
252,778
 
Amortizable intangibles, net
   
 
70,189
 
   
 
73,108
 
Investments in third-party dialysis businesses
   
 
4,145
 
   
 
4,346
 
Other long-term assets
   
 
2,027
 
   
 
2,027
 
Goodwill
   
 
857,132
 
   
 
855,760
 
    
  
    
$
1,664,832
 
   
$
1,662,683
 
    
  
LIABILITIES AND SHAREHOLDERS’ EQUITY
                  
Accounts payable
   
$
83,559
 
   
$
74,630
 
Other liabilities
   
 
126,153
 
   
 
111,164
 
Accrued compensation and benefits
   
 
86,213
 
   
 
88,826
 
Current portion of long-term debt
   
 
1,597
 
   
 
9,034
 
Income taxes payable
   
 
15,288
 
   
 
15,027
 
    
  
Total current liabilities
   
 
312,810
 
   
 
298,681
 
Long-term debt
   
 
798,707
 
   
 
811,190
 
Other long-term liabilities
   
 
4,725
 
   
 
5,012
 
Deferred income taxes
   
 
30,147
 
   
 
23,441
 
Minority interests
   
 
21,423
 
   
 
20,722
 
Shareholders’ equity:
                  
Preferred stock ($0.001 par value; 5,000,000 shares authorized; none issued or outstanding)
                  
Common stock ($0.001 par value, 195,000,000 shares authorized;
87,017,029 and 85,409,037 shares issued)
   
 
87
 
   
 
85
 
Additional paid-in capital
   
 
493,184
 
   
 
467,904
 
Retained earnings
   
 
91,986
 
   
 
56,008
 
Treasury stock, at cost (3,834,400 and 888,700 shares)
   
 
(88,237
)
   
 
(20,360
)
    
  
Total shareholders’ equity
   
 
497,020
 
   
 
503,637
 
    
  
    
$
1,664,832
 
   
$
1,662,683
 
    
  
 
See notes to condensed consolidated financial statements.

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DAVITA INC.
 
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
(unaudited)
(dollars in thousands, except per share data)
 
    
Three months ended March 31,
  
    
2002
     
2001
  
Net operating revenues
   
$
427,665
 
   
$
386,217
 
Operating expenses:
                  
Dialysis centers and labs
   
 
291,634
 
   
 
260,974
 
General and administrative
   
 
36,053
 
   
 
31,813
 
Depreciation and amortization
   
 
15,805
 
   
 
26,148
 
Provision for uncollectible accounts
   
 
5,255
 
   
 
(8,185
)
    
  
Total operating expenses
   
 
348,747
 
   
 
310,750
 
    
  
Operating income
   
 
78,918
 
   
 
75,467
 
Other income, net
   
 
565
 
   
 
1,348
 
Debt expense
   
 
15,072
 
   
 
19,724
 
Minority interests in income of consolidated subsidiaries
   
 
(2,433
)
   
 
(2,457
)
    
  
Income before income taxes
   
 
61,978
 
   
 
54,634
 
Income tax expense
   
 
26,000
 
   
 
23,700
 
    
  
Net income
   
$
35,978
 
   
$
30,934
 
    
  
Comprehensive income
   
$
35,978
 
   
$
30,934
 
    
  
Basic earnings per common share
   
$
0.43
 
   
$
0.37
 
    
  
Diluted earnings per common share
   
$
0.40
 
   
$
0.35
 
    
  
 
 
 
See notes to condensed consolidated financial statements.

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DAVITA INC.
 
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
(dollars in thousands)
 
    
Three months ended March 31,
  
    
2002
     
2001
  
Cash flows from operating activities:
                  
Net income
   
$
35,978
 
   
$
30,934
 
Adjustments to reconcile net income to cash provided by operating activities:
                  
Depreciation and amortization
   
 
15,805
 
   
 
26,148
 
Gain on divestures
   
 
(458
)
         
Deferred income taxes
   
 
7,861
 
   
 
2,900
 
Non-cash debt expense
   
 
634
 
   
 
500
 
Stock options, principally tax benefits
   
 
8,931
 
   
 
3,287
 
Equity investment (income)
   
 
(298
)
   
 
(694
)
Minority interests in income of consolidated subsidiaries
   
 
2,433
 
   
 
2,457
 
Changes in operating assets and liabilities, excluding acquisitions and divestitures:
                  
Accounts receivable
   
 
(11,163
)
   
 
(2,846
)
Inventories
   
 
6,726
 
   
 
(24,418
)
Other current assets
   
 
(2,840
)
   
 
(3,540
)
Other long-term assets
            
 
49
 
Accounts payable
   
 
8,969
 
   
 
2,160
 
Accrued compensation and benefits
   
 
(2,617
)
   
 
(1,539
)
Other current liabilities
   
 
15,050
 
   
 
4,200
 
Income taxes
   
 
261
 
   
 
18,333
 
Other long-term liabilities
   
 
(287
)
   
 
(100
)
    
  
Net cash provided by operating activities
   
 
84,985
 
   
 
57,831
 
    
  
Cash flows from investing activities:
                  
Additions of property and equipment, net
   
 
(16,115
)
   
 
(6,755
)
Acquisitions and divestitures, net
   
 
(1,379
)
   
 
(50,667
)
Investments in affiliates, net
   
 
499
 
   
 
19,593
 
    
  
Net cash used in investing activities
   
 
(16,995
)
   
 
(37,829
)
    
  
Cash flows from financing activities:
                  
Borrowings
   
 
335,883
 
   
 
814,813
 
Payments on long-term debt
   
 
(355,803
)
   
 
(851,667
)
Deferred financing costs
   
 
(57
)
   
 
(50
)
Purchase of treasury stock
   
 
(67,877
)
         
Proceeds from issuance of common stock
   
 
16,351
 
   
 
4,630
 
Distributions to minority interests
   
 
(1,501
)
   
 
(1,492
)
    
  
Net cash used in financing activities
   
 
(73,004
)
   
 
(33,766
)
    
  
Net decrease in cash
   
 
(5,014
)
   
 
(13,764
)
Cash and cash equivalents at beginning of period
   
 
36,711
 
   
 
31,207
 
    
  
Cash and cash equivalents at end of period
   
$
31,697
 
   
$
17,443
 
    
  
 
See notes to condensed consolidated financial statements.

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DAVITA INC.
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
(dollars in thousands, except per share data)
 
Unless otherwise indicated in this Form 10-Q “the Company”, “we”, “us”, “our” and similar terms refer to DaVita Inc. and its subsidiaries.
 
1.    Condensed consolidated interim financial statements
 
The condensed consolidated interim financial statements included in this report are prepared by the Company without audit. In the opinion of management, all adjustments consisting only of normal recurring items necessary for a fair presentation of the results of operations are reflected in these consolidated interim financial statements. All significant intercompany accounts and transactions have been eliminated. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. The most significant estimates and assumptions underlying these financial statements and accompanying notes generally involve revenues and bad debt provisions, and correspondingly accounts receivable. The results of operations for the three month period ended March 31, 2002 are not necessarily indicative of the operating results for the full year. The consolidated interim financial statements should be read in conjunction with the Management’s Discussion and Analysis and consolidated financial statements and notes thereto included in the Company’s 2001 Form 10-K. Certain reclassifications have been made for consistent presentation.
 
2.    Significant new accounting standards
 
The Company has adopted Statement of Financial Accounting Standards (SFAS) No. 142, Goodwill and Other Intangible Assets, and SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. Under SFAS No. 142, goodwill is not amortized effective January 1, 2002. SFAS No. 142 also requires that the goodwill balance be regularly assessed for possible valuation impairment and that there be an impairment charge against current earnings if the recorded goodwill balance exceeds fair value. If this standard had been implemented as of January 1, 2001, amortization expense would have been reduced by approximately $6,300 net of tax, for the three months ended March 31, 2001 and net income and diluted earnings per share would have been approximately $37,300 and $0.41 per share.
 
SFAS No. 144 supercedes SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of. Other than expanding discontinued operations treatment, previously applied only to operating segments, SFAS No. 144 does not fundamentally alter the provisions of SFAS No. 121. Adoption of this standard did not have a material impact on the Company’s financial position or results of operations.
 
3.    Shareholders’ equity
 
In November 2001, the Board of Directors approved a stock repurchase program authorizing management to repurchase up to $200,000 of the Company’s common stock on the open market. As of March 31, 2002, a total of 3,708,400 shares at a cost of approximately $85,743 were repurchased under this program. This program was discontinued in connection with the recapitalization plan described in note 4.

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DAVITA INC.
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(continued)
(unaudited)
(dollars in thousands except per share data)

 
Earnings per share
 
The reconciliation of the numerators and denominators used to calculate basic and diluted earnings per share is as follows:
 
    
Three months ended March 31,
    
2002
   
2001
    
(in thousands
except per share)
Basic:
              
Net income
   
$
35,978
   
$
30,934
    
  
Weighted average shares outstanding
   
 
82,925
   
 
82,537
Vested deferred stock units
   
 
42
       
    
  
Shares for basic earnings per share
   
 
82,967
   
 
82,537
    
  
Basic earnings per share
   
$
0.43
   
$
0.37
    
  
Diluted:
              
Net income
   
$
35,978
   
$
30,934
Debt expense savings, net of tax, resulting from assumed conversion of convertible debt
   
 
4,915
   
 
4,662
    
  
Net income for diluted earnings per share
   
$
40,893
   
$
35,596
    
  
Weighted average shares outstanding
   
 
82,925
   
 
82,537
Vested deferred stock units
   
 
42
       
Assumed incremental shares from stock option plans
   
 
3,885
   
 
4,270
Assumed incremental shares from convertible debt
   
 
15,394
   
 
15,394
    
  
Shares for diluted earnings per share
   
 
102,246
   
 
102,201
    
  
Diluted earnings per share
   
$
0.40
   
$
0.35
    
  
 
Options to purchase 643,573 shares at $23.61 to $33.00 per share and 2,207,367 shares at $16.77 to $33.50 per share were excluded from the diluted earnings per share calculations for the three months ended March 31, 2002 and 2001, respectively, because they were anti-dilutive. The calculation of diluted earnings per share assumes conversion of both the 5 5/8% convertible subordinated notes and the 7% convertible subordinated notes for the periods ended March 31, 2002 and 2001.
 
4.    Subsequent event
 
In March 2002, the Company initiated a recapitalization plan that includes the repurchase of up to 20 million shares of its common stock in a modified dutch auction tender offer at prices ranging from $22 to $26 per share at a total potential cost of up to $520,000 plus fees, and the repurchase of all of its $225,000 outstanding 9¼% Senior Subordinated Notes due 2011 at a total cost of approximately $265,000. On April 26, 2002, the Company completed the repurchase of its outstanding 9¼% Senior Subordinated Notes due 2011. The tender offer for the Company’s common stock has been extended until May 17, 2002. The Company has secured a new senior credit facility arrangement for up to $1,115,000 to finance these repurchases and to pay down all outstanding amounts under the previous existing senior credit facilities. The Company’s common stock has recently been trading below the tender offer range. As of the filing of this report, the Company is considering all

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DAVITA INC.
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(continued)
(unaudited)
(dollars in thousands except per share data)

options available regarding the stock tender, including completing the tender on the existing terms, lowering the price range and terminating the tender offer.
 
The new senior credit facility consists of a Term Loan A for up to $150,000 and a Term Loan B for up to $850,000 and a $115,000 undrawn revolving credit facility. The Term Loan A and the revolving credit facility bear interest at a rate equal to LIBOR plus a margin ranging from 1.50% to 2.75% based on the Company’s leverage ratio. The Term Loan B bears interest at LIBOR plus 3.00%. As of the filing of this report, $380,000 of the Term Loan B has been drawn. The Company has no obligation to draw the remaining amounts of the Term Loan A or the Term Loan B. If the entire $1,000,000 term credit facility is drawn, the aggregate annual amortization of principal will range from $15,000 to $51,000 in years one through five, $404,000 in years six and seven, and the balance will be due not later than 2009. The entire credit facility will be secured by all personal property of the Company and that of all wholly-owned subsidiaries, along with the stock of the Company’s subsidiaries.
 
5.    Contingencies
 
Health care provider revenues may be subject to adjustment as a result of (1) examination by government agencies or contractors, for which the resolution of any matters raised may take extended periods of time to finalize; (2) differing interpretations of government regulations by different fiscal intermediaries; (3) differing opinions regarding a patient’s medical diagnosis or the medical necessity of services provided; and (4) retroactive applications or interpretations of governmental requirements.
 
The Company’s Florida-based laboratory subsidiary is the subject of a third-party carrier review of its Medicare reimbursement claims. The carrier has issued formal overpayment determinations in the amount of $5,600 for the review period from January 1995 to April 1996 and $15,000 for the review period from May 1996 to March 1998. The carrier also has determined that $16,100 of the suspended claims for the review period from April 1998 to August 1999 and $11,600 of the suspended claims for the review period from August 1999 to May 2000 were not properly supported by the prescribing physicians’ medical justification. The carrier has alleged that approximately 99% of the tests the laboratory performed during the review period from January 1995 to April 1996, 96% of the tests performed in the period from May 1996 to March 1998, 70% of the tests performed in the period from April 1998 to August 1999, and 72% of the tests performed in the period from August 1999 to May 2000 were not properly supported by the prescribing physicians’ medical justification. In March 2002, the carrier requested selected patient records for two additional review periods, June 2000 to December 2000 and December 2000 to May 2001.
 
The Company is disputing the overpayment determinations and has provided supporting documentation of its claims. The Company has initiated the process of a formal review of each of the carrier’s determinations. The first step in this formal review process is a hearing before a hearing officer at the carrier. The hearing regarding the initial review period from January 1995 to April 1996 was held in July 1999. In January 2000, the hearing officer issued a decision upholding the overpayment determination of $5,600. The hearing regarding the second review period from May 1996 to March 1998 was held in April 2000. In July 2000, the hearing officer issued a decision upholding $14,200, or substantially all of the overpayment determination. The Company filed a consolidated appeal of both decisions to a federal administrative law judge. The appeal was divided into two separate hearings. The first took place in January 2002 and addressed the validity of the two statistical samples the carrier used to support its determinations. The Company is awaiting the judge’s decision. The second hearing will address the carrier’s determinations on the individual claims in the two samples. The administrative law judge previously informed the Company that it could expect the second hearing to occur in the second quarter of 2002.

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DAVITA INC.
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(continued)
(unaudited)
(dollars in thousands except per share data)

 
In addition to the formal appeal process with the carrier and the federal administrative law judge, beginning in the third quarter of 1999 the Company sought a meeting with the Department of Justice, or DOJ, to begin a process to resolve this matter. The carrier had previously informed the local office of the DOJ and the Department of Health and Human Services, or HHS, of this matter and the Company had provided requested information to the DOJ. The Company met with the DOJ in February 2001, at which time the DOJ requested additional information, which we have provided. The discussions with the DOJ are ongoing.
 
The carrier had also previously suspended all payments of Medicare claims from the laboratory, beginning in May 1998. In May 2002 the carrier informed the Company that the carrier will begin paying approved current Medicare claims. However, the laboratory’s Medicare claims will continue to be subject to the carrier’s existing payment screens, under which the carrier has been denying a substantial majority of claims. The Company currently intends to continue to appeal selected payment denials by the carrier, but no prediction can be made as to the outcome of any such appeals. The carrier’s action will not result in the release of any suspended payments for periods prior to May 2, 2002 and does not affect the status of the Company’s pending challenges to the carrier’s denials of previously submitted claims.
 
The timing of the final resolution of this matter is highly uncertain and beyond the Company’s control or influence. Based on the carrier’s overpayment findings noted above, the Company estimates that the potential cash exposure as of March 31, 2002 was not more than $10,000. If this matter is resolved in a manner adverse to the Company, the government could impose additional fines and penalties, which could be substantial. During 2000, the Company stopped accruing Medicare revenue from this laboratory because of the uncertainties regarding both the timing of resolution and the ultimate revenue valuations. Pending resolution of the revenue valuation uncertainties associated with current billings, the Company will recognize revenue only to the extent that the carrier makes payments to the laboratory.
 
The Medicare carrier for our Minnesota laboratory is conducting a post-payment review of Medicare reimbursement claims for the period January 1996 through December 1999. The scope of the review is similar to the review being conducted at our Florida laboratory. At this time, the Company is unable to determine how long it will take the carrier to complete this review. There is currently no overpayment determination or payment suspension with respect to the Minnesota laboratory. The DOJ has also requested information with respect to this laboratory, which the Company has provided. Medicare revenues at the Minnesota laboratory, which is much smaller than the Florida laboratory, were approximately $15,000 for the period under review. In November 2001, the Company closed the Minnesota laboratory and combined the operations of this laboratory with its Florida laboratory.
 
In February 2001, the Civil Division of the United States Attorney’s Office for the Eastern District of Pennsylvania in Philadelphia contacted the Company and requested its cooperation in a review of some of the Company’s historical practices, including billing and other operating procedures and its financial relationships with physicians. The Company cooperated in this review and provided the requested records to the United States Attorney’s office. In May 2002, the Company received a subpoena from the Philadelphia office of the Office of Inspector General for HHS, or OIG. The subpoena requires an update to the information the Company provided in its response to the February 2001 request, and also seeks a wide range of documents relating to pharmaceutical and other ancillary services provided to patients, including laboratory and other diagnostic testing services, as
well as documents relating to the Company’s financial relationships with physicians and pharmaceutical companies. The subpoena covers the period from May 1, 1996 to the present. We will be working with the United States Attorney’s Office and the OIG to provide the documents requested. The inquiry remains at an early stage. As it proceeds, the government could expand its areas of concern. If a court determines there has been wrongdoing, the penalties under applicable statutes could be substantial.

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DAVITA INC.
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(continued)
(unaudited)
(dollars in thousands except per share data)

 
In addition to the foregoing, DaVita is subject to claims and suits in the ordinary course of business. Management believes that the ultimate resolution of these additional pending proceedings, whether the underlying claims are covered by insurance or not, will not have a material adverse effect on the Company's financial condition, results of operations or cash flows.
 
6.    Condensed consolidating financial statements
 
The following information is presented as required under the Securities and Exchange Commission Financial Reporting Release No. 55 in connection with the Company’s publicly traded debt. The operating and investing activities of the separate legal entities included in the consolidated financial statements are fully interdependent and integrated. Revenues and operating expenses of the separate legal entities include intercompany charges for management and other services.
 
The $125,000 5 5/8% Convertible Subordinated Notes Due 2006, issued by the wholly-owned subsidiary Renal Treatment Centers, Inc., or RTC, are guaranteed by DaVita Inc. Non-wholly-owned subsidiaries, joint ventures and partnerships are not guarantors of this obligation.
 
Condensed Consolidating Balance Sheets
 
    
DaVita Inc.
   
RTC
   
Non-guarantor subsidiaries
   
Consolidating adjustments
     
Consolidated total
As of March 31, 2002
                                     
Cash and cash equivalents
   
$
31,692
   
$
5
                   
$
31,697
Accounts receivable, net
   
 
204,990
   
 
111,507
   
$
27,741
            
 
344,238
Other current assets
   
 
77,702
   
 
19,506
   
 
2,150
            
 
99,358
    
  
  
  
  
Total current assets
   
 
314,384
   
 
131,018
   
 
29,891
            
 
475,293
Property and equipment, net
   
 
168,368
   
 
64,191
   
 
23,487
            
 
256,046
Investments in subsidiaries
   
 
342,151
                 
$
(342,151
)
       
Receivables from subsidiaries
   
 
153,700
                 
 
(153,700
)
       
Amortizable intangible assets, net
   
 
47,217
   
 
15,850
   
 
7,122
            
 
70,189
Other assets
   
 
5,433
   
 
695
   
 
44
            
 
6,172
Goodwill
   
 
469,200
   
 
281,507
   
 
106,425
            
 
857,132
    
  
  
  
  
Total assets
   
$
1,500,453
   
$
493,261
   
$
166,969
   
$
(495,851
)
   
$
1,664,832
    
  
  
  
  
Current liabilities
   
$
300,132
   
$
8,364
   
$
4,314
            
$
312,810
Payables to subsidiaries/parent
          
 
137,515
   
 
16,185
   
$
(153,700
)
       
Long-term liabilities
   
 
703,301
   
 
125,442
   
 
4,836
            
 
833,579
Minority interests
                        
 
21,423
 
   
 
21,423
Shareholders’ equity
   
 
497,020
   
 
221,940
   
 
141,634
   
 
(363,574
)
   
 
497,020
    
  
  
  
  
Total liabilities and shareholders’ equity
   
$
1,500,453
   
$
493,261
   
$
166,969
   
$
(495,851
)
   
$
1,664,832
    
  
  
  
  
As of December 31, 2001
                                     
Cash and cash equivalents
   
$
34,949
   
$
1,762
                   
$
36,711
Accounts receivable, net
   
 
195,074
   
 
111,413
   
$
27,059
            
 
333,546
Other current assets
   
 
81,021
   
 
21,142
   
 
2,244
            
 
104,407
    
  
  
  
  
Total current assets
   
 
311,044
   
 
134,317
   
 
29,303
            
 
474,664
Property and equipment, net
   
 
169,675
   
 
59,717
   
 
23,386
            
 
252,778
Investments in subsidiaries
   
 
326,751
                 
$
(326,751
)
       
Receivables from subsidiaries
   
 
160,150
                 
 
(160,150
)
       
Amortizable intangible assets, net
   
 
49,479
   
 
16,294
   
 
7,335
            
 
73,108
Other assets
   
 
5,649
   
 
680
   
 
44
            
 
6,373
Goodwill
   
 
470,150
   
 
279,185
   
 
106,425
            
 
855,760
    
  
  
  
  
Total assets
   
$
1,492,898
   
$
490,193
   
$
166,493
   
$
(486,901
)
   
$
1,662,683
    
  
  
  
  
Current liabilities
   
$
283,387
   
$
10,728
   
$
4,566
            
$
298,681
Payables to subsidiaries/parent
          
 
140,548
   
 
19,602
   
$
(160,150
)
       
Long-term liabilities
   
 
705,874
   
 
128,976
   
 
4,793
            
 
839,643
Minority interests
                        
 
20,722
 
   
 
20,722
Shareholders’ equity
   
 
503,637
   
 
209,941
   
 
137,532
   
 
(347,473
)
   
 
503,637
    
  
  
  
  
Total liabilities and shareholders’ equity
   
$
1,492,898
   
$
490,193
   
$
166,493
   
$
(486,901
)
   
$
1,662,683
    
  
  
  
  

8

Table of Contents

DAVITA INC.
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(continued)
(unaudited)
(dollars in thousands except per share data)

 
Condensed Consolidating Statements of Income
 
    
DaVita Inc.
   
RTC
     
Non-guarantor subsidiaries
   
Consolidating adjustments
     
Consolidated total
  
For the three months ended March 31, 2002
                                         
Net operating revenues
   
$
272,862
   
$
137,960
     
$
46,690
   
$
(29,847
)
   
$
427,665
 
Operating expenses
   
 
227,669
   
 
115,500
     
 
35,425
   
 
(29,847
)
   
 
348,747
 
    
  
    
  
  
Operating income
   
 
45,193
   
 
22,460
     
 
11,265
   
 
—  
 
   
 
78,918
 
Other income
   
 
565
                            
 
565
 
Debt expense
   
 
12,170
   
 
1,767
     
 
1,135
            
 
15,072
 
Minority interests
                          
 
(2,433
)
   
 
(2,433
)
Income taxes
   
 
17,300
   
 
8,694
     
 
6
            
 
26,000
 
Equity earnings in consolidated subsidiaries
   
 
19,690
                   
 
(19,690
)
         
    
  
    
  
  
Net income
   
$
35,978
   
$
11,999
     
$
10,124
   
$
(22,123
)
   
$
35,978
 
    
  
    
  
  
For the three months ended March 31, 2001
                                         
Net operating revenues
   
$
256,150
   
$
117,789
     
$
44,147
   
$
(31,869
)
   
$
386,217
 
Operating expenses
   
 
211,182
   
 
98,563
     
 
32,874
   
 
(31,869
)
   
 
310,750
 
    
  
    
  
  
Operating income
   
 
44,968
   
 
19,226
     
 
11,273
            
 
75,467
 
Other income
   
 
1,290
   
 
58
                     
 
1,348
 
Debt expense
   
 
16,650
   
 
1,743
     
 
1,331
            
 
19,724
 
Minority interests
                          
 
(2,457
)
   
 
(2,457
)
Income taxes
   
 
16,237
   
 
7,463
                     
 
23,700
 
Equity earnings in consolidated subsidiaries
   
 
17,563
                   
 
(17,563
)
         
    
  
    
  
  
Net income
   
$
30,934
   
$
10,078
     
$
9,942
   
$
(20,020
)
   
$
30,934
 
    
  
    
  
  

9

Table of Contents

DAVITA INC.
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(continued)
(unaudited)
(dollars in thousands except per share data)

Condensed Consolidating Statements of Cash Flows
 
    
DaVita Inc.
     
RTC
       
Non-guarantor subsidiaries
     
Consolidating adjustments
     
Consolidated total
  
For the three months ended March 31, 2002
                                               
Cash flows from operating activities
                                               
Net income
   
$
35,978
 
   
$
11,999
 
     
$
10,124
 
   
$
(22,123
)
   
$
35,978
 
Changes in operating and intercompany assets and liabilities and non cash items included in net income
   
 
40,514
 
   
 
(4,746
)
     
 
(8,884
)
   
 
22,123
 
   
 
49,007
 
    
  
    
  
  
Net cash provided by (used in) operating activities
   
 
76,492
 
   
 
7,253
 
     
 
1,240
 
   
 
—  
 
   
 
84,985
 
    
  
    
  
  
Cash flows from investing activities
                                               
Purchases of property and equipment, net
   
 
(6,870
)
   
 
(7,955
)
     
 
(1,290
)
            
 
(16,115
)
Acquisitions and divestitures, net
            
 
(1,379
)
                       
 
(1,379
)
Other items
   
 
499
 
                                
 
499
 
    
  
    
  
  
Net cash used in investing activities
   
 
(6,371
)
   
 
(9,334
)
     
 
(1,290
)
            
 
(16,995
)
    
  
    
  
  
Cash flows from financing activities
                                               
Long-term debt
   
 
(20,294
)
   
 
324
 
     
 
50
 
            
 
(19,920
)
Other items
   
 
(53,084
)
                                
 
(53,084
)
    
  
    
  
  
Net cash provided (used in) financing activities
   
 
(73,378
)
   
 
324
 
     
 
50
 
            
 
(73,004
)
    
  
    
  
  
Net decrease in cash
   
 
(3,257
)
   
 
(1,757
)
     
 
—  
 
            
 
(5,014
)
Cash at the beginning of the period
   
 
34,949
 
   
 
1,762
 
                       
 
36,711
 
    
  
    
  
  
Cash at the end of the period
   
$
31,692
 
   
$
5
 
     
$
—  
 
   
$
—  
 
   
$
31,697
 
    
  
    
  
  
For the three months ended March 31, 2001
                                               
Cash flows from operating activities
                                               
Net income
   
$
30,934
 
   
$
10,078
 
     
$
9,942
 
   
$
(20,020
)
   
$
30,934
 
Changes in operating and intercompany assets and liabilities and non cash items included in net income
   
 
24,041
 
   
 
(10,903
)
     
 
(6,261
)
   
 
20,020
 
   
 
26,897
 
    
  
    
  
  
Net cash provided by (used in) operating activities
   
 
54,975
 
   
 
(825
)
     
 
3,681
 
   
 
—  
 
   
 
57,831
 
    
  
    
  
  
Cash flows from investing activities
                                               
Purchases of property and equipment, net
   
 
(2,888
)
   
 
(1,039
)
     
 
(2,828
)
            
 
(6,755
)
Acquisitions and divestitures, net
   
 
(50,667
)
                                
 
(50,667
)
Other items
   
 
19,568
 
              
 
25
 
            
 
19,593
 
    
  
    
  
  
Net cash used in investing activities
   
 
(33,987
)
   
 
(1,039
)
     
 
(2,803
)
            
 
(37,829
)
    
  
    
  
  
Cash flows from financing activities:
                                               
Long-term debt
   
 
(37,468
)
              
 
614
 
            
 
(36,854
)
Other items
   
 
4,580
 
              
 
(1,492
)
            
 
3,088
 
    
  
    
  
  
Net cash provided (used in) financing
activities
   
 
(32,888
)
              
 
(878
)
            
 
(33,766
)
    
  
    
  
  
Net decrease in cash
   
 
(11,900
)
   
 
(1,864
)
     
 
—
 
            
 
(13,764
)
Cash at the beginning of the period
   
 
29,336
 
   
 
1,871
 
                       
 
31,207
 
    
  
    
  
  
Cash at the end of the period
   
$
17,436
 
   
$
7
 
     
$
—  
 
   
$
—  
 
   
$
17,443
 
    
  
    
  
  

10

Table of Contents
 
Item 2.     Management’s Discussion and Analysis of Financial Condition and Results of Operations.
 
Forward-looking statements
 
This Form 10-Q contains statements that are forward-looking statements within the meaning of the federal securities laws, including statements about our expectations, beliefs, intentions or strategies for the future. These statements involve known and unknown risks and uncertainties, including risks resulting from the regulatory environment in which we operate, economic and market conditions, competitive activities, other business conditions, accounting estimates, and the risk factors set forth in this Form 10-Q. These risks, among others, include those relating to possible reductions in private and government reimbursement rates, the concentration of profits generated from PPO and private and indemnity patients and from ancillary services including the administration of pharmaceuticals, the ongoing review of the Company’s Florida laboratory subsidiary by its Medicare carrier and the Department of Justice, the ongoing review by the US Attorney’s Office and the HHS Office of Inspector General in Philadelphia and the Company’s ability to maintain contracts with physician medical directors. Our actual results may differ materially from results anticipated in our forward-looking statements. We base our forward-looking statements on information currently available to us, and we have no current intention to update these statements, whether as a result of changes in underlying factors, new information, future events or other developments.
 
Results of operations
 
Continental U.S. and non-continental U.S. operating revenues and operating expenses were as follows (dollars in millions):
 
    
Quarter ended
  
    
March 31,
2002
       
December 31,
2001
       
March 31,
2001
  
Revenues:
                                              
Continental U.S.
   
$
424
   
99
%
     
$
426
   
99
%
     
$
382
   
99
%
Non-continental U.S.
   
 
4
   
1
%
     
 
4
   
1
%
     
 
4
   
1
%
    
  
    
  
    
  
    
 
428
   
100
%
     
 
430
   
100
%
     
 
386
   
100
%
    
  
    
  
    
  
Operating expenses:
                                              
Continental U.S.
   
 
345
   
99
%
     
 
350
   
99
%
     
 
306
   
98
%
Non-continental U.S.
   
 
4
   
1
%
     
 
5
   
1
%
     
 
5
   
2
%
    
  
    
  
    
  
    
 
349
   
100
%
     
 
355
   
100
%
     
 
311
   
100
%
    
  
    
  
    
  
Consolidated operating income
   
$
79
            
$
75
            
$
75
       
    
           
           
      
 
The Company’s divestiture of its dialysis operations outside the continental United States was substantially completed during 2000, reducing the number of dialysis centers that we operate outside the continental United States from 84 to two by the end of 2000. Because all operations outside the continental United States have been divested with the exception of the pending completion of the sale of two centers in Puerto Rico, the non-continental U.S. operating results are excluded from the revenue and cost trends discussed below.
 

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Table of Contents
 
Continental U.S. operations
(dollars in millions)
 
    
Quarter ended
  
    
March 31,
2002
       
December 31,
2001
       
March 31,
2001
  
Revenues
   
$
424
   
100
%
     
$
426
 
   
100
%
     
$
382
   
100
%
    
  
    
  
    
  
Operating expenses:
                                                
Dialysis centers and labs
   
 
288
   
68
%
     
 
288
 
   
68
%
     
 
256
   
67
%
General and administrative
   
 
36
   
8
%
     
 
34
 
   
8
%
     
 
32
   
8
%
Depreciation and amortization
   
 
16
   
4
%
     
 
26
 
   
6
%
     
 
26
   
7
%
Provision for uncollectible accounts (excluding recoveries of $2, $5 and $16 associated with amounts reserved in 1999)
   
 
7
   
2
%
     
 
8
 
   
2
%
     
 
8
   
2
%
Impairment gains
                   
 
(1
)
                       
    
           
           
      
    
 
347
   
82
%
     
 
355
 
   
83
%
     
 
322
   
84
%
    
           
           
      
Operating income (excluding recoveries and
impairment gains)
   
$
77
   
18
%
     
$
71
 
   
17
%
     
$
60
   
16
%
    
           
           
      
Dialysis treatments (000’s)
   
 
1,434
            
 
1,482
 
            
 
1,366
       
Average dialysis treatments per treatment day
   
 
18,767
            
 
18,618
 
            
 
17,677
       
Average dialysis revenue per dialysis treatment
   
$
290
            
$
283
 
            
$
274
       
 
Net operating revenues for the continental U.S. operations were $424 million for the first quarter of 2002, an increase of 11% from the first quarter of 2001. Approximately 6% of the increase in revenue was due to higher average revenue per treatment and approximately 5% was due to the increase in the number of treatments. The average dialysis revenue per treatment (excluding lab and clinical research revenues and management fee income) was $290 for the first quarter of 2002, compared to $274 for the same period of 2001. The increase in average revenue per treatment was principally due to increases in our standard fee schedules (impacting non-contract commercial revenue), changes in mix and intensity of physician prescribed pharmaceuticals, and continued improvements in revenue capture, billing and collecting operations, and payor contracting. The increase in the number of treatments was principally attributable to same center growth, which was 4.2% in the first quarter of 2002 compared to 4.0% in the first quarter of 2001. Other operating revenues were approximately $7 million in the first quarter of 2002, a decrease of approximately $1 million from the first quarter of 2001.
 
First quarter 2002 net operating revenues were approximately the same as in the fourth quarter of 2001. The number of treatments decreased by approximately 3% in the first quarter, principally due to fewer treatment days in the first quarter. Net dialysis revenue per treatment in the first quarter of 2002 increased approximately $7 from the fourth quarter of 2001, which offset most of the decrease in revenue due to fewer treatment days. The increase was due to improvements in revenue realization as noted above.
 
Center operating expenses were approximately 68% of net operating revenues for continental U.S. operations in the first quarter of 2002 and the fourth quarter of 2001, and 67% in the first quarter of 2001. On a per-treatment basis, center operating expenses for the first quarter of 2002 were approximately $7 higher than the fourth quarter of 2001 and approximately $13 higher than in the first quarter of 2001. The higher average cost per treatment was primarily attributable to higher labor and drug costs.
 
General and administrative expense was approximately 8% of net operating revenues for continental U.S. operations for the first quarter of 2002, approximately the same as in 2001. In absolute dollar amounts, general and administrative expenses were approximately 6% higher in the first quarter of 2002 as compared to the fourth quarter of 2001. The increase in the dollar amount of general and administrative expenses was primarily attributable to increases in labor costs and continued investments in infrastructure.

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Table of Contents
 
The provisions for uncollectible accounts receivable before considering cash recoveries were approximately 1.8% in the first quarter of 2002, compared to 2% in both the fourth quarter of 2001 and the first quarter of 2001. The decrease in the provision resulted from continued improvements in billing and collecting processes. During the first quarter of 2002, we realized cash recoveries of approximately $2 million, compared to $5 million in the fourth quarter of 2001 and $16 million in the first quarter of 2001. The recoveries are the result of improved collection processes and are associated with aged accounts receivables reserved in 1999.
 
Debt expense of $15 million for the first quarter of 2002 was approximately $5 million lower than the the first quarter of 2001 due to lower effective interest rates and reduced debt balances.
 
Projections for 2002 and 2003
 
Based on the current conditions and recent experience, our current projections for 2002 remain unchanged, that is, normal operating earnings before depreciation and amortization, debt expense and taxes, or EBITDA, in the range of $350 million to $380 million. In the near term we expect recent expense trends to continue, and as a result EBITDA may be several million dollars lower in the second quarter of 2002 than in the first quarter. Our current projections for 2003 are for EBITDA to be in the same range as in 2002, that is, $350 million to $380 million.
 
These projections assume minimal acquisitions, an internal growth rate of the number of dialysis treatments of approximately 3%-4%, no increase in the Medicare composite rate, minimal incremental revenue from our laboratory beginning in May 2002 due to the change in payment status, some reduction in the levels of revenues from physician prescribed pharmaceuticals due to changes in reimbursement policies, incremental legal and other expenses of approximately $6 million to $12 million per year related to the OIG subpoena and the associated government investigation, and underlying cost growth trends consistent with recent years, with additional substantial investments in infrastructure, process improvement initiatives and training planned for 2002 and 2003. These and other underlying assumptions involve significant risks and uncertainties, and actual results may vary significantly from these current projections. Additionally, the renegotiation or restructuring of unfavorable managed care contracts, medical director agreements or other arrangements may result in future impairments or other charges. We undertake no duty to update these projections, whether due to changes in current or expected trends, underlying market conditions, decisions of the United States Attorney’s Office, the Department of Justice or the Office of Inspector General of the Department of Health and Human Services in any pending or future review of our business, or otherwise.
 
Significant new accounting standards
 
We have adopted Statement of Financial Accounting Standards (SFAS) No. 142, Goodwill and Other Intangible Assets, and SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. Under SFAS No. 142, goodwill is not amortized effective January 1, 2002. SFAS No. 142 also requires that the goodwill balance be regularly assessed for possible valuation impairment and that there be an impairment charge against current earnings if the recorded goodwill balance exceeds fair value. If this standard had been implemented as of January 1, 2001, amortization expense would have been reduced by approximately $6.3 million net of tax, for the first quarter of 2001 and net income and diluted earnings per share would have been approximately $37.3 million and $0.41 per share.
 
SFAS No. 144 supercedes SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of. Other than expanding discontinued operations treatment, previously applied only to operating segments, SFAS No. 144 does not fundamentally alter the provisions of SFAS No. 121. Adoption of this standard did not have a material impact on our financial position or results of operations.

13

Table of Contents
 
Liquidity and capital resources
 
Cash flow from operations during the first quarter of 2002 amounted to $85 million. The non-operating cash outflows included paying down long-term debt by $20 million, repurchasing approximately 2.9 million shares of common stock at a total cost of $68 million and investing $16 million in capital assets.
 
In March 2002, we initiated a recapitalization plan that includes the repurchase of up to 20 million shares of our common stock in a modified dutch auction tender offer at prices ranging from $22 to $26 per share at a total potential cost of up to $520 million plus fees and the repurchase of all of our $225 million outstanding 9 1/4% Senior Subordinated Notes due 2011 at a total cost of approximately $265 million. On April 26, 2002, we completed our repurchase of the outstanding 9 1/4% Senior Subordinated Notes due 2011. Our tender offer for our common stock has been extended until May 17, 2002. We have secured a new senior credit facility arrangement for up to $1.15 billion to finance these repurchases and to pay down all outstanding amounts under our previous existing senior credit facilities. Our common stock has recently been trading below the tender offer range. As of the filing of this report, we are considering all options available regarding the stock tender, including completing the tender on the existing terms, lowering the price range and terminating the tender offer.
 
The new senior credit facility consists of a Term Loan A for up to $150 million and a Term Loan B for up to $850 million and a $115 million revolving credit facility. The Term Loan A and the revolving credit facility bear interest at a rate equal to LIBOR plus a margin ranging from 1.50% to 2.75% based on our leverage ratio. The Term Loan B bears interest at LIBOR plus 3.00%. As of the filing of this report, $380 million of the Term Loan B has been drawn. We have no obligation to draw the remaining amounts of the Term Loan A or the Term Loan B. If the entire $1 billion term credit facility is drawn, the aggregate annual amortization of principal will range from $15 million to $51 million in years one through five, $404 million in years six and seven, and the balance will be due not later than 2009. The entire credit facility is secured by all of our personal property and that of all of our wholly-owned subsidiaries, along with all of the stock of our subsidiaries.
 
Continental U.S. accounts receivable at March 31, 2002 amounted to $337 million, an increase of approximately $13 million during the quarter. The first quarter continental U.S. accounts receivable balance represented approximately 73 days of revenue, an increase of approximately 1 day for the quarter.
 
Our current plans continue to call for a significant increase in capital expenditures this year, including significant investment expenditures for information technology projects and for new dialysis centers, relocations and expansions.
 
We believe that we will have sufficient liquidity and operating cash flows to fund our scheduled debt service and other obligations over the next twelve months.
 
Item 3.     Quantitative and Qualitative Disclosures About Market Risk.
 
As of March 31, 2002, there have been no material changes in our market risk exposure from that reported in our Form 10-K for the fiscal year ended December 31, 2001.

14

Table of Contents
 
RISK FACTORS
 
This Form 10-Q contains statements that are forward-looking statements within the meaning of the federal securities laws, including statements about our expectations, beliefs, intentions or strategies for the future. These forward-looking statements include statements regarding our expectations for treatment growth rates, revenue per treatment, expense growth, levels of the provision for uncollectible accounts receivable, earnings before depreciation and amortization, debt expense and taxes, and capital expenditures. We base our forward-looking statements on information currently available to us, and we do not intend to update these statements, whether as a result of changes in underlying factors, new information, future events or other developments.
 
These statements involve known and unknown risks and uncertainties, including risks resulting from economic and market conditions, the regulatory environment in which we operate, competitive activities and other business conditions. Our actual results may differ materially from results anticipated in these forward-looking statements. Important factors that could cause actual results to differ materially from the forward-looking statements include those set forth below. The risks discussed below are not the only ones facing our business.
 
If the percentage of our patients paying at or near our list prices declines, then our revenues, cash flows and earnings would be substantially reduced.
 
Approximately 42% to 44% of our continental U.S. dialysis revenues are generated from patients who have private payors as the primary payor. A minority of these patients have insurance policies that reimburse us at or near our list prices, which are significantly higher than Medicare rates. The majority of these patients have insurance policies that reimburse us at rates that are below our list prices but, in most cases, higher than Medicare rates. We believe that pressure from private payors to decrease the rates they pay us may increase. If the percentage of patients who have insurance that pays us at or near our list prices decreases significantly, it would have a material adverse effect on our revenues, cash flows and earnings.
 
If we are unable to renegotiate material contracts with managed care plans on acceptable terms, we may experience a decline in same center growth.
 
We have contracts with some large managed care plans that include unfavorable terms. Although we are attempting to renegotiate the terms of these contracts, we cannot predict whether we will reach agreement on new terms or whether we will renew these contracts. As a result, we may lose numerous patients of these managed care plans and experience a decline in our same center growth, which would negatively impact our revenues.
 
Changes in clinical practices and reimbursement rates or rules for EPO and other drugs could substantially reduce our revenue and earnings.
 
The administration of EPO and other drugs accounts for approximately 35% to 40% of our net operating revenue. Changes in physician practice patterns and accepted clinical practices, changes in private and governmental reimbursement rates and rules, the introduction of new drugs and the conversion to alternate types of administration, for example from intravenous administration to subcutaneous or oral administration, that may also result in lower or less frequent dosages, could reduce our revenues and earnings from the administration of EPO and other drugs. For example, some of the Medicare intermediaries throughout the U.S. are seeking to implement local medical review policies for EPO and vitamin D analogs that would, effectively, limit utilization of and reimbursement for these drugs.
 
Future declines, or the lack of further increases, in Medicare reimbursement rates would reduce our net income and cash flows.
 
Approximately 51% to 53% of our continental U.S. dialysis revenues were generated from patients who had Medicare as their primary payor.

15

Table of Contents
The Medicare ESRD program reimburses us for dialysis and ancillary services at fixed rates. Unlike many other Medicare programs, the Medicare ESRD program does not provide for periodic inflation increases in reimbursement rates. These rates have declined over 70% in real dollars since 1972. Increases of 1.2% in 2000 and 2.4% in 2001 were the first increases in the composite rate since 1991, and were significantly less than the cumulative rate of inflation since 1991. There was no increase to the composite rate for 2002. Increases in operating costs that are subject to inflation, such as labor and supply costs, have occurred and are expected to continue to occur without a compensating increase in reimbursement rates. We cannot predict the nature or extent of future rate changes, if any. To the extent these rates are not adjusted to keep pace with inflation, our net income and cash flows would be adversely affected.
 
Future changes in the structure of, and reimbursement rates under, the Medicare ESRD program could substantially reduce our operating earnings and cash flows.
 
In legislation enacted in December 2000, Congress mandated government studies on whether:
 
 
•
 
The Medicare composite rate for dialysis should be modified to include an annual inflation increase—study due July 2002;
 
 
•
 
The Medicare composite rate for dialysis should be modified to include additional services, such as laboratory and other diagnostic tests and the administration of EPO and other pharmaceuticals, in the composite rate—study due July 2002; and
 
 
•
 
Reimbursement for many outpatient prescription drugs that we administer to dialysis patients should be reduced from the current rate of 95% of the average wholesale price. This study was completed; the resulting recommendations exclude most drugs administered during dialysis, but Congress has yet to act on these recommendations.
 
If Medicare began to include in its composite reimbursement rate any ancillary services that it currently reimburses separately, our revenue would decrease to the extent there was not a corresponding increase in that composite rate. In particular, Medicare revenue from EPO and other pharmaceuticals is approximately 40% to 42% of our total Medicare revenue. If these pharmaceuticals were included in the composite rate, and if the composite rate were not increased sufficiently, our operating earnings and cash flows could decrease substantially. Reductions in current reimbursement rates for EPO or other pharmaceuticals would also reduce our net earnings and cash flows.
 
If a significant number of physicians were to cease referring patients to our dialysis centers, whether due to regulatory or other reasons, our revenue and earnings would decline.
 
If a significant number of physicians stop referring patients to our centers, it could have a material adverse effect on our revenue and earnings. Many physicians prefer to have their patients treated at centers where they or other members of their practice supervise the overall care provided as medical directors of the centers. As a result, the primary referral source for our centers is often the physician or physician group providing medical director services to the center. If a medical director agreement terminates, whether before or at the end of its term, it may negatively impact the former medical director’s decision to treat his or her patients at our centers.
 
Our medical director contracts are for fixed periods, generally five to ten years. Medical directors have no obligation to extend their agreements with us. As of March 31, 2002, the agreements with medical directors at 52 centers required renewal on or before March 31, 2003. This includes agreements with terms expiring on or before March 31, 2003 and those with automatic renewal terms that will expire on or before March 31, 2003 if we or the medical director elect not to renew the agreement. In the twelve months ended March 31, 2002, we renewed agreements with medical directors at 14 centers, and were unable to renew one medical director agreement covering six centers. We have engaged replacement medical directors at these six centers, and the former medical director group is competing with us in a joint venture with another dialysis provider.

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We also may take actions to restructure existing relationships or take positions in negotiating extensions of relationships in order to assure compliance with anti-kickback and similar laws. These actions could negatively impact physicians’ decisions to extend their medical director agreements with us. For example, we have recalled stock options and we require monthly statements from our medical directors certifying that they have performed their contractual obligations. To our knowledge, we are the only major dialysis provider to have done this. In addition, if the terms of an existing agreement were found to violate applicable laws, we may not be successful in restructuring the relationship, which could lead to the early termination of the agreement.
 
If the current shortage of skilled clinical personnel or our high level of personnel turnover continues, we may experience disruptions in our business operations and increases in operating expenses.
 
We are experiencing increased labor costs and difficulties in hiring nurses due to a nationwide shortage of skilled clinical personnel. This shortage limits our ability to expand our operations. We also have a high personnel turnover rate in our dialysis centers. Turnover has been the highest among our technicians, nurses and unit secretaries. Recent efforts to reduce this turnover may not succeed. If we are not successful, or if we are unable to hire skilled clinical personnel when needed, our operations and our same center growth will be negatively impacted.
 
Adverse developments with respect to EPO could materially reduce our net income and cash flows and affect our ability to care for our patients.
 
Amgen is the sole supplier of EPO and may unilaterally decide to increase its price for EPO at any time. For example, Amgen unilaterally increased its base price for EPO by 3.9% in each of 2002, 2001 and 2000. Also, we cannot predict whether we will continue to receive the same discount structure for EPO that we currently receive, or whether we will continue to achieve the same levels of discounts within that structure as we have historically achieved. In addition, Amgen has developed a new product, NESP, that may replace EPO or reduce its use with dialysis patients. We cannot predict if or when NESP will be introduced to the U.S. dialysis market, nor what its cost and reimbursement structure will be. Increases in the cost of EPO and the introduction of NESP could have a material adverse effect on our net income and cash flows.
 
If we fail to adhere to all of the complex government regulations that apply to our business, we could suffer severe consequences that would substantially reduce our revenues and earnings.
 
Our dialysis operations are subject to extensive federal, state and local government regulations, including Medicare and Medicaid reimbursement rules and regulations and federal and state anti-kickback laws. The regulatory scrutiny of healthcare providers, including dialysis providers, has increased significantly in recent years. For the fiscal year ended September 30, 2001, the DOJ announced total recoveries of more than $1.2 billion from healthcare civil fraud cases. In the prior fiscal year, one of our competitors entered into a $486 million settlement as a result of an Office of Inspector General of the Department of Health and Human Services, or OIG, and DOJ investigation into some of its business practices. In addition, the frequency and intensity of Medicare certification surveys and inspections of dialysis centers has increased markedly since 2000, consistent with recommendations of the OIG.
 
We endeavor to comply with all of the requirements for receiving Medicare and Medicaid reimbursement and to structure all of our relationships with referring physicians to comply with the anti-kickback laws; however, the laws and regulations in this area are complex and subject to varying interpretations. In addition, our historic dependence on manual processes that vary widely across our network of dialysis centers exposes us to greater risk of errors in billing and other business processes.
 
If any of our operations are found to violate these or other government regulations, we could suffer severe consequences, including:
 
 
•
 
Mandated practice changes that significantly increase operating expenses;
 
 
•
 
Suspension of payments from government reimbursement programs;

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•
 
Refunds of amounts received in violation of law or applicable reimbursement program requirements;
 
 
•
 
Loss of required government certifications or exclusion from government reimbursement programs, such as the Medicare ESRD program and Medicaid programs;
 
 
•
 
Loss of licenses required to operate healthcare facilities in some of the states in which we operate; and
 
 
•
 
Fines or monetary penalties for anti-kickback law violations, submission of false claims or other failures to meet reimbursement program requirements.
 
The pending federal review of some of our practices and third-party carrier review of our laboratory subsidiary could result in substantial penalties against us.
 
We are voluntarily cooperating with the United States Attorney’s Office and HHS Office of Inspector General in Philadelphia in a review of some of our practices, including billing and other operating procedures, financial relationships with physicians and pharmaceutical companies, and the provision of pharmaceutical and other ancillary services. In addition, our Florida-based laboratory subsidiary is the subject of a third-party carrier review of claims it has submitted for Medicare reimbursement. The DOJ has also requested and received information regarding the laboratory. We are unable to determine when these matters will be resolved, whether any additional areas of inquiry will be opened or any outcome of these matters, financial or otherwise. Any negative findings could result in substantial financial penalties against us and exclusion from future participation in the Medicare and Medicaid programs.
 
Our rollout of new information technology systems may significantly disrupt our billing and collection activity, may not work as planned and could have a negative impact on our results of operations and financial condition.
 
We are rolling out new information technology systems and new processes in each of our dialysis centers over the next few years. It is likely that this rollout will disrupt our billing and collection activity and may cause other disruptions to our business operations, which may negatively impact our cash flows. Also, the new information systems may not work as planned or improve our billing and collection processes. If they do not, we may have to spend substantial amounts to enhance or replace these systems.
 
Provisions in our charter documents and compensation programs we have adopted may deter a change of control that our stockholders would otherwise determine to be in their best interests.
 
Our charter documents include provisions which may deter hostile takeovers, delay or prevent changes of control or changes in our management, or limit the ability of our stockholders to approve transactions that they may otherwise determine to be in their best interests. These include provisions prohibiting our stockholders from acting by written consent, requiring 60 days advance notice of stockholder proposals or nominations to our Board of Directors and granting our Board of Directors the authority to issue up to five million shares of preferred stock and to determine the rights and preferences of the preferred stock without the need for further stockholder approval.
 
In addition, most of our outstanding employee stock options include a provision accelerating the vesting of the options in the event of a change of control. We have also adopted a change of control protection program for our employees who do not have a significant number of stock options, which provides for cash bonuses to the employees in the event of a change of control. Based on the shares of our common stock outstanding and the market price of our stock on March 31, 2002, these cash bonuses would total approximately $78 million. These compensation programs may affect the price an acquirer would be willing to pay.
 
We may, in the future, adopt other measures that may have the effect of delaying, deferring or preventing an unsolicited takeover, even if such a change of control were at a premium price or favored by a majority of unaffiliated stockholders. Furthermore, we may adopt some of these measures without any further vote or action by our stockholders.

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PART II
 
OTHER INFORMATION
 
Item 1.     Legal Proceedings
 
The information in Note 5 of the Notes to Condensed Consolidated Financial Statements in Part I, Item 1 of this report is incorporated by this reference in response to this item.
 
Items 2 and 3 are not applicable.
 
Item 4.     Submission of Matters to a Vote of Security Holders
 
Our annual meeting of stockholders was held on April 11, 2002.
 
Proposal 1 submitted to our stockholders at the meeting was the election of directors. The following directors were elected at the meeting with the number of votes cast for each director or withheld from each director set forth after the director’s respective name.
 
Name
   
Votes for Director
   
Authority Withheld
Nancy-Ann DeParle
   
74,921,086
   
1,517,868
Richard B. Fontaine
   
75,372,944
   
1,066,010
Peter T. Grauer
   
75,372,483
   
1,066,471
C. Raymond Larkin, Jr.
   
74,976,272
   
1,462,682
John M. Nehra
   
74,976,872
   
1,462,082
William L. Roper
   
75,371,783
   
1,067,171
Kent J. Thiry
   
64,607,023
   
11,831,931
 
Proposal 2 submitted to our stockholders at the meeting was the approval of our proposed 2002 Equity Compensation Plan. The votes were cast as follows:
 
For
  
Against
  
Abstain
59,999,276
  
16,345,516
  
94,162
 
Item 5 is not applicable.
 

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Item 6.     Exhibits and Reports on Form 8-K
 
(a)    Exhibits
 
Exhibit Number
   
Description
10.1
   
Credit Agreement, dated as of April 26, 2002, by and among DaVita Inc., the lenders party thereto, Credit Suisse First Boston Corporation as Administrative Agent and Joint Book Manager, Banc of America Securities LLC as Joint Book Manager and Bank of America, N.A., as Syndication Agent (the “Credit Agreement”). ü**
10.2
   
Amendment No. 1, dated as of May 9, 2002 to the Credit Agreement by and among DaVita, Inc., the lenders party thereto, Credit Suisse First Boston Corporation as Administrative Agent and Joint Book Manager, Banc of America Securities LLC as Joint Book Manager and Bank of America, N.A., as Syndication Agent. ü
10.3
   
Security Agreement, dated as of April 26, 2002, made by DaVita Inc. and the subsidiaries of DaVita Inc. named therein to Credit Suisse First Boston, Cayman Islands Branch, as the Collateral Agent for the lenders party to the Credit Agreement. ü
10.4
   
Subsidiary Guarantee, dated as of April 26, 2002, made by the subsidiaries of DaVita Inc. named therein in favor of the lenders party to the Credit Agreement. ü
10.5
   
2002 Equity Compensation Plan (1)*
10.6
   
Employment Agreement, dated as of April 1, 2001, by and between DaVita Inc. and Richard K. Whitney.ü*
12.1
   
Ratio of earnings to fixed charges.ü
ü
 
Filed herewith.
*
 
Management contract or executive compensation plan or arrangement.
**
 
Portions of this exhibit are subject to a request for confidential treatment and have been redacted and filed separately with the SEC.
 
(1)
 
Filed on March 14, 2002 as an exhibit to the Definitive Proxy Statement for our 2002 Annual Meeting of Stockholders.
 
(b)     Reports on Form 8-K
 
None.
 

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SIGNATURE
 
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
DAVITA INC.
By:
  
/s/    GARY W. BEIL        
   
Gary W. Beil
Vice President and Controller*
 
Date:  May 14, 2002
 
*
 
Mr. Beil has signed both on behalf of the registrant as a duly authorized officer and as the Registrant’s chief accounting officer.

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INDEX TO EXHIBITS
 
Exhibit Number
   
Description
10.1
   
Credit Agreement, dated as of April 26, 2002, by and among DaVita Inc., the lenders party thereto, Credit Suisse First Boston Corporation as Administrative Agent and Joint Book Manager, Banc of America Securities LLC as Joint Book Manager and Bank of America, N.A., as Syndication Agent (the “Credit Agreement”). ü**
10.2
   
Amendment No. 1, dated as of May 9, 2002 to the Credit Agreement by and among DaVita Inc., the lenders party thereto, Credit Suisse First Boston Corporation as Administrative Agent and Joint Book Manager, Banc of America Securities LLC as Joint Book Manager and Bank of America, N.A., as Syndication Agent. ü
10.3
   
Security Agreement, dated as of April 26, 2002, made by DaVita Inc. and the subsidiaries of DaVita Inc. named therein to Credit Suisse First Boston, Cayman Islands Branch, as the Collateral Agent for the lenders party to the Credit Agreement. ü
10.4
   
Subsidiary Guarantee, dated as of April 26, 2002, made by the subsidiaries of DaVita Inc. named therein in favor of the lenders party to the Credit Agreement. ü
10.5
   
2002 Equity Compensation Plan (1)*
10.6
   
Employment Agreement, dated as of April 1, 2001, by and between DaVita Inc. and Richard K. Whitney.ü*
12.1
   
Ratio of earnings to fixed charges.ü
ü
 
Filed herewith.
*
 
Management contract or executive compensation plan or arrangement.
**
 
Portions of this exhibit are subject to a request for confidential treatment and have been redacted and filed separately with the SEC.
 
(1)
 
Filed on March 14, 2002 as an exhibit to the Definitive Proxy Statement for our 2002 Annual Meeting of Stockholders.

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