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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K
For the Fiscal Year Ended December 31, 2000
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission File Number: 1-4034
DAVITA INC.
(Former name: Total Renal Care Holdings, Inc.)
21250 Hawthorne Blvd., Suite 800
Torrance, California 90503-5517
Telephone number (310) 792-2600
Delaware 51-0354549
(State of incorporation) (I.R.S. Employer
Identification No.)
Securities registered pursuant to Section 12(b) of the Act:
Class of Security: Registered on:
Common Stock, $0.001 par value New York Stock Exchange
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.
Disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not
contained herein, and will not be contained to the best of Registrant's
knowledge, in definitive proxy or information statements incorporated by
reference in Part III of this Form 10-K or any amendments to this Form 10-K.
As of March 12, 2001, the number of shares of the Registrant's common stock
outstanding was 82,732,250 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 $1.36 billion.
Documents incorporated by reference
Portions of the Registrant's proxy statement for its 2001 annual meeting of
stockholders are incorporated by reference in Part III of this Form 10-K.
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PART I
Item 1. Business.
The following should be read in conjunction with our consolidated financial
statements and the related notes contained elsewhere in this Form 10-K. This
Form 10-K contains forward-looking statements that involve risks and
uncertainties. Our actual results may differ significantly from the results
discussed in the forward-looking statements.
Overview
DaVita Inc., headquartered in Torrance, California, is the second largest
provider of dialysis services in the United States for patients suffering from
chronic kidney failure, also known as end stage renal disease, or ESRD. We
currently operate 488 outpatient dialysis centers located in 32 states and the
District of Columbia, serving over 41,000 patients. In addition, we provide
acute inpatient dialysis services in more than 275 hospitals.
Beginning in late 1999, we initiated a multiyear turnaround plan focused on
improving our financial and operational infrastructure. In October 1999, Kent
Thiry was named our chairman and chief executive officer. During 2000, we sold
our non-continental U.S. operations, restructured our credit facilities and
reduced our debt, settled a securities class action lawsuit, improved
collections and focused on our core operations.
Effective October 9, 2000, we changed our name from Total Renal Care Holdings
to DaVita. Our common stock trades on the NYSE under our new ticker symbol
"DVA".
The dialysis industry
ESRD is the state of advanced kidney impairment that is irreversible and
requires routine dialysis treatments or kidney transplantation to sustain life.
Dialysis is the removal of toxins, fluids and salt from the blood of ESRD
patients by artificial means. Patients suffering from ESRD generally require
dialysis at least three times per week for the rest of their lives.
Since 1972, the federal government has provided universal reimbursement for
dialysis under the Medicare ESRD program regardless of age or financial
circumstances. Under this system, Congress establishes Medicare reimbursement
rates for dialysis treatments and related supplies, tests and medications.
ESRD patient base
According to the United States Renal Data System, or USRDS, the number of
ESRD patients in the United States, including patients with functioning
transplants, is forecasted to increase from approximately 324,000 at the end of
1998 to approximately 660,000 in 2010, a compound annual growth rate of
approximately 6%. We believe factors affecting this growth include:
. The continued aging of the general population;
. Better treatment and longer survival of patients with diseases that
typically lead to ESRD, including diabetes and hypertension;
. Improved medical and dialysis technology; and
. The growth of minority populations that have a higher incidence rate of
ESRD.
Treatment options for ESRD
Treatment options for ESRD are hemodialysis, peritoneal dialysis and kidney
transplantation. According to the USRDS, of the approximately 324,000 ESRD
patients in the United States at the end of 1998, approximately 233,000
patients were receiving dialysis. The number of ESRD patients receiving
dialysis treatments is forecasted
2
to grow to approximately 520,000 in 2010, a compound annual growth rate of
approximately 7%. In 2000, hemodialysis treatments, excluding treatments to
hospital inpatients, accounted for approximately 87% of our total dialysis
treatments.
.Hemodialysis
Hemodialysis, the most common form of ESRD treatment, is usually performed
either in a freestanding or hospital-based outpatient center. A patient can
also perform hemodialysis at home with assistance. Hemodialysis uses an
artificial kidney, called a dialyzer, to remove toxins, fluids and salt from
the patient's blood, combined with a machine to control external blood flow and
monitor vital signs. The dialysis process occurs across a semi-permeable
membrane that divides the dialyzer into two distinct chambers. While blood is
circulated through one chamber, a pre-mixed dialyzer fluid is circulated
through the other chamber. The toxins, salt and excess fluids from the blood
selectively cross the membrane into the dialyzer fluid, allowing cleansed blood
to return into the patient's body. Each hemodialysis treatment typically lasts
approximately three and one-half hours. Hemodialysis is usually performed three
times per week.
.Peritoneal dialysis
A patient generally performs peritoneal dialysis at home. The most common
methods of peritoneal dialysis are continuous ambulatory peritoneal dialysis,
or CAPD, and continuous cycling peritoneal dialysis, or CCPD. All forms of
peritoneal dialysis use the patient's peritoneal, or abdominal, cavity to
eliminate fluid and toxins. Because it does not involve going to a center three
times a week for treatment, peritoneal dialysis is an attractive alternative to
hemodialysis for patients who desire more freedom in their lifestyle. However,
peritoneal dialysis is not a suitable method of treatment for many patients,
including patients who are not able to perform the necessary procedures and
those at greater risk of peritoneal infection.
CAPD introduces dialysis solution into the patient's peritoneal cavity
through a surgically placed catheter. Toxins in the blood continuously cross
the peritoneal membrane into the dialysis solution. After several hours, the
patient drains the used dialysis solution and replaces it with fresh solution.
This procedure is usually repeated four times per day.
CCPD is performed in a manner similar to CAPD, but uses a mechanical device
to cycle dialysis solution through the patient's peritoneal cavity while the
patient is sleeping or at rest.
.Transplantation
An alternative treatment that we do not provide is kidney transplantation.
However, we do provide both pre- and post-transplant nursing services.
Although transplantation, when successful, is generally the most desirable
form of therapeutic intervention, the shortage of suitable donors, side effects
of immunosuppressive drugs given to transplant recipients and dangers
associated with transplant surgery for some patient populations limit the use
of this treatment option. The USRDS reports that while the number of
transplants performed have increased since 1994, the rate of transplantation is
not keeping pace with the growth in the ESRD patient population.
Outpatient dialysis services
Our dialysis centers are designed specifically for outpatient hemodialysis.
Throughout our network of outpatient dialysis centers, we also provide
training, supplies and on-call support services to our home dialysis patients.
We contract with an individual nephrologist or a group of affiliated
nephrologists to provide medical director services at each of our centers. In
addition, other nephrologists may apply for practice privileges in
3
order to treat their patients at our centers. Each center also has an
administrator, typically a registered nurse, who supervises the day-to-day
operations of the center and its staff. The staff of each center typically
consists of registered nurses, licensed practical or vocational nurses, patient
care technicians, a social worker, a registered dietician, biomedical
technicians and other administrative and support personnel.
Our centers offer high-flux and high-efficiency hemodialysis. High-flux and
high-efficiency hemodialysis utilizes machinery and dialyzers that allow
patients to dialyze in a shorter period of time per treatment because they
cleanse the blood at a faster rate than conventional hemodialysis. We also
provide conventional hemodialysis at many of our centers.
In addition, many of our centers offer services for home dialysis patients,
primarily CAPD and CCPD. Home dialysis services consist of providing equipment
and supplies, training, patient monitoring and follow-up assistance to patients
who prefer and are able to receive peritoneal dialysis treatments in their
homes. Registered nurses train patients and their families or other patient
assistants to perform either CAPD or CCPD at home. Our training programs for
home dialysis generally last two to three weeks. In 2000, peritoneal dialysis
accounted for approximately 9% of our total dialysis treatments.
Quality care
We believe our reputation for quality care is a key factor in attracting
patients and physicians and in securing relationships with managed care payors.
We engage in organized and systematic efforts to measure, maintain and improve
the quality of services we deliver through our quality management programs.
These efforts include the development and implementation of patient care
policies and procedures, education and training programs, and audits of the
quality of services rendered at each of our centers. An important measure of
the quality of dialysis care rendered is the urea reduction ratio, or URR,
which is a measure of how well toxins are being removed from a patient's blood.
In December 2000, approximately 88% of our dialysis patients had a URR of 65%
or greater. In comparison, according to the most recently published national
data from HCFA, only 74% of all U.S. dialysis patients had a URR of 65% or
greater in the fourth quarter of 1998.
Our quality management programs are under the direction of our chief medical
officer. Our vice president of quality management and over 40 regional quality
management coordinators implement these programs in our centers. In addition,
our regional biomedical quality management coordinators audit the technical and
biomedical quality of our centers. The corporate and regional teams also work
with each center's multi-disciplinary quality management team, including the
medical director, to implement the programs.
We have ten regional physician councils of three to six medical directors
each that advise our regional management on clinical and other operating
issues. We have also formed a national physician council of ten physicians to
advise our senior management on clinical issues impacting our operations across
the country. In addition, we have a five-physician laboratory advisory
committee which acts as a medical advisory board for our two clinical
laboratories. Our chief medical officer participates in all national physician
council and laboratory advisory committee meetings.
4
Location and capacity of our centers
As of December 31, 2000, we operated 488 outpatient dialysis centers in the
continental United States. We owned, either through wholly-owned subsidiaries
or through majority-owned joint ventures, 440 of these centers. Of the
remaining centers, we owned minority interests in eight centers, which were
accounted for as equity investments, and managed 40 centers in which we have no
ownership interest. The locations of the 440 wholly-owned and majority-owned
centers were as follows:
Number of Number of Number of
State centers State centers State centers
----- --------- ----- --------- ----- ---------
Alabama 1 Kentucky 2 North Carolina 28
Arizona 6 Louisiana 8 Ohio 1
California 79 Maryland 15 Oklahoma 21
Colorado 17 Michigan 11 Pennsylvania 20
Delaware 1 Minnesota 26 South Carolina 2
District of Columbia 4 Missouri 5 South Dakota 4
Florida 37 Nebraska 1 Texas 41
Georgia 25 Nevada 5 Utah 4
Illinois 10 New Jersey 6 Virginia 17
Indiana 9 New Mexico 2 Washington 6
Kansas 9 New York 16 Wisconsin 1
We believe we have adequate capacity within our existing network to
accommodate greater patient volume. In addition, we are currently expanding
capacity at some of our centers by adding dialysis stations and intend to open
and acquire additional centers in 2001.
Inpatient dialysis services
We provide inpatient dialysis services, excluding physician professional
services, to patients in more than 275 hospitals. We render these services for
a per-treatment fee individually negotiated with each hospital. When a hospital
requests our services, we administer the dialysis treatment at the patient's
bedside or in a dedicated treatment room in the hospital. Inpatient dialysis
services are often required for patients with acute kidney failure resulting
from trauma or similar causes, patients in the early stages of ESRD and ESRD
patients who require hospitalization for other reasons.
Ancillary services
We also provide a range of ancillary services to ESRD patients, including:
. EPO and other pharmaceuticals. The most significant ancillary service
that we provide is the administration of pharmaceuticals, including
erythropoietin, or EPO, vitamin D analogs and calcium and iron
supplements, upon a physician's prescription. EPO is a genetically-
engineered form of a naturally occurring protein that stimulates the
production of red blood cells. EPO is used in connection with all forms
of dialysis to treat anemia, a medical complication ESRD patients
frequently experience. The administration of EPO accounted for
approximately 25% of our net operating revenues in 2000.
. ESRD laboratory services. We own two licensed clinical laboratories,
located in Florida and Minnesota, specializing in ESRD patient testing.
These specialized laboratories provide routine laboratory tests included
in the Medicare composite rate for dialysis and other laboratory tests
for ESRD patients. Our laboratories provide these tests primarily for
our own ESRD patients throughout the United States. These tests are
performed to monitor a patient's ESRD condition, including the adequacy
of dialysis, as well as other diseases a patient may have. Our Florida
laboratory, which serves most of our dialysis centers, utilizes our
proprietary KlinLab information system, which provides information to
our dialysis centers regarding critical outcome indicators.
5
. ESRD clinical research programs. Our commitment to improve treatment
outcomes, reduce costs and enhance the quality of life for ESRD patients
includes our participation in the research and development of new
products and services. Through our subsidiary Total Renal Research, or
TRR, we conduct phase I through phase IV clinical trials on devices,
drugs and new technologies in the renal and renal-related fields
utilizing over 45 clinical trial sites. TRR has conducted over 280
clinical trials for more than 70 drug companies and 12 device companies
over the last 15 years.
Growth of our business
The table below shows the growth of our company, by number of dialysis
centers, following its formation in 1994 in connection with the spin-off of the
outpatient dialysis services business of Tenet Healthcare, formerly National
Medical Enterprises. In February 1998, we completed a merger with Renal
Treatment Centers, then the fourth largest provider of dialysis services in the
United States, approximately doubling the size of our operations. The pace of
our acquisitions slowed significantly during the second half of 1999 and was
very limited in 2000, as we focused on restructuring our balance sheet and
improving our financial infrastructure and center operations.
2000 1999 1998 1997 1996 1995
---- ---- ---- ---- ---- ----
Number of centers at beginning of year........ 572 508 197 134 68 42
Acquired centers.............................. 10 45 263 52 57 23
Developed centers............................. 11 13 24 12 9 3
New managed centers........................... 8 18 32
Terminations, closures and divestitures....... 111 12 8 1
Number of centers at end of year.............. 490 572 508 197 134 68
In 2000, we completed the sale of our operations outside the continental
United States, with the exception of two centers in Puerto Rico, which are
under an agreement of sale. The sale of the Puerto Rico operations will be
completed upon receipt of required regulatory approvals and third-party
consents. Net cash proceeds from the completed sales were approximately $133
million, most of which was applied to reduce debt outstanding under our credit
facilities in accordance with the conditions under which our lenders consented
to the sales.
Our business has grown through increasing capacity at our existing centers,
developing new centers, acquiring centers or entering into agreements to manage
centers. We expand capacity at our existing centers by increasing hours and/or
days of operation or, if additional space is available within a center, through
the addition of dialysis stations. The development of a typical outpatient
center generally requires $1 million to $1.5 million for initial construction
and equipment and approximately $350,000 for working capital in the first year.
Based on our experience, a new center typically opens six to nine months after
the property lease is signed, achieves operating profitability, if at all, by
the ninth to eighteenth month of operation and reaches maturity within three
years. Acquiring an existing center requires a substantially greater initial
investment, but profitability and cash flow initially are more predictable. In
addition to acquiring centers, we enter into agreements to manage third-party
owned centers in return for management fees, typically based on a percentage of
revenues.
Physician relationships
An ESRD patient generally seeks treatment at a dialysis center near his or
her home and at which his or her treating nephrologist has practice privileges.
Our relationships with local nephrologists and our ability to meet their needs
and the needs of their patients are key factors in the success of a dialysis
center. We estimate that approximately 1,200 nephrologists currently refer
patients to our centers. As is typical in the dialysis industry, one or a few
physicians, including the center's medical director, account for all or a
significant portion of a dialysis center's patient referral base. Our medical
directors account for a substantial majority of our patient referrals. The loss
of the medical director or other key referring physicians at a particular
center could therefore materially reduce the revenue of that center.
6
The conditions of participation in the Medicare ESRD program mandate that
treatment at a dialysis center be "under the general supervision of a director
who is a physician." Generally, the medical director must be board eligible or
board certified in internal medicine or nephrology and have had at least 12
months of experience or training in the care of patients at dialysis centers.
We have engaged physicians or groups of physicians to serve as medical
directors for each of our centers. At some centers, we also separately contract
with one or more physicians to serve as assistant or associate medical
directors or to direct specific programs, such as home dialysis training, or,
in a few instances, to provide medical director services for acute dialysis
programs at hospitals. We have contracts with approximately 300 individual
physicians and physician groups to provide medical director services.
Medical directors, associate medical directors and assistant medical
directors enter into written multiyear contracts that specify their duties and
fix their compensation for periods of one or more years. The compensation of
our medical directors is the result of arm's length negotiations and generally
depends upon competitive factors in the local market, the physician's
professional qualifications and the specific duties and responsibilities of the
physician.
Our medical director agreements generally include covenants not to compete.
Also, in all cases in which we acquire a center from one or more physicians, or
where one or more physicians own interests in centers as co-owner with us,
these physicians have agreed to refrain from owning interests in competing
centers within a defined geographic area for various periods. These
noncompetition agreements restrict the physicians from owning, or providing
medical director services to, other dialysis centers, but do not restrict the
physicians from referring patients to competing centers. Many of these
noncompetition agreements expire at the same time as the corresponding medical
director agreements. We have from time to time experienced competition from a
new dialysis center established by a former medical director following the
termination of his or her relationship with us.
Sources of revenue
Overview
The following table sets forth the percentage of our net patient operating
revenues provided by the respective payor category for our continental U.S.
operations.
2000 1999 1998
---- ---- ----
Percent of total dialysis revenues for continental U.S.
operations:
Medicare............................................... 53% 54% 53%
Medicaid............................................... 5 5 4
--- --- ---
58 59 57
HMO's, health insurance carriers and private patient
payments.............................................. 42 41 43
--- --- ---
100% 100% 100%
=== === ===
Medicare reimburses dialysis providers for the treatment of individuals who
are diagnosed with ESRD and are eligible for participation in the Medicare ESRD
program, regardless of age or financial circumstances. ESRD patients receiving
dialysis become eligible for primary Medicare coverage at various times,
depending on their age or disability status, as well as whether they are
covered by an employer group health plan. Generally, for a patient not covered
by an employer group health plan, Medicare becomes the primary payor either
immediately or after a three-month waiting period. For a patient covered by an
employer group health plan, Medicare generally becomes the primary payor after
33 months, or earlier if the patient's employer group health plan coverage
terminates. When Medicare becomes the primary payor, the payment rate we
receive for that patient shifts from the employer group health plan rate to the
Medicare reimbursement rate.
7
For each treatment, Medicare pays 80% of the amount set by the Medicare
reimbursement system. The patient is responsible for the remaining 20%, and in
most cases a secondary payor, such as Medicare supplemental insurance, a state
Medicaid program or a private payor, covers these balances. Some patients who
do not qualify for Medicaid but otherwise cannot afford secondary insurance can
apply for premium payment assistance from charitable organizations, primarily a
program offered by the American Kidney Fund. We and other dialysis providers
support the American Kidney Fund and similar programs through voluntary
contributions.
If a patient does not qualify for Medicaid based on financial need and does
not purchase secondary insurance through a private insurer, the dialysis
provider may not be reimbursed for the 20% portion of the ESRD composite rate
that Medicare does not pay. Congress passed legislation in 1998 requiring the
promulgation of regulations to allow dialysis providers to pay their patients'
premiums for secondary insurance. These insurance premiums are generally less
than the 20% co-payment that a private insurer would pay. Accordingly, dialysis
providers could capture the difference between the premiums paid to these
secondary insurers and the reimbursement amounts received from them. The
regulations, as currently proposed, would not allow centers that are owned by
providers that also provide other services to Medicare patients on a fee-for-
service basis, including our company, to pay these premiums directly. Under the
proposed regulations, most chain providers, hospitals and physicians also would
be prevented from paying these premiums. We cannot predict whether these
proposed regulations will be adopted as is or modified to permit us to pay
these premiums directly.
Medicare reimbursement
Under the Medicare ESRD program, reimbursement rates for dialysis are
established by Congress. The Medicare composite rate set by HCFA determines the
Medicare reimbursement available for a designated group of dialysis services,
including the dialysis treatment, supplies used for that treatment, some
laboratory tests and some medications. The Medicare composite rate is subject
to regional differences based upon several factors, including regional
differences in wage levels. Other services and items are eligible for separate
reimbursement under Medicare and are not part of the composite rate, including
EPO, vitamin D analogs and calcium and iron supplements.
Medicare reimburses for home dialysis services under one of two methods.
Under the first method, a dialysis center is designated as the supplier of home
supplies and services, and provides all dialysis treatment-related services,
including equipment and supplies. The center is reimbursed using a methodology
based on the Medicare composite rate. Under the second method, a durable
medical equipment supply company is designated as the direct supplier, provides
the patient directly with all necessary equipment and supplies and is
reimbursed by Medicare subject to a capitated ceiling. Under the second method,
the patient also selects an outpatient dialysis center to provide additional
required support services. The center is reimbursed for these support services
on a monthly fee-for-service basis subject to a capitated ceiling. The
reimbursement rates under these two methods differ, but both are determined
prospectively and are subject to adjustment by Congress. Most of our centers
are approved to provide home dialysis services under the first method and home
dialysis support services under the second method. We also own a durable
medical equipment supply company that provides equipment and supplies directly
to patients under the second method.
We receive reimbursement for outpatient dialysis services provided to
Medicare-eligible patients at composite rates set by Congress that are
currently between $118 and $140 per treatment, with an average rate of $129 per
treatment. Historically, there have been very few changes to the Medicare
composite reimbursement rate. Since 1972, the rate has declined over 70% in
real dollars. The rate did not change from commencement of the program in 1972
until 1983. From 1983 through December 1990, numerous Congressional actions
resulted in a net reduction of the average reimbursement rate from $138 per
treatment in 1983 to approximately $125 per treatment in 1990. Congress
increased the ESRD reimbursement rate, effective January 1, 1991, by $1.00 per
treatment. The composite rate was increased by 1.2% on each of January 1, 2000
and 2001. An additional 1.2% increase will become effective April 1, 2001, plus
an adjustment factor designed to provide the benefits of the increase as if it
had become effective on January 1, 2001.
8
In January 1996, HCFA announced a demonstration project involving the
enrollment of Medicare ESRD patients in managed care organizations. The
demonstration project is evaluating the appropriateness of fixed, or capitated,
reimbursement for dialysis services. We are participating in the two
demonstration project sites currently implementing the pilot program. We expect
the ESRD demonstration project and the analysis of the results of the project
to continue over the next two years. If successful, the pilot program could
result in HCFA allowing Medicare ESRD patients to enroll in managed care
organizations. The likelihood and timing of this decision is impossible for us
to predict.
Medicaid reimbursement
Medicaid programs are state-administered programs partially funded by the
federal government. These programs are intended to provide health coverage for
patients whose income and assets fall below state-defined levels and who are
otherwise uninsured. In some states, these programs also serve as supplemental
insurance programs for the Medicare co-insurance portion of the ESRD composite
rate and provide reimbursement for additional services, including some oral
medications, that are not covered by Medicare. State regulations generally
follow Medicare schedules with respect to reimbursement levels and coverages.
Some states, however, require beneficiaries to pay a monthly share of the cost
based upon levels of income or assets. We are an authorized Medicaid provider
in the states in which we conduct our business.
Nongovernment payors
Before Medicare becomes the primary payor, a patient's employer group health
plan, private insurance or other nongovernment payor, if any, is responsible
for payment at its negotiated rates or, in the absence of negotiated rates, at
our usual and customary rates. The patient is responsible for any deductibles
and co-payments under the terms of his or her employer group health plan or
other insurance. Our usual and customary rates are, and the rates paid by
nongovernment payors typically are, higher than Medicare reimbursement rates.
Traditional indemnity plans and PPO plans typically pay at higher rates than
HMO-type plans. After Medicare becomes the primary payor, the employer group
health plan, private insurer or other nongovernment payor, if any, becomes
secondary to Medicare. Secondary payors are responsible for the 20% of the
Medicare reimbursement rates that Medicare does not pay. Secondary payors are
not required to reimburse us for the difference between the rates they
previously paid and Medicare rates.
Hospital inpatient dialysis services
We provide inpatient dialysis services, excluding physician professional
services, to patients in hospitals pursuant to written agreements with the
hospitals. We provide these services for a per-treatment fee which is
individually negotiated with each hospital. Some of these agreements provide
that we are the exclusive provider of dialysis services to the hospital, but
many of them are nonexclusive. Many of these agreements also allow either party
to terminate the agreement without cause.
Reimbursement for EPO and other drugs
On June 1, 1989, the FDA approved the production and sale of EPO and HCFA
approved Medicare reimbursement for the use of EPO for dialysis patients. EPO
stimulates the production of red blood cells and is beneficial in the treatment
of anemia, with the effect of reducing or eliminating the need for blood
transfusions for dialysis patients. Physicians began prescribing EPO for their
patients in August 1989. Most of our dialysis patients receive EPO.
Approximately 25% of our net operating revenues in 2000 were generated from the
administration of EPO. Therefore, EPO reimbursement significantly impacts our
net income.
Medicare generally reimburses for EPO only when it is administered to
patients whose hematocrits do not exceed 36%. Hematocrit is a measure of red
blood cell concentration. When a patient's hematocrit exceeds 36%, Medicare
reimbursement is contingent upon the medical justification. The Office of the
Inspector General of the Department of Health and Human Services, or OIG, has
recommended that Medicare reimbursement for
9
EPO be reduced from the current amount of $10 to $9 per 1,000 units. The
Department of Health and Human Services, or HHS, has concurred with this
recommendation. To date, HHS has not pursued this change through the rulemaking
process. In addition, the Clinton Administration proposed the same EPO
reimbursement reduction in its fiscal year 2000 and 2001 budget proposals, but
Congress did not pass any EPO reimbursement reduction. EPO reimbursement
programs have been, and in the future may be, subject to these and other
legislative or administrative proposals. We cannot predict whether future rate
or reimbursement method changes will be made.
Furthermore, EPO is produced by a single manufacturer, Amgen, and any
interruption of supply or product cost increases could adversely affect our
operations. Amgen is also developing a new product that may replace EPO or
reduce its use. The Food and Drug Administration has not yet approved this new
product. We cannot predict when, or whether, Amgen will seek to introduce this
product into the dialysis market or how it will impact our revenues if
introduced.
Other intravenous drugs that we administer include vitamin D analogs, calcium
and iron supplements, various antibiotics and other medications. Medicare
currently reimburses us separately for these drugs at a rate of 95% of the
average wholesale price of each drug.
Congress has mandated government studies of whether to include EPO and other
pharmaceuticals in the composite rate and whether to reduce the reimbursement
rate for other drugs and biological products. The recommendations with respect
to drug reimbursement rates are due in September 2001. The recommendations with
respect to changes in the services included in the composite rate are due in
July 2002. We do not know whether or to what extent future rate changes will be
implemented as a result of the studies.
United States Attorney's inquiry
In February 2001, the Civil Division of the United States Attorney's Office
for the Eastern District of Pennsylvania contacted us and requested that we
cooperate with them in a review of some of our historical practices, including
billing and other operating procedures and our financial relationships with
physicians.
The Civil Division has requested that we provide a wide range of information
responding to the areas of review, but has not initiated any legal process or
served any subpoena on us. The Civil Division has indicated that it is not
making any allegation of wrongdoing at this time and that no criminal action
against us or any individual is currently contemplated. However, the Civil
Division could change the scope or focus of its inquiry at any time. We are
cooperating in this review.
We have consulted with outside counsel, are reviewing our records and will
evaluate our position with respect to all of the areas of inquiry. We are
unable to determine at this time:
.When this matter will be resolved;
.What position the Civil Division will take regarding any potential
liability on our part;
.Whether any additional areas of inquiry will be opened; and
.Any outcome of this inquiry, financial or otherwise.
Any determination adverse to us could have a material adverse impact on our
business, results of operation and financial condition. As described further
below under the subheading "Government regulation," the penalties under the
federal anti-kickback law, Stark I and II and the False Claims Act and other
federal and state statutes can be substantial.
10
Laboratory payment reviews
Our 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 $5.6 million for the review
period from January 1995 to April 1996 and $15 million for the review period
from May 1996 to March 1998. The carrier has suspended all payments of Medicare
claims from this laboratory since May 1998. The carrier also has determined
that $16.1 million of the suspended claims for the review period from April
1998 to August 1999 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 and 70% of the tests performed in the period from April 1998 to August
1999 were not properly supported by the prescribing physicians' medical
justification. In August 2000, the carrier requested additional records with
respect to the time period August 1999 to May 2000.
We are disputing the overpayment determinations and have provided supporting
documentation of our claims. We have 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 $5.6 million. 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 $14.2 million, or substantially
all of the overpayment determination. We have filed appeals of both decisions
to a federal administrative law judge and have moved to consolidate the two
appeals. At this time, we have not received a scheduled date for a hearing with
an administrative law judge, although HHS has informed us that we can expect a
hearing during the second quarter of 2001.
In February 1999, our Florida-based laboratory subsidiary filed a complaint
against the carrier and HHS seeking a court order to lift the payment
suspension. In July 1999, the court dismissed our complaint because we had not
exhausted all administrative remedies, that is, the carrier review and
administrative law judge processes described above.
In addition to the formal appeal process with a federal administrative law
judge, beginning in the third quarter of 1999 we 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 DOJ and HHS of this matter
and we had provided requested information to DOJ. We met with representatives
of DOJ in February 2001, at which time they requested additional information
from us, which we intend to provide.
The timing of the final resolution of this matter is highly uncertain and
beyond our control or influence. Beginning in the third quarter of 2000, we
stopped accruing additional Medicare revenue from this laboratory until the
uncertainties regarding both the timing of resolution and the ultimate revenue
valuations are at least substantially eliminated. The amount of potential
Medicare revenue not accrued beginning in the third quarter of 2000 was
approximately $4 million per quarter. As of June 30, 2000, the cumulative
recognized gross revenue associated with the withheld billings was
approximately $38 million. We estimate that the potential cash exposure as of
December 31, 2000 was not more than $15 million based on the carrier's
overpayment findings noted above. In addition, the government could impose
additional fines and penalties, which could be substantial.
We are unable to determine at this time:
. When this matter will be resolved or when the laboratory's payment
suspension will be lifted;
. The amount of the laboratory claims for which we may be paid;
. What action the carrier, DOJ or HHS may take with respect to this
matter;
. Whether the carrier may review additional periods beyond the four
identified; and
. Any outcome of this review, financial or otherwise.
11
Any determination adverse to us could have a material adverse impact on our
business, results of operations and financial condition.
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. We are unable to determine at this time
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. DOJ has also requested information with respect to this
laboratory, which we are in the process of collecting. Medicare revenues at
the Minnesota laboratory, which is much smaller than the Florida laboratory,
were approximately $15 million for the period under review.
Government regulation
Our dialysis operations are subject to extensive federal, state and local
governmental regulations. These regulations require us to meet various
standards relating to, among other things, reimbursement from government
programs, premises, the management of centers, personnel, the maintenance of
proper records and equipment, and quality assurance programs/patient care.
All of our dialysis centers are certified by HCFA, as is required for the
receipt of Medicare reimbursement. In some states our dialysis centers also
are required to secure additional state health licenses. Governmental
authorities, primarily state departments of health, periodically survey our
centers to determine if we satisfy applicable federal and state standards and
requirements, including the conditions of participation in the Medicare ESRD
program. Consistent with recommendations of the OIG, the frequency and
intensity of this survey activity increased industry-wide in 2000. We expect
this level of survey activity to continue in 2001.
Our business would be adversely impacted by:
. Any loss or suspension of federal certifications;
. Any loss or suspension of authorization to participate in the Medicare
or Medicaid programs;
. Any loss or suspension of licenses under the laws of any state or
governmental authority in which we generate substantial revenues;
. Any refunds of reimbursement received because of any failures to meet
applicable billing requirements; or
. A significant reduction in reimbursement or reduction or elimination of
coverage for dialysis and ancillary services.
To date, we have not had any material difficulty in maintaining our licenses
or our Medicare and Medicaid authorizations. However, we expect that our
industry will continue to be subject to significant government regulation and
scrutiny, the scope and application of which are difficult to predict. This
regulation and scrutiny could adversely impact us in a material way.
Fraud and abuse under federal law
The "anti-kickback" statute contained in the Social Security Act imposes
criminal and civil sanctions on persons who receive or make payments in return
for:
. The referral of a patient for treatment; or
. The ordering or purchasing of items or services that are paid for in
whole or in part by Medicare, Medicaid or similar state programs.
Federal penalties for the violation of these laws include imprisonment,
fines and exclusion of the provider from future participation in the Medicare
and Medicaid programs. Civil penalties for violation of these laws include
assessments of $10,000 per improper claim for payment plus twice the amount of
the claim and suspension from future participation in Medicare and Medicaid.
Some state anti-kickback statutes also include criminal penalties. The federal
statute expressly prohibits traditionally criminal transactions, such as
kickbacks,
12
rebates or bribes for patient referrals. Court decisions have also said that,
under certain circumstances, the statute is also violated when a purpose of a
payment is to induce referrals.
In July 1991, November 1992 and November 1999, the Secretary of HHS published
regulations that create exceptions or "safe harbors" for some business
transactions and arrangements. Transactions and arrangements structured within
these safe harbors do not violate the anti-kickback statute. A business
transaction or arrangement must satisfy each and every element of a safe harbor
to be protected by that safe harbor. Transactions and arrangements that do not
satisfy all elements of a relevant safe harbor do not necessarily violate the
anti-kickback statute, but enforcement agencies may subject them to greater
scrutiny and could determine that they violate the statute.
Because our medical directors refer patients to our centers, the federal
anti-kickback statute may apply. Among the available safe harbors is one for
personal services, which is relevant to our arrangements with our medical
directors. Most of our agreements with our medical directors do not satisfy all
seven of the requirements of the personal services safe harbor. We believe
that, except in cases where a center is in transition from one medical director
to another or where the term of an agreement with a physician has expired and a
new agreement is in negotiation, our agreements with our medical directors
satisfy most of the elements of this safe harbor. One of the requirements not
satisfied is a requirement that if the services provided under the agreement
are on a part-time basis, as they are with our medical directors, the agreement
must specify the schedule of intervals of service, their precise length and the
exact charge for such intervals. Because of the nature of our medical
directors' duties, we believe it is impossible to meet this requirement. Also,
one of the requirements is that the compensation is fair market value for the
services rendered. There is little guidance available as to what constitutes
fair market value for medical director services. Although our medical director
agreements are the result of arm's length negotiations, an enforcement agency
could challenge the level of compensation that we pay to our medical directors.
Accordingly, we could in the future be required to change our practices pay
substantial fines or otherwise experience a material adverse effect as a result
of a challenge to these arrangements. One of the areas that the United States
Attorney's inquiry described above covers is our financial relationships with
physicians.
At 29 of our dialysis centers, physicians who refer patients to the centers
hold interests in partnerships or limited liability companies owning the
centers. The anti-kickback statute may apply to these situations. Among the
available safe harbors with respect to these arrangements is one for small
entity investment interests. Although none of our arrangements satisfy all of
the elements of this small entity investment interests safe harbor, we believe
that each of these partnerships and limited liability companies satisfies a
majority of the safe harbor's elements.
We lease approximately 50 of our centers from entities in which physicians
hold interests and we also sublease space to referring physicians at
approximately 100 of our dialysis centers. The anti-kickback statute may apply
in these situations. Among the available safe harbors with respect to these
arrangements is one for space rentals. We believe that the leases and subleases
we have entered into are in material compliance with the anti-kickback statute.
Because we are purchasing and selling items and services in the operation of
our centers that may be paid for in whole, or in part, by Medicare or a state
healthcare program and because these items and services might be purchased or
sold at a discount, the federal anti-kickback statute may apply. Among the
available safe harbors is one for discounts, which is relevant to our discount
arrangements. We believe that the discount arrangements that we have entered
into are in material compliance with the anti-kickback statute and that these
arrangements satisfy, in all material respects, each of the elements of the
discounts' safe harbor applicable to these arrangements.
13
Fraud and abuse under state law
In several states, including California, Florida, Georgia, Kansas, Louisiana,
Maryland, New York, Utah and Virginia, in which we operate dialysis centers
jointly owned with referring physicians, statutes prohibit physicians from
holding financial interests in various types of medical facilities to which
they refer patients. Some states also have laws similar to the federal anti-
kickback statute that may affect our ability to receive referrals from
physicians with whom we have financial relationships, such as our medical
directors. Some of these statutes include exemptions applicable to our medical
directors and other physician relationships. Some, however, include no explicit
exemption for medical director services or other services for which we contract
with and compensate referring physicians or for joint ownership interests of
the type held by some of our referring physicians. If these statutes are
interpreted to apply to referring physicians with whom we contract for medical
director and similar services or to referring physicians who hold joint
ownership interests, we would be required to restructure some or all of our
relationships with these referring physicians and could be subject to financial
penalties. We cannot predict the consequences of this type of restructuring.
Stark I/Stark II
The Omnibus Budget Reconciliation Act of 1989 includes provisions, known as
Stark I, that restrict physician referrals for clinical laboratory services to
entities with which a physician or an immediate family member has a "financial
relationship." Federal regulatory agencies may interpret Stark I to apply to
our operations. Regulations interpreting Stark I, however, have created an
exception to its applicability regarding services furnished in a dialysis
center if payment for those services is included in the ESRD composite rate.
The Omnibus Budget Reconciliation Act of 1993 contains provisions, known as
Stark II, that restrict physician referrals for "designated health services" to
entities with which a physician or immediate family member has a "financial
relationship." The entity is prohibited under Stark II, as is the case for
entities restricted by Stark I, from claiming reimbursement for such services
under the Medicare or Medicaid programs, is liable for the refund of amounts
received pursuant to prohibited claims, is subject to civil penalties of up to
$15,000 per service and can be excluded from future participation in the
Medicare and Medicaid programs. Stark II includes certain exceptions. Stark II
provisions that may be relevant to us became effective in January 1995. Phase I
of federal regulations interpreting Stark II were issued in January 2001, to
become effective, in relevant part, in the first quarter of 2002.
A "financial relationship" with an entity under Stark II is defined as an
ownership or investment interest in, or a compensation arrangement with, the
entity. We have entered into compensation agreements with our medical
directors. Some of our medical directors own equity interests in entities that
operate our dialysis centers. Some of our dialysis centers are leased from
entities in which referring physicians hold interests and we sublease space to
referring physicians at some of our dialysis centers. In addition, while nearly
all of our stock option arrangements with referring physicians were terminated
in 2000, a few medical directors own options to acquire our common stock. Under
the Stark II regulations, these stock options constitute compensation
arrangements that must meet an applicable exception. Also, some medical
directors and other physicians own our common stock, which they either
purchased in the open market or received from us as consideration in an
acquisition of dialysis centers from them. Although we believe that the
ownership of our stock and the other ownership interests and lease arrangements
for our centers are in material compliance with Stark II, it is possible that
HCFA would view them as prohibited arrangements that must be restructured or
for which we could be subject to other applicable penalties.
We believe that our compensation arrangements with medical directors and
other contract physicians materially satisfy the personal services compensation
arrangement exception to the Stark II prohibitions. Payments made by a lessor
to a lessee for the use of premises are also excepted from Stark II
prohibitions if
14
specific requirements are met. We believe that our leases and subleases with
referring physicians materially satisfy this exception to the Stark II
prohibitions. The Stark II exception applicable to physician ownership
interests in entities to which they make referrals does not encompass the
kinds of ownership arrangements that referring physicians hold in several of
our subsidiaries that operate dialysis centers. Accordingly, HCFA may require
us to restructure some of these arrangements or seek to impose substantial
fines or additional penalties on us.
For purposes of Stark II, "designated health services" include clinical
laboratory services, equipment and supplies, home health services, outpatient
prescriptions drugs and inpatient and outpatient hospital services. We believe
that the language and legislative history of Stark II and phase I of the final
Stark II regulations indicate that Congress did not intend to include as
designated health services dialysis services and the services and items
provided incident to dialysis services. For example, the final Stark II
regulations exempt from the referral prohibition referrals for clinical
laboratory services furnished in an ESRD center if payment for those services
is included in the ESRD composite rate and for EPO and other dialysis-related
outpatient prescription drugs furnished in or by an ESRD center. However, our
provision of, or arrangement and assumption of financial responsibility for,
certain other outpatient prescription drugs, center dialysis services and
supplies, home dialysis supplies and equipment and services to hospital
inpatients under our dialysis services agreements with hospitals, include
services and items that still could be construed as designated health services
within the meaning of Stark II. Although we bill the hospital and not Medicare
or Medicaid for hospital inpatient services, our medical directors may request
or establish a plan of care that includes dialysis services for hospital
inpatients that may be considered a referral to us within the meaning of Stark
II.
Because the Stark II regulations do not expressly address all of our
operations, HCFA may interpret Stark II to apply to parts of our operations.
Consequently, HCFA could determine that Stark II may require us to restructure
existing compensation agreements with our medical directors and to repurchase
or to request the sale of ownership interests in subsidiaries and partnerships
held by referring physicians or, alternatively, to refuse to accept referrals
for designated health services from these physicians. We would be materially
impacted if HCFA interprets Stark II to apply to us and we either could not
achieve material compliance with Stark II or the cost of achieving that
compliance would be substantial.
Medicare reform
Because the Medicare program represents a substantial portion of the federal
budget, Congress takes action in almost every legislative session to modify
the Medicare program for the purpose of, or with the result of, reducing the
amounts payable from the program to healthcare providers or placing additional
burdens or restrictions on healthcare providers. Legislation or regulations
may be enacted in the future that may significantly modify the ESRD program or
substantially reduce the amount paid for our services. Further, statutes or
regulations may be adopted that impose additional requirements for eligibility
to participate in the federal and state payment programs. Any legislation or
regulations of this type could adversely affect our business operations in a
material way.
The False Claims Act
The federal False Claims Act, or FCA, is another means of policing false
bills or false requests for payment in the healthcare delivery system. In
part, the FCA imposes a civil penalty on any person who:
. Knowingly presents, or causes to be presented, to the federal government
a false or fraudulent claim for payment or approval;
. Knowingly makes, uses, or causes to be made or used, a false record or
statement to get a false or fraudulent claim paid or approved by the
federal government;
. Conspires to defraud the federal government by getting a false or
fraudulent claim allowed or paid; or
. Knowingly makes, uses or causes to be made or used, a false record or
statement to conceal, avoid, or decrease an obligation to pay or
transmit, money or property to the federal government.
15
The penalties for a violation of the FCA range from $5,000 to $10,000 for
each fraudulent claim plus three times the amount of damages caused by each
such claim. The federal government has used the FCA to prosecute Medicare fraud
in areas such as coding errors, billing for services not rendered, the
submission of false cost reports, billing services at a higher reimbursement
rate than is appropriate, billing under a comprehensive code as well as under
one or more component codes included in the comprehensive code and billing for
care which is not medically necessary. Although subject to some dispute, at
least two federal district courts have also determined that an alleged
violation of the federal anti-kickback statute or Stark I and Stark II are
sufficient to state a claim for relief under the FCA. In addition to the civil
provisions of the FCA, the federal government can use several other criminal
statutes to prosecute persons who submit false or fraudulent claims for payment
to the federal government.
The Health Insurance Portability and Accountability Act of 1996
The Health Insurance Portability and Accountability Act of 1996, or HIPAA,
among other things, allows individuals who lose or change jobs to transfer
their insurance, limits exclusions for preexisting conditions and establishes a
pilot program for medical savings accounts. In addition, HIPAA also expanded
federal attempts to combat healthcare fraud and abuse by making amendments to
the Social Security Act and the federal criminal code. Among other things,
HIPAA created a new "Health Care Fraud Abuse Control Account," under which
"advisory opinions" are issued by the OIG regarding the application of the
anti-kickback statute, criminal penalties for Medicare and Medicaid fraud were
extended to other federal healthcare programs, the exclusion authority of the
OIG was expanded, Medicare and Medicaid civil monetary penalty provisions were
extended to other federal healthcare programs, the amounts of civil monetary
penalties were increased and a criminal healthcare fraud statute was
established.
HIPAA also included provisions relating to the privacy of medical
information. HHS published HIPAA privacy regulations in December 2000. Based on
our initial review of the privacy rules, compliance will require the
development of extensive policies and procedures, the designation of privacy
officers and the implementation of elaborate administrative safeguards with
respect to private health information in our possession. Similarly, based on
our review of the proposed security and electronic signature standards,
compliance will require us to develop additional information systems and
administrative and electronic safeguards to protect data integrity. Complying
with the HIPAA privacy rules and the proposed security and electronic signature
standards will require substantial time and may require us to incur significant
expenditures. Under HIPAA, compliance with these proposed regulations is
required by April 2003.
Other regulations
Our operations are subject to various state hazardous waste and non-hazardous
medical waste disposal laws. These laws do not classify as hazardous most of
the waste produced from dialysis services. Occupational Safety and Health
Administration regulations require employers to provide workers who are
occupationally subject to blood or other potentially infectious materials with
prescribed protections. These regulatory requirements apply to all healthcare
facilities, including dialysis centers, and require employers to make a
determination as to which employees may be exposed to blood or other
potentially infectious materials and to have in effect a written exposure
control plan. In addition, employers are required to provide or employ
hepatitis B vaccinations, personal protective equipment and other safety
devices, infection control training, post-exposure evaluation and follow-up,
waste disposal techniques and procedures and engineering and work practice
controls. Employers are also required to comply with various record-keeping
requirements. We believe that we are in material compliance with these laws and
regulations.
A few states have certificate of need programs regulating the establishment
or expansion of healthcare facilities, including dialysis centers. We believe
that we are in material compliance with all applicable state certificate of
need laws.
16
Although we believe we comply materially with current applicable laws and
regulations, our industry will continue to be subject to substantial
regulation, the scope and effect of which are difficult to predict. Our
activities could be reviewed or challenged by regulatory authorities at any
time in the future.
Corporate compliance program
We have implemented a company-wide corporate compliance program as part of
our commitment to comply fully with all applicable laws and regulations and to
maintain the high standards of conduct we expect from all of our employees. We
continuously review this program and enhance it as necessary. The primary
purposes of the program include:
. Through training and education, increasing the awareness of our
employees and affiliated professionals of the necessity of complying
with all applicable laws and regulations in an increasingly complicated
regulatory environment;
. Auditing our dialysis centers, laboratories and billing offices on a
regular basis to identify quickly any potential instances of
noncompliance; and
. Ensuring that we take steps to resolve instances of noncompliance as
promptly as we become aware of them.
We have adopted a code of conduct that each of our employees and affiliated
professionals must follow and have implemented a confidential, toll-free
hotline (888-272-7272) for employees to report potential instances of non-
compliance. Our chief compliance officer administers the compliance program.
The chief compliance officer reports directly to our chief operating officer
and to the compliance committee of our board of directors.
Competition
The dialysis industry is highly competitive, particularly in terms of
acquiring existing dialysis centers. Competition for qualified physicians to
act as medical directors and for inpatient dialysis services agreements with
hospitals is also vigorous. We have also, from time to time, experienced
competition from former medical directors or referring physicians who have
opened their own dialysis centers. A portion of our business also consists of
monitoring and providing supplies for ESRD treatments in patients' homes.
Other companies provide similar services. In addition, a company is developing
a portable hemodialysis machine for unassisted use by patients in their homes.
The market share of the large multi-center providers has increased
significantly over the last several years and the four largest dialysis chains
now comprise approximately 60% of the market, compared to approximately 30% in
1992. We expect consolidation by these large chain providers to continue.
Approximately half of the independent centers are owned or controlled by
hospitals. Hospital-based dialysis units typically are more difficult to
acquire than independent, physician-owned centers.
Large chain dialysis providers with whom we compete include Fresenius
Medical Care, Gambro and Renal Care Group. Some of our competitors have
substantially greater financial resources than we do and may compete with us
for acquisitions and the development of new centers in markets targeted by us.
There are also a number of large healthcare providers that have entered or may
decide to enter the dialysis business.
Our two largest competitors, Fresenius and Gambro, manufacture a full-line
of dialysis supplies and equipment in addition to owning and operating
dialysis centers. This may give them cost advantages over us because of their
ability to manufacture their own products. In addition, Fresenius is our
largest supplier of dialysis products and is also our largest competitor in
the dialysis services market.
17
Insurance
We carry property and general liability insurance, professional liability
insurance and other insurance coverage in amounts deemed adequate by
management, based on our claims experience. Future claims could, however,
exceed our applicable insurance coverage. Physicians practicing at our dialysis
centers are required to maintain their own malpractice insurance and our
medical directors maintain coverage for their individual
private medical practices. In most cases, our agreements with our medical
directors require the medical directors to secure their own liability insurance
coverage for the performance of their duties as medical directors. Our
liability policies cover medical directors who are not required or able to
obtain insurance and also provide excess secondary coverage above those limits
maintained by our medical directors.
Employees
As of December 31, 2000, we had approximately 12,200 employees, including:
. Licensed professional staff (nurses, dieticians and social
workers)........................................................... 4,500
. Other patient care, support and maintenance staff (patient care and
reuse technicians, biomedical personnel and laboratory personnel).. 6,600
. Corporate, billing and regional staff.............................. 1,100
Item 2. Properties.
We own six parcels of real property. We operate dialysis centers on three of
these properties. One of the remaining three properties is under contract to be
sold and the other two are being evaluated for possible sale. We also own a 50%
interest in a limited liability company that owns an additional property on
which we operate a dialysis center.
The other dialysis centers that we operate are located on premises leased by
us or our general partnerships, limited liability companies or subsidiary
corporations, or by entities that we manage. Our leases generally cover periods
from five to ten years and typically contain renewal options of five to ten
years at the fair rental value at the time of renewal or at rates subject to
periodic consumer price index increases. Our outpatient dialysis centers range
in size from 500 to 30,000 square feet, with an average size of 6,500 square
feet. We maintain our corporate headquarters in approximately 35,800 square
feet of office space in Torrance, California, which we currently lease for a
term expiring in 2008. Our business office in Tacoma, Washington is in an
80,000-square foot facility leased for a term expiring in 2009. We maintain a
43,000-square foot facility in Berwyn, Pennsylvania for additional billing and
collections staff and limited corporate and regional staff. The Berwyn lease
expires in December 2001. We are currently negotiating an extension of this
lease with our landlord. Our Florida-based laboratory is located in a 30,000-
square foot facility owned by us, with a long-term ground lease, and our
Minnesota-based laboratory is located in a 9,500-square foot facility leased by
us.
Some of our dialysis centers are operating at or near capacity. However, we
believe that we have adequate capacity within most of our existing dialysis
centers to accommodate additional patient volume through increased hours and/or
days of operation, or, if additional space is available within an existing
facility, through the addition of dialysis stations. In addition, we often can
build new centers if existing centers reach capacity. With respect to
relocating centers or building new centers, we believe that we can generally
lease space at economically reasonable rates in the area planned for each of
these centers. Expansion or relocation of our dialysis centers would be subject
to review for compliance with conditions relating to participation in the
Medicare ESRD program. In states that require a certificate of need or center
license, additional approvals would generally be necessary for expansion or
relocation.
18
Item 3. Legal Proceedings.
In July 2000, we entered into a Stipulation of Settlement with the plaintiffs
in the consolidated securities class action that was filed against us and
several of our former officers in February 1999, In Re Total Renal Care
Securities Litigation, Master File No. CV-99-1745-CBM (RCx), United States
District Court, Central District of California. The Court entered a final
judgment approving the settlement and dismissing the litigation on October 16,
2000. The consolidated complaint alleged violations of the federal securities
laws arising from allegedly false and misleading statements during a class
period of March 11, 1997 to July 18, 1999. Under the terms of the settlement, a
total settlement fund of $25 million has been established. We contributed
$10.8 million to the settlement fund and our directors' and officers' liability
insurance carriers funded the balance of the settlement fund. In addition, we
have implemented corporate governance principles and procedures to ensure the
accountability of our board of directors and management to our stockholders. We
admitted to no wrongdoing or liability in the settlement.
See the heading "United States Attorney's inquiry" in "Item 1. Business" of
this report for information on our cooperation with the Civil Division of the
United States Attorney's Office for the Eastern District of Pennsylvania in a
review of some of our historical practices, including billing and other
operating procedures and our financial relationships with physicians.
See the heading "Laboratory payment reviews" in "Item 1. Business" of this
report for information on the payment dispute with our Florida laboratory's
Medicare carrier.
In addition, we are subject to claims and suits in the ordinary course of
business. We do not believe that the ultimate resolution of these additional
pending proceedings, whether the underlying claims are covered by insurance or
not, will have a material adverse effect on our results of operations or
financial condition.
Item 4. Submission of Matters to a Vote of Securities Holders.
None.
19
PART II
Item 5. Market for the Registrant's Common Equity and Related Stockholder
Matters.
Our common stock is traded on the New York Stock Exchange under the symbol
"DVA". Prior to October 2000, when we formally changed our name to "DaVita
Inc." from "Total Renal Care Holdings, Inc.," our stock traded on the New York
Stock Exchange under the symbol "TRL". The following table sets forth, for the
periods indicated, the high and low closing prices for our common stock as
reported by the New York Stock Exchange.
High Low
------ -----
Year ended December 31, 1999
1st quarter................................................ $28.00 $7.50
2nd quarter................................................ 15.94 9.81
3rd quarter................................................ 15.31 7.06
4th quarter................................................ 8.56 5.88
Year ended December 31, 2000
1st quarter................................................ $ 7.19 $2.56
2nd quarter................................................ 6.00 2.63
3rd quarter................................................ 7.63 6.13
4th quarter................................................ 17.50 8.19
The closing price of our common stock on March 12, 2001 was $16.50 per share.
According to The Bank of New York, our registrar and transfer agent, as of
March 12, 2001, there were 2,432 holders of record of our common stock. Since
our recapitalization in 1994, we have not declared or paid cash dividends to
holders of our common stock. We do not anticipate paying any cash dividends in
the foreseeable future. Our bank credit agreements restrict our ability to pay
dividends on our common stock. For more details, see the heading "Liquidity and
capital resources" under "Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations" and the notes to our
consolidated financial statements.
20
Item 6. Selected Financial Data.
The following table presents selected consolidated financial and operating
data for the periods indicated. The following financial and operating data
should be read in conjunction with "Item 7. Management's Discussion and
Analysis of Financial Condition and Results of Operations" and our consolidated
financial statements filed as part of this report.
Year ended December 31,
---------------------------------------------------------
2000 1999 1998 1997 1996
---------- ----------- ---------- ---------- --------
(in thousands, except per share)
Income statement data:
Net operating revenues.. $1,486,302 $ 1,445,351 $1,203,738 $ 758,403 $496,651
Total operating
expenses(1)............ 1,311,587 1,509,333 1,068,825 646,816 428,698
---------- ----------- ---------- ---------- --------
Operating income
(loss)................. 174,715 (63,982) 134,913 111,587 67,953
Other income (loss)..... (7,201) (1,895) 4,894 3,175 3,858
Debt expense(2)......... 116,637 110,797 84,003 29,082 13,670
Minority interests in
income of consolidated
subsidiaries........... (5,942) (5,152) (7,163) (4,502) (3,578)
---------- ----------- ---------- ---------- --------
Income (loss) before
income taxes,
extraordinary item and
cumulative effect of
change in accounting
principle.............. 44,935 (181,826) 48,641 81,178 54,563
Income tax expense
(benefit).............. 27,960 (34,570) 38,449 35,654 22,031
---------- ----------- ---------- ---------- --------
Income (loss) before
extraordinary item and
cumulative effect of
change in accounting
principle.............. $ 16,975 $ (147,256) $ 10,192 $ 45,524 $ 32,532
========== =========== ========== ========== ========
Net income (loss)(3).... $ 13,485 $ (147,256) $ (9,448) $ 45,524 $ 24,832
========== =========== ========== ========== ========
Earnings (loss) per
common share:
Income (loss) before
extraordinary item
and cumulative effect
of change in
accounting
principle............ $ 0.21 $ (1.81) $ 0.12 $ 0.59 $ 0.43
========== =========== ========== ========== ========
Net income (loss)(3).. $ 0.17 $ (1.81) $ (0.12) $ 0.59 $ 0.33
========== =========== ========== ========== ========
Earnings (loss) per
common share--assuming
dilution:
Income (loss) before
extraordinary item
and cumulative effect
of change in
accounting
principle............ $ 0.20 $ (1.81) $ 0.12 $ 0.57 $ 0.42
========== =========== ========== ========== ========
Net income (loss)(3).. $ 0.16 $ (1.81) $ (0.12) $ 0.57 $ 0.32
========== =========== ========== ========== ========
Ratio of earnings to
fixed charges(4)....... 1.34:1 (See note 5) 1.50:1 3.18:1 3.88:1
Balance sheet data:
Working capital(6)...... $ 148,348 $(1,043,796) $ 388,064 $ 205,798 $185,904
Total assets ........... 1,596,632 2,056,718 1,911,619 1,279,261 664,799
Long-term debt(7) ...... 974,006 5,696 1,225,781 731,192 233,126
Shareholders' equity.... 349,368 326,404 473,864 422,446 358,677
- --------
(1) Total operating expenses include impairments and valuation losses of $4,556
in 2000 and $139,805 in 1999 and merger related costs of $78,188 in 1998.
(2) Debt expense includes a write-off of deferred financing costs of $1,192 in
2000 and $1,601 in 1999 and a loss on termination of interest rate swap
agreements related to refinanced debt of $9,823 in 1998.
21
(3) Extraordinary losses associated with early extinguishment of debt were
$3,490 ($0.04 per share) in 2000, $12,744 ($0.16 per share) in 1998 and
$7,700 ($0.10 per share) in 1996.
In 1998 we adopted Statement of Position No. 98-5, Reporting on the Costs
for Start-up Activities, or SOP 98-5, which requires that pre-opening and
organization costs be expensed as incurred. As a result, unamortized
deferred pre-opening and organizational costs of $6,896 ($0.08 per share)
were written-off as a cumulative effect of a change in accounting principle
in 1998.
(4) The ratio of earnings to fixed charges is computed by dividing fixed
charges into earnings. Earnings for this purpose is defined as pretax
income from continuing operations adjusted by adding non-capitalized fixed
charges during the period. Fixed charges is defined for this purpose as the
total of interest expense, amortization of deferred financing costs and the
estimated interest component of rental expense on operating leases.
(5) Due to our loss in 1999, the ratio coverage in 1999 was less than 1:1. We
would have had to generate additional earnings of $181,826 to achieve a
coverage of 1:1.
(6) The working capital calculation as of December 31, 1999 includes long-term
debt that was potentially callable under covenant provisions of $1,425,610.
(7) Long-term debt excludes $1,425,610 as of December 31, 1999 that was
potentially callable under covenant provisions. In 2000, the debt was
restructured and the 2000 long-term debt reflects scheduled debt
maturities.
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
The following should be read in conjunction with our consolidated financial
statements and "Item 1. Business." Forward-looking statements should be read in
conjunction with the risk factors set forth below.
Prior to mid-1999, the company had an aggressive growth strategy of acquiring
other dialysis businesses. In early 1998, the company merged with RTC in a
stock-for-stock transaction valued at approximately $1.3 billion. After the
merger with RTC, the company became the second largest provider of dialysis
services in the United States. As of December 31, 2000, we operated 488
outpatient dialysis centers in the continental United States. We owned, either
through wholly-owned subsidiaries or through majority-owned joint ventures, 440
of these centers. Of the remaining centers, we owned minority interests in
eight centers, which were accounted for as equity investments, and we managed
40 centers in which we have no ownership interest.
The company became highly leveraged as a result of the aggressive growth
strategy in place prior to mid-1999. During the fourth quarter of 1999, we
announced our intention to sell our dialysis centers outside the continental
United States as an important first step in restructuring our balance sheet and
reducing our debt burden. In January 2000, we signed definitive agreements to
sell substantially all of our operations outside the continental United States.
These divestitures were substantially completed in the second quarter of 2000,
reducing the number of dialysis centers that we operate outside the continental
United States from 84 to 2.
The rapid growth through acquisitions over the past several years also has
had a significant impact on administrative functions, including billing and
cash collection processes, which at times operated below optimal levels of
efficiency and effectiveness. Beginning in late 1999, we initiated a multiyear
turnaround plan focused on improving our financial and operational
infrastructure. In October 1999, Kent Thiry was named our chairman and chief
executive officer. During 2000, we sold our non-continental U.S. operations,
restructured our credit facilities and reduced our debt, settled a securities
class action lawsuit, improved collections and focused on our core operations.
22
Results of operations
Continental U.S. and non-continental U.S. operating revenues and operating
expenses were as follows:
Year ended December 31,
----------------------------------
2000 1999 1998
---------- ---------- ----------
(dollars in millions)
Revenues:
Continental U.S. .................... $1,412 95% $1,321 91% $1,115 93%
Non-continental U.S. ................ 74 5% 124 9% 89 7%
------ --- ------ --- ------ ---
$1,486 100% $1,445 100% $1,204 100%
====== ====== ======
Operating expenses:
Continental U.S. .................... $1,234 94% $1,243 83% $ 906 85%
Non-continental U.S. ................ 73 6% 126 8% 85 8%
Impairment and merger costs ......... 4 -- 140 9% 78 7%
------ --- ------ --- ------ ---
$1,311 100% $1,509 100% $1,069 100%
====== ====== ======
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.
Operating results excluding the divested non-continental U.S. operations,
impairments and merger costs, were as follows (see note 16 to the consolidated
financial statements for non-continental U.S. operating results):
Continental U.S. Operations
Year ended December 31,
-----------------------------------
2000 1999 1998
----------- ---------- ----------
(dollars in millions)
Revenues ............................. $1,412 100% $1,321 100% $1,115 100%
Operating expenses:
Dialysis centers and labs .......... 973 69% 893 68% 709 64%
General and administrative ......... 120 8% 124 9% 72 6%
Depreciation and amortization ...... 103 7% 99 7% 83 7%
Provision for uncollectible accounts
................................... 38 3% 127 10% 42 4%
------ --- ------ --- ------ ---
1,234 87% 1,243 94% 906 81%
------ --- ------ --- ------ ---
Operating income before impairment
losses and merger costs ............. $ 178 13% $ 78 6% $ 209 19%
====== ====== ======
Impairment losses and merger costs:
Non-continental U.S. operations .... $ (1) $ 83
Continental U.S. operations ........ 5 57
Merger costs ....................... $ 78
------ ------ ------
$ 4 $ 140 $ 78
====== ====== ======
23
Revenues. Operating revenues for the continental United States were made up
of the following:
Year ended
December 31,
----------------
2000 1999 1998
---- ---- ----
Percent of total revenue:
Dialysis services ............................................ 97% 96% 96%
Lab and other ................................................ 2 3 3
Management fee income ........................................ 1 1 1
--- --- ---
100% 100% 100%
=== === ===
Dialysis services. Dialysis services include outpatient center hemodialysis,
which accounts for approximately 87% of total dialysis treatments, home
dialysis, and inpatient hemodialysis with contracted hospitals. A major
component of dialysis revenue is the administration of EPO, which represents
approximately 25% of net operating revenues, and other drugs as part of the
dialysis treatment.
Dialysis services are paid for primarily by Medicare and state Medicaid
programs in accordance with rates established by HCFA, and by other third-party
payors such as HMOs and health insurance carriers. Services provided to
patients covered by third-party insurance companies are normally reimbursed at
rates higher than Medicare or Medicaid rates. Patients covered by employer
group health plans generally convert to Medicare after 33 months of treatment.
The majority of earnings from dialysis services are derived from commercial
payors, some of which pay at negotiated reimbursement rates and others which
pay based on our usual and customary rates. The commercial reimbursement rates
are under continual pressure as we negotiate contract rates with large HMO's
and insurance carriers. Additionally, as a patient transitions from commercial
coverage to Medicare or Medicaid coverage, the reimbursement rates generally
decline substantially.
Dialysis services revenues by payor type were as follows:
Year ended
December 31,
----------------
2000 1999 1998
---- ---- ----
Percent of total dialysis revenue:
Medicare.................................................... 53% 54% 53%
Medicaid.................................................... 5 5 4
--- --- ---
58 59 57
Commercial and other........................................ 42 41 43
--- --- ---
100% 100% 100%
=== === ===
The number of equivalent hemodialysis treatments associated with the
continental U.S. operations totaled 5.4 million, 5.1 million and 4.4 million
for 2000, 1999 and 1998, respectively. The increases in the number of
treatments accounted for approximately 50% and 97% of the total growth in
dialysis services revenue for 2000 and 1999, respectively. The treatment volume
growth in 2000 was principally associated with existing centers and the growth
in 1999 was principally due to the acquisition and development of new dialysis
centers. The treatment growth rate for centers in place for at least one year
was approximately 3% for 2000 and 5% for 1999 and 1998.
Approximately 50% of the increase in revenue for 2000 was attributable to an
increase in the average reimbursement rate per treatment. The average
reimbursement rates per equivalent hemodialysis treatment were $256, $246 and
$245 for 2000, 1999 and 1998, respectively. The substantial increase in the
average reimbursement rates in 2000 was principally attributable to
improvements in revenue capture and billing and collections operations, the
administering of two new higher cost drugs and a 1.2% increase in Medicare
24
reimbursement rates. The average reimbursement rate for the fourth quarter of
2000 was approximately $266, compared with approximately $260 for the third
quarter and $248 for the first half of 2000. The higher average reimbursement
rate in the fourth quarter over the third quarter was principally due to the
two new drugs being administered. These new drugs, Ferrlecit(R) and Zemplar(R),
are higher cost replacement therapies that provide superior clinical results.
As of year-end 2000, the Medicare ESRD composite rates were between $118 and
$140 per treatment, with an overall average of $129 per treatment. The Medicare
ESRD composite rate was increased by 1.2% both on January 1, 2000 and on
January 1, 2001. An additional 1.2% increase will become effective April 1,
2001, plus an adjustment factor designed to provide the benefits of the
increase as if it had been effective on January 1, 2001.
We currently expect that our growth rate of dialysis treatments, other than
through acquisitions, will generally be in the 3% to 4% range for 2001, which
is below the industry average growth rate. We believe that we will be able to
sustain or improve average revenue per treatment during 2001 based on current
information, trends and projections. These projections involve significant
risks and uncertainties and actual results may vary significantly from these
current projections.
Lab and other services. We operate two licensed clinical laboratories
specializing in ESRD patient testing, principally for our own patients. Routine
lab tests are included in the Medicare composite treatment rates and do not
generate incremental revenue. Total lab and other services revenue was 2% of
total revenue for 2000 and 3% of total revenue for 1999 and 1998. See the
"Liquidity and capital resources" discussion below regarding revenue collection
contingencies associated with our laboratory operations.
Management fee income. Management fee income represents approximately 1% of
total revenues. We currently manage 48 third-party dialysis centers utilizing
our existing infrastructure. The management fees are established by contract
and are typically based on a percentage of revenue of the managed facility.
Dialysis centers and lab expenses. Operating expenses consist of costs and
expenses specifically attributable to the operations of dialysis centers and
labs, including direct labor, drugs, medical supplies, and other patient care
service costs. Operating expenses as a percentage of dialysis, lab and pharmacy
services revenues, excluding non-continental U.S. operations, were 69%, 68% and
64% for 2000, 1999 and 1998, respectively. The higher percentages for 2000 and
1999 operating expenses reflect cost growth in excess of the average revenue
increases realized. Cost increases as a percentage of revenues for 2000 and
1999 were principally associated with increased compensation expense, including
profit sharing plan expense in 2000.
General and administrative expenses. General and administrative expenses
consist of those costs not specifically attributable to the dialysis centers
and labs and include expenses for corporate and regional administration,
including centralized accounting, billing and cash collection functions.
General and administrative expenses as a percentage of total revenues,
excluding non-continental U.S. operations, were 8.5%, 9.4% and 6.5% for 2000,
1999 and 1998, respectively. The higher level of general and administrative
expenses in 1999 compared with 1998 was principally associated with
compensation costs, including severance and retention payments, legal and other
professional fees and consulting fees. Compensation costs increased in 1999 as
additional management and staff were added to address the process problems that
had developed following the merger with RTC in early 1998. Shortly after the
merger, many of the RTC general and administrative departments were eliminated
in an attempt to achieve integration synergies more quickly. While the actions
in 1998 lowered some general administrative costs during 1998, the resulting
process inefficiencies impacted revenue collections and other business
processes. The significant increase in general and administrative expense as a
percentage of revenue for 1999 compared to 1998 reflects both the reductions in
staffing in 1998 and the increases in staffing in 1999. In addition to the
increases in staffing levels during 1999 for centralized business processes,
there were also management increases in the regional operations. We continued
to add administrative staff during 2000 to further address operating
performance needs. Additionally, current plans include further staffing
increases and infrastructure investments in 2001, including development
activities for new clinical and billing systems.
25
Provision for uncollectible accounts receivable. The provision for
uncollectible accounts receivable as a percentage of revenue was approximately
3%, 10% and 4% for 2000, 1999 and 1998, respectively. The high level of
provision for uncollectible accounts in 1999 resulted from our inability to
achieve our projected cash collection trends during 1999. As discussed above,
the rapid growth through acquisitions and the merger with RTC in 1998 had a
significant impact on administrative functions, including billing and cash
collection processes, which at times operated below optimal levels of
efficiency and effectiveness. The backlog of aged accounts receivable continued
to increase during the first half of 1999 due to high turnover of billing and
collection personnel and process inefficiencies. The build-up of the backlog of
aged accounts not processed on a timely basis created collection difficulties
at a level not previously experienced, resulting in the unusually high write-
offs in 1999. Other than the uncertainty associated with the Florida lab
receivables, as discussed below, the provision for uncollectible accounts
receivable is expected to be generally in the range of 2% to 3% over the long
term.
Impairment and valuation losses. During the fourth quarter of 1999, we
announced our intention to sell our dialysis operations outside the continental
United States resulting in an impairment charge of $83 million representing the
estimated losses on the sales of these operations, including the costs of
buying out minority interests and the direct transaction costs of completing
the sale. The divestitures were substantially completed in the second quarter
of 2000. Net recoveries of approximately $1 million were recorded in 2000
associated with the non-continental U.S. operations.
The impairment and valuation losses of $57 million recorded in 1999
associated with dialysis centers within the continental United States similarly
relate to actions taken and decisions made during 1999. In addition to
divesting non-continental U.S. operations, we took actions to curtail new
center acquisitions and developments and to close centers not supporting our
new strategic direction. The losses principally related to centers identified
for closure or sale during the first half of 2000, new center plans terminated
and projects abandoned and impairments of loans to and investments in third-
party dialysis-related businesses. The impairment losses were determined based
on estimated net realizable values and projections of cash flows. Additional
charges of $5 million on continental U.S. operations were taken in 2000. The
closure and abandonment losses averaged less than $1 million per center and
were principally associated with the impairment of leasehold improvements and
intangible assets specifically identified with these centers. Our new strategic
direction and curtailed new center acquisitions had also affected the valuation
of several partnership investments in third-party dialysis related businesses.
We do not expect recovery of the impairment losses even through potential
bankruptcy processes. With respect to impaired loans, we do not accrue interest
receivable unless the estimated recovery amounts justify such accruals.
We perform impairment reviews for our investments in and advances to third-
party dialysis businesses whenever a change in condition occurs, including
changes in our business strategy and plans, or when the third-party dialysis
business experiences deteriorating operating performance or liquidity problems.
With regard to the potential impairment of goodwill balances, we routinely
review cash flows for the specific center operations associated with the
respective goodwill balances that resulted from the acquisition of that
specific group of centers. Other than in connection with the impairment losses
discussed above, we determined that there were no goodwill impairments as of
year-end 2000.
Merger related costs. Merger related costs were incurred in 1998 in
connection with the RTC merger, which is reported under the pooling-of-
interests method of accounting. These costs included merger transaction costs,
integration costs, employee severance costs and other directly associated
compensation expenses. Transaction costs associated with all other
acquisitions, which were accounted for under the purchase method of accounting,
were capitalized as goodwill.
Debt expense
Debt expense for 2000 and 1999 consisted of interest expense of approximately
$113 and $107 million, respectively, and the amortization and write-off of
deferred financing costs of approximately $4 million in both years. Although
the average debt balance was lower in 2000 compared with 1999, the effective
interest rates
26
during the first half of 2000 for the credit facilities were significantly
higher because we were not in compliance with several debt covenants during
that time.
Other income (loss)
The net of other income and loss items was a loss of $7.2 million and $1.9
million for 2000 and 1999 and income of $4.9 million for 1998. Included in
other income (loss) for 2000 was $7.7 million of interest income and losses of
$10.8 million and $4.7 million related to the settlement of a stockholder class
action lawsuit and the recognition of the foreign currency translation loss
associated with the divestitures of the non-continental U.S. operations. The
foreign currency translation loss had previously been recognized in
comprehensive income. Interest income for 1999 amounted to $4.8 million, which
was more than offset by equity investment and other non-operating losses. Other
income for 1998 included $3.9 million of interest income.
Provision for income taxes
The provision for income taxes for 2000 was $28 million, or an effective rate
of 62%. The high effective rate resulted from the relatively low level of pre-
tax earnings in relation to permanent differences such as non-deductible
amortization and deferred tax valuation allowances associated with the sale of
non-continental U.S. operations and the cancellation of medical director stock
options.
The provision for income taxes for 1999 was a tax benefit (negative expense)
of $35 million, reflecting current and deferred tax benefits resulting from the
1999 pre-tax loss. The 1999 tax benefit was reduced by a deferred tax asset
valuation allowance for impairment and valuation losses that are capital in
nature. For tax purposes, such losses may only be offset against capital gains
within a limited carryback and carryforward period. Due to our limited ability
to generate capital gains from operations, a tax benefit has not been recorded
for these losses.
The provision for income taxes for 1998 was $38 million, resulting in an
effective tax rate of 79%. This high effective rate was primarily due to non-
deductible merger expenses.
Based on current plans and projections we expect the effective income tax
rate for our core operations to be in the range of 41% to 44% for 2001.
Extraordinary items
The extraordinary losses of $3.5 million and $12.7 million net of tax for
2000 and 1998 are related to the write off of unamortized deferred financing
costs associated with the early extinguishment of debt. In July 2000, we
restructured our revolving and term credit facilities. In 1998, in conjunction
with the RTC merger, the RTC revolving credit agreement was terminated.
Cumulative effect of change in accounting principle
Effective January 1, 1998, we adopted SOP 98-5, which requires that pre-
opening and organizational costs incurred in conjunction with our new centers
be expensed as incurred. Previously we had amortized such costs over five
years. We recorded a 1998 charge of $6.9 million, net of income tax effect,
representing the cumulative effect of this change in accounting principle.
Projections for 2001
Based on current conditions and recent experience, our current projections
for 2001 are for normal operating earnings before depreciation and
amortization, debt expense and taxes to be in the range of $300 million to $330
million. These projections assume minimal acquisitions, an internal annual
growth rate of the number of dialysis treatments of approximately 3% to 4%,
limited opportunities to improve the mix of and reimbursement rates for non-
Medicare treatments, and underlying cost growth trends consistent with recent
27
years. 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 impairment 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,
DOJ or HHS in any pending or future review of our business, or otherwise.
Liquidity and capital resources
Following several years of rapid growth through acquisitions financed by
increases in debt, our borrowings totaled approximately $1.5 billion by of the
end of 1999, or 82% of total debt plus book equity. Because of our poor
operating performance and earnings charges in 1999, we were not in compliance
with several debt covenants as of December 31, 1999. As a result of this non-
compliance, all outstanding debt under the credit facilities and the
convertible subordinated notes were potentially callable and therefore
classified as a current liability as of December 31, 1999. In July 2000, we
restructured our credit facilities and are now in compliance with all credit
facility covenants.
The major terms of the restructured credit facilities included the
collateralization of the debt with substantially all our assets, the reduction
in the revolving credit availability to $150 million together with conversion
of $299 million of the previously existing revolving facility into a term loan,
a new quarterly amortization schedule beginning September 30, 2000 and an
immediate permanent pay-down of $50 million. In conjunction with the
restructuring, the associated interest rates returned to the lower LIBOR-based
rate formulas in effect prior to the non-compliance.
As of December 31, 2000, total borrowings had been reduced to $976 million,
or 74% of total debt plus book equity. This represented a reduction of $482
million or 33% from the beginning of the year. Because of pre-payments on the
term loan of the credit facility, the next principal payment was not due until
December 2002 and the available balance under the current $150 million
revolving line of credit was unused as of December 31, 2000. We made these
substantial pay-downs on the credit facilities with proceeds from the
divestitures of our non-continental U.S. operations and improved operating cash
flows during 2000.
Net cash provided by operating activities amounted to $308 million, $172
million and $11 million for 2000, 1999 and 1998, respectively. Approximately
half of the $308 million operating cash flow in 2000 was attributable to cash
earnings, net earnings adjusted for non-cash items, and the balance was
attributable to changes in working capital. Reductions in accounts receivable
of $60 million and income tax refunds of $37 million accounted for the majority
of the positive cash flow from working capital changes. Operating cash flow
less capital expenditures was $267 million for 2000, compared with $65 million
for 1999. Net proceeds from the sale of the non-continental U.S. operations
were approximately $133 million in 2000.
The continental U.S. accounts receivable balance at December 31, 2000
represented approximately 73 days of net revenue, net of bad debt provision, an
improvement of 21 days over the prior year end.
During 2000, investing activities generated net cash of $93 million as a
result of the divestiture of our non-continental U.S. operations for
approximately $133 million. Net cash used in investing activities for 1999 and
1998 amounted to $297 million and $469 million, including $154 million and $338
million for acquisitions. These acquisitions were funded with long-term debt.
Capital expenditures including development of new centers were $41 million,
$107 million and $83 million for 2000, 1999 and 1998, respectively. Based on
current projections, we expect capital expenditures to be in the $75 million to
$85 million range for 2001, with a substantial portion related to new center
developments.
As of December 31, 2000, we had net working capital of $148 million,
including cash of $31 million. Additionally, we have $150 million available
under our revolving line of credit. 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.
28
Contingencies
Our 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 $5.6 million for the review
period from January 1995 to April 1996 and $15 million for the review period
from May 1996 to March 1998. The carrier has suspended all payments of Medicare
claims from this laboratory since May 1998. The carrier has also determined
that $16.1 million of the suspended claims for the review period from April
1998 to August 1999 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 and 70% of the tests performed in the period from April 1998 to August
1999 were not properly supported by the prescribing physicians' medical
justification. In August 2000, the carrier requested additional records with
respect to the time period August 1999 to May 2000.
We are disputing the overpayment determinations and have provided supporting
documentation of our claims. We have 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 $5.6 million. 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 $14.2 million, or substantially
all of the overpayment determination. We have filed appeals of both decisions
to a federal administrative law judge and have moved to consolidate the two
appeals. At this time, we have not received a scheduled date for a hearing with
an administrative law judge, although HHS has informed us that we can expect a
hearing during the second quarter of 2001.
In February 1999, our Florida-based laboratory subsidiary filed a complaint
against the carrier and HHS seeking a court order to lift the payment
suspension. In July 1999, the court dismissed our complaint because we had not
exhausted all administrative remedies, that is, the carrier review and
administrative law judge processes described above.
In addition to the formal appeal process with a federal administrative law
judge, beginning in the third quarter of 1999 we 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 DOJ and HHS of this matter,
and we had provided requested information to DOJ. We met with DOJ in February
2001, at which time they requested additional information from us, which we
will provide.
The timing of the final resolution of this matter is highly uncertain and
beyond our control or influence. Beginning in the third quarter of 2000, we
stopped accruing additional Medicare revenue from this laboratory until the
uncertainties regarding both the timing of resolution and the ultimate revenue
valuations are at least substantially eliminated. The amount of potential
Medicare revenue not accrued beginning in the third quarter of 2000 was
approximately $4 million per quarter. As of June 30, 2000, the cumulative
recognized gross revenue associated with the withheld billings was
approximately $38 million. We estimate that the potential cash exposure as of
December 31, 2000 was not more than $15 million based on the carrier's
overpayment findings noted above. In addition, the government could impose
additional fines and penalties, which could be substantial.
In February 2001, the Civil Division of the United States Attorney's Office
for the Eastern District of Pennsylvania contacted us and requested that we
cooperate with them in a review of some of our historical practices, including
billing and other operating procedures and our financial relationships with
physicians.
The Civil Division has requested that we provide a wide range of information
responding to the areas of review but has not initiated any legal process or
served any subpoena on us. The Civil Division has indicated that it is not
making any allegation of wrongdoing at this time and that no criminal action
against us or any individual is currently contemplated. However, the Civil
Division could change the scope or focus of its inquiry at any time. We are
cooperating in this review.
29
Quarterly results of operations
The following table sets forth selected unaudited quarterly financial data
and operating information for 2000 and 1999.
Quarters ended
-------------------------------------------------------------------------------------------
2000 1999
-------------------------------------------- ---------------------------------------------
December 31 September 30 June 30 March 31 December 31 September 30 June 30 March 31
----------- ------------ -------- -------- ----------- ------------ -------- --------
Financial data (000's):
Net operating revenues.. $372,746 $362,535 $378,908 $372,113 $ 373,120 $367,168 $352,819 $352,244
Operating expenses...... 256,407 248,734 267,714 259,298 262,618 250,433 250,548 229,640
General and
administrative
expenses............... 30,164 29,920 31,619 31,921 44,663 32,725 29,559 23,608
Operating income
(loss)................. 51,649 49,906 32,843 40,317 (154,864) 35,107 (6,353) 62,128
Income before
extraordinary item..... 15,333 13,150 (15,355) 3,847 (150,664) 2,259 (22,059) 23,207
Net income (loss)....... 15,333 9,660 (15,355) 3,847 (150,664) (2,259) (22,059) 23,207
Per share data--assuming
dilution:
Income (loss) per share
before extraordinary
item................... $ 0.18 $ 0.16 $ (0.19) $ 0.05 $ (1.86) $ 0.03 $ (0.27) $ 0.28
Income (loss) per
share.................. 0.18 0.12 (0.19) 0.05 (1.86) 0.03 (0.27) 0.28
Selected operating
statistics:
Outpatient dialysis
centers................ 490 490 574 569 572 569 564 541
Total treatments
(000's)................ 1,371 1,364 1,564 1,519 1,541 1,510 1,467 1,393
Net operating revenues
per treatment.......... $ 272 $ 266 $ 242 $ 245 $ 242 $ 243 $ 241 $ 253
Operating income
margin................. 13.9% 13.8% 8.7 % 10.8% (41.5)% 9.6 % (1.8)% 17.6%
RISK FACTORS
This Form 10-K 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. We have
identified some of these forward-looking statements with words such as
"anticipates," "believes," "expects," "will," "should" and "intends" and the
negative of these words or other comparable terminology. 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, effective income tax rates and capital
expenditures.
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. We base our forward-looking statements on information currently
available to us, and we undertake no obligation to update these statements,
whether as a result of changes in underlying factors, new information, future
events or other developments.
If the percentage of our patients paying at or near our list prices declines,
then our revenues, cash flows and net income would be substantially reduced.
Approximately 41% of our net operating revenues in 1999 and 40% in 2000 were
generated from patients who had 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 remainder of
these patients have insurance policies that reimburse us at rates that are
below our list prices but, in most cases,
30
higher than Medicare rates. We believe that pressure from private payors to
decrease the rates at which they pay us will increase. If the percentage of
patients who have insurance that pays us at or near our list prices decreases
significantly, it would have an adverse effect on our revenues, cash flows and
net income.
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 will negatively impact our revenues.
Over the long term, we expect the profit margins in the dialysis industry to
decline, which will have a negative impact on our net income and cash flows.
During the past few years, industry operating margins have increased due to:
. Increased provision of ancillary services that have higher profit
margins;
. The extension of the period for which private payors remain the primary
insurer, until Medicare becomes the primary insurer; and
. Pricing increases for private pay patients.
We believe that the profit margins in ancillary services will not continue
to grow and that the additional profit from the extension of the private
insurance coverage period was a one-time event. Accordingly, we expect to see
declining profit margins in the dialysis industry.
Other forces that also may result in long-term industry margin compression
include increases in labor and supply costs at a faster rate than
reimbursement rate increases, reimbursement cuts for ancillary services and an
inability to achieve future pricing increases, or maintain current pricing,
for both private pay and managed care patients. Any significant decrease in
our margins would have a negative impact on our net income and cash flows.
Future declines, or the lack of further increases, in Medicare reimbursement
rates could reduce our net income and cash flows.
Approximately 54% of our net operating revenues in 1999 and 53% in 2000 were
generated from patients who had Medicare as their primary payor. 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. Congress recently enacted
two separate increases of 1.2% to the Medicare composite reimbursement rate
for dialysis effective January 1, 2000 and January 1, 2001. An additional 1.2%
increase will become effective April 1, 2001, plus an adjustment factor
designed to provide the benefits of the increase as if it had become effective
on January 1, 2001. These were the first increases in the composite rate since
1991 and are significantly less than the cumulative rate of inflation since
1991. The Medicare Payment Advisory Commission has also recommended to
Congress that there be no increase in 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 for inflation, our net income and cash flows may be adversely
affected.
31
Future changes in the structure of, and reimbursement rates under, the Medicare
ESRD program could substantially reduce our net income 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 of each drug--study due September 2001.
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 was approximately 13% of our net
revenue in 1999 and 2000. If EPO were included in the composite rate, and if
the composite rate were not increased sufficiently, our revenue would decrease
substantially. Reductions in current reimbursement rates for EPO or other
outpatient prescription drugs would also reduce our revenue.
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. Most
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 typically 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.
Medical directors contract with us for fixed periods, generally five to ten
years. Unless extended, the agreements with medical directors at centers
serving approximately 3,600 patients will expire on or before December 31,
2002. Medical directors have no obligation to extend their agreements with us.
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.
Our rollout of new information technology systems will 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 intend to roll out new information technology systems 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.
32
We have experienced disruption of our billing and collection activity in the
past. From the time of our formation in 1994 through 1998, we expanded
aggressively through acquisitions. We experienced difficulty integrating our
operations with the newly acquired businesses, which negatively impacted
administrative functions, including billing and collection activity.
Also, the new 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.
If the current shortage of skilled clinical personnel or our high level of
personnel turnover continues, we may experience disruptions in our business
operations.
We are experiencing 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 and central billing and accounting offices. Turnover has been
the highest among our reuse technicians, patient care technicians 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. For example, Amgen unilaterally decided to increase its
base price for EPO by 3.9% effective March 1, 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. Recent
developments in accepted clinical procedures with respect to the
administration of EPO may also decrease the frequency of EPO administration,
increase our administration costs or require us to purchase EPO with
preservative at a higher price. In addition, Amgen is developing a new product
that may replace EPO or reduce its use. We cannot predict when this product
may be introduced to the dialysis market, nor what its cost and reimbursement
structure will be. Increases in the cost of EPO, whether through net price
increases or higher administration costs, or the introduction of Amgen's new
product, could have a material adverse effect on our net income and cash
flows.
The cost of our medical supplies on a per-treatment basis has been increasing.
If this trend continues it could negatively impact our net income and cash
flows.
During the past two years, we have experienced an increase in the cost per
treatment of our medical supplies due to an increase in our utilization of
supplies and increases in pricing from suppliers. Two of our major competitors
are also major providers of medical supplies and equipment, and our largest
supplier, Fresenius Medical Care, is also the largest provider of dialysis
services in the world. In the past few years, the number of suppliers of
dialysis-specific medical supplies has declined due to consolidation among
these suppliers. If we are not able to manage our medical supply utilization
better or achieve cost savings from our suppliers, we may experience a
reduction in our net income and cash flows.
We may not have sufficient cash flow from our business to pay our substantial
debt.
As of December 31, 2000 we had:
. Total consolidated debt of approximately $976 million, including $499
million outstanding under our credit facilities; and
. A ratio of earnings to fixed charges of 1.34:1.
33
The following table shows the aggregate interest and principal payments due
on all of our currently outstanding debt for each of the next five fiscal
years. Also, because the interest rate under our credit facilities is based
upon a variable market rate plus a margin determined by the amount of debt we
incur relative to our earnings before income taxes, depreciation and
amortization, the amount of these interest payments could fluctuate
substantially in the future. Also, we are not prohibited from incurring
additional debt.
Scheduled payments Interest Principal
------------------ -------- ---------
(dollars in
thousands)
For the year ending December 31:
2001.................................................... $83,033 $ 1,676
2002.................................................... 82,871 15,062
2003.................................................... 65,444 232,519
2004.................................................... 54,800 70,212
2005.................................................... 47,541 70,198
Due to the large amount of these principal and interest payments, we may not
generate enough cash from our operations to meet these obligations or to fund
other liquidity needs. Our ability to generate cash in the future is, to some
extent, subject to risks and uncertainties that are beyond our control. If we
are unable to meet our debt obligations, we may need to refinance all or a
portion of our indebtedness, sell assets or raise funds in the capital
markets. We may not be able to engage in any of these activities on desirable
terms or at all, which could result in a default on our debt obligations.
The large amount and terms of our outstanding debt may prevent us from taking
actions we would otherwise consider in our best interest.
Our credit facilities contain numerous financial and operating covenants
that limit our ability to engage in activities such as incurring additional
debt, acquiring and developing new dialysis centers, disposing of assets, or
repurchasing our common stock. These covenants require that we meet financial
ratios including interest coverage, net worth and leverage tests.
The large amount of our outstanding debt and the limitations our credit
facilities impose on us could have other important consequences, including:
. We will have to use much of our cash flow for scheduled debt service
rather than for operations;
. We may not be able to increase our borrowings under the credit
facilities or obtain other debt financing for future working capital,
capital expenditures, acquisitions or other corporate purposes;
. We could be less able to take advantage of significant business
opportunities, including acquisitions or divestitures;
. Our vulnerability to general adverse economic and industry conditions
could be increased; and
. We could be at a competitive disadvantage to competitors with less debt.
If we fail to adhere to all of the complex government regulations that apply
to our business, we could incur substantial fines or be excluded from
participating in government reimbursement programs.
Our dialysis operations are subject to extensive federal, state and local
government regulations, including federal and state anti-kickback laws. We
endeavor to structure all of our relationships with referring physicians to
comply with these laws. In many cases, our physician arrangements do not
satisfy all of the elements of the safe harbor protections from the anti-
kickback laws and could be found to violate these laws. If any of our
operations are found to violate these or other government regulations, we
could suffer severe penalties, including:
. Suspension of payments from government programs;
. Loss of required government certifications;
34
. Loss of authorizations to participate in or exclusion from government
reimbursement programs, such as the Medicare ESRD program and Medicaid
programs;
. Loss of licenses required to operate health care 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 regulatory scrutiny of healthcare providers, including dialysis
providers, has increased significantly in recent years. For the fiscal year
ended September 30, 2000, DOJ announced total recoveries of $840 million from
healthcare civil fraud cases, including a $486 million settlement with one of
our competitors as a result of an 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 markedly increased, consistent with
recommendations of the OIG included in its June 2000 testimony before the
Senate Special Committee on Aging regarding Medicare's system for the external
quality review of kidney dialysis centers. We have incurred increases in
administrative costs as a result of this regulatory activity. We expect this
regulatory scrutiny to continue, if not increase, which will result in
additional administrative expenses and could lead to penalties being assessed
against us or the loss of Medicare certification at affected centers.
The pending federal review of some of our historical practices could result in
substantial penalties against us.
We are voluntarily cooperating with the Civil Division of the United States
Attorney's Office for the Eastern District of Pennsylvania in a review of some
of our historical practices, including billing and other operating procedures
and our financial relationships with physicians. We are unable to determine
when this matter will be resolved, whether any additional areas of inquiry
will be opened or any outcome of this inquiry, financial or otherwise. Any
negative findings from this review could result in substantial financial
penalties against us and exclusion from future participation in the Medicare
and Medicaid programs.
We may never collect the payments suspended as a result of a third-party
carrier review of our laboratory subsidiary.
Our Florida-based laboratory subsidiary is the subject of a third-party
carrier review relating to claims the laboratory submitted for Medicare
reimbursement. In May 1998, the carrier suspended all further Medicare
payments to this laboratory. For the first six months of 2000, Medicare
revenue from this laboratory represented approximately 1% of our net revenues.
Beginning in the third quarter of 2000, we ceased recognizing current Medicare
revenue from this laboratory. As of June 30, 2000, the cumulative recognized
gross revenue associated with the withheld billings was approximately $38
million. Based on the carrier's overpayment determinations to date, we
estimate that our potential cash exposure at December 31, 2000 was not more
than $15 million. We may never recover the amounts withheld and we cannot
predict what action DOJ or the OIG may take in this matter. The government
could impose additional penalties or fines against us, which could be
substantial.
Total assets, stockholders' equity and earnings could be materially reduced if
goodwill balances become impaired.
Our balance sheet includes an amount designated as "goodwill" that
represents 50% of our total assets and 228% of our stockholders' equity at
December 31, 2000. Goodwill arises when an acquiror pays more for a business
than the fair value of the tangible and separately measurable intangible net
assets. Generally accepted
35
accounting principles require the amortization of goodwill and all other
intangible assets over the period benefitted. The current average remaining
amortization period is 35 years for our goodwill. We routinely review cash
flows for the specific operations associated with the respective goodwill
balances to determine whether there are potential impairments of the
unamortized goodwill balances. If goodwill balances are determined to be
impaired and impairment losses are recorded, total assets, stockholders' equity
and earnings could be materially reduced.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
Interest rate sensitivity
The table below provides information about our financial instruments that are
sensitive to changes in interest rates.
For our debt obligations, the table presents principal repayments and current
weighted average interest rates on these obligations as of December 31, 2000.
For our debt obligations with variable interest rates, the rates presented
reflect the current rates in effect at the end of 2000. These rates are based
on LIBOR plus a margin of 3.00% and 3.75% for the revolving and term credit
facilities debt, respectively.
Expected maturity date Average
------------------------ Fair interest
2001 2002 2003 2004 2005 Thereafter Total value rate
---- ---- ---- ---- ---- ---------- ----- ----- --------
(dollars in millions)
Long-term debt
Fixed rate.......... $470 $470 $403 6.63%
Variable rate....... $ 2 $15 $233 $70 $70 116 506 506 10.11
Exchange rate sensitivity
In the second quarter of 2000, we divested our foreign operations in
Argentina, Germany, Italy and the United Kingdom and we are currently not
exposed to any foreign currency exchange rate risk.
Item 8. Financial Statements and Supplementary Data.
See the Index included at "Item 14. Exhibits, Financial Statement Schedules
and Reports on Form 8-K."
Item 9. Changes In and Disagreements with Accountants on Accounting and
Financial Disclosure.
A change in our accountants was previously reported in a current report on
Form 8-K filed on August 23, 2000.
36
PART III
Item 10. Directors and Executive Officers of the Registrant.
The information required by this item will appear in, and is incorporated by
reference from, the section entitled "Proposal No. 1. Election of Directors"
under the subheading "Information concerning nominees to our board of
directors" and the section entitled "Executive Officers, Compensation and Other
Information" under the subheadings "Information concerning our executive
officers" and "Section 16(a) beneficial ownership reporting compliance"
included in our definitive proxy statement relating to our 2001 annual
stockholder meeting.
Item 11. Executive Compensation.
The information required by this item will appear in, and is incorporated by
reference from, the section entitled "Proposal No. 1. Election of Directors"
under the subheading "Compensation of directors" and the section entitled
"Executive Officers, Compensation and Other Information" under the subheadings
"Executive compensation," "Employment agreements" and "Compensation committee
interlocks and insider participation" included in our definitive proxy
statement relating to our 2001 annual stockholder meeting. The compensation
committee report and performance graph required by Items 402(k) and (l) of
Regulation S-K are not incorporated herein.
Item 12. Security Ownership of Certain Beneficial Owners and Management.
The information required by this item will appear in, and is incorporated by
reference from, the section entitled "Security Ownership of Principal
Stockholders, Directors and Officers" included in our definitive proxy
statement relating to our 2001 annual stockholder meeting.
Item 13. Certain Relationships and Related Transactions.
The information required by this item will appear in, and is incorporated by
reference from, the section entitled "Certain Relationships and Related
Transactions" included in our definitive proxy statement relating to our 2001
annual stockholder meeting.
37
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.
(a) Documents filed as part of this Report:
(1) Index to Financial Statements:
Page
----
Reports of Independent Accountants...................................... F-1
Consolidated Balance Sheets as of December 31, 2000 and December 31,
1999................................................................... F-2
Consolidated Statements of Income and Comprehensive Income for the years
ended December 31, 2000, December 31, 1999 and December 31, 1998....... F-3
Consolidated Statements of Cash Flows for the years ended December 31,
2000, December 31, 1999 and December 31, 1998.......................... F-4
Consolidated Statements of Shareholders' Equity for the years ended
December 31, 2000, December 31, 1999 and December 31, 1998............. F-5
Notes to Consolidated Financial Statements.............................. F-6
(2) Index to Financial Statement Schedules:
Reports of Independent Accountants on Financial Statement Schedule...... S-1
Schedule II--Valuation and Qualifying Accounts.......................... S-2
(3) Exhibits:
3.1 Amended and Restated Certificate of Incorporation of Total Renal Care
Holdings Inc., or TRCH, dated December 4, 1995.(1)
3.2 Certificate of Amendment of Certificate of Incorporation of TRCH, dated
February 26, 1998.(2)
3.3 Certificate of Amendment of Certificate of Incorporation of DaVita Inc.
(formerly Total Renal Care Holdings, Inc.), dated October 5, 2000.X
3.4 Bylaws of TRCH, dated October 6, 1995.(3)
4.1 Indenture, dated June 12, 1996 by Renal Treatment Centers, Inc., or
RTC, to PNC Bank including form of RTC Note.(5)
4.2 First Supplemental Indenture, dated as of February 27, 1998, among RTC,
TRCH and PNC Bank under the 1996 Indenture.(2)
4.3 Second Supplemental Indenture, dated as of March 31, 1998, among RTC,
TRCH and PNC Bank under the 1996 Indenture.(2)
4.4 Indenture, dated as of November 18, 1998, between TRCH and United
States Trust Company of New York, as trustee, and form of Note.(6)
4.5 Registration Rights Agreement, dated as of November 18, 1998, between
TRCH and DLJ, BNY Capital Markets, Inc., Credit Suisse First Boston
Corporation and Warburg Dillon Read LLC, as the initial purchasers.(6)
4.6 Purchase Agreement, dated as of November 12, 1998, between TRCH and the
initial purchasers.(6)
10.1 Employment Agreement, dated as of March 2, 1998, by and between TRCH
and Barry C. Cosgrove.(7)*
10.2 Employment Agreement, dated as of October 18, 1999, by and between TRCH
and Kent J. Thiry.(8)*
38
10.3 Amendment to Mr. Thiry's Employment Agreement, dated May 20, 2000.
(10)*
10.4 Second Amendment to Mr. Thiry's Employment Agreement, dated November
28, 2000.X*
10.5 Employment Agreement, dated as of March 1, 1998, by and between TRCH
and John J. McDonough.(11)*
10.6 Employment Agreement, dated as of November 29, 1999, by and between
TRCH and Gary W. Beil.X*
10.7 Employment Agreement, dated as of July 19, 2000, by and between TRCH
and Charles J. McAllister.X*
10.8 Consulting Agreement, dated as of October 1, 1998, by and between
Total Renal Care, Inc. and Shaul G. Massry, M.D.(8)*
10.9 Second Amended and Restated 1994 Equity Compensation Plan.(11)*
10.10 Form of Stock Subscription Agreement relating to the 1994 Equity
Compensation Plan.(4)*
10.11 Form of Promissory Note and Pledge Agreement relating to the 1994
Equity Compensation Plan.(4)*
10.12 Form of Purchased Shares Award Agreement relating to the 1994 Equity
Compensation Plan.(4)*
10.13 Form of Nonqualified Stock Option relating to the 1994 Equity
Compensation Plan.(4)*
10.14 First Amended and Restated 1995 Equity Compensation Plan.(11)*
10.15 Employee Stock Purchase Plan, 1999 Amendment and Restatement.(11)*
10.16 First Amended and Restated 1997 Equity Compensation Plan.(11)*
10.17 First Amended and Restated Special Purpose Option Plan.(11)*
10.18 1999 Equity Compensation Plan.(9)*
10.19 Second Amended and Restated Revolving Credit Agreement, dated as of
July 14, 2000, by and among TRCH, the lenders party thereto, DLJ
Capital Funding, Inc., as Syndication Agent, First Union National
Bank, as Documentation Agent, and The Bank of New York, as
Administrative Agent.(10)
10.20 Second Amended and Restated Term Loan Agreement, dated as of July 14,
2000, by and among TRCH, the lenders party thereto, DLJ Capital
Funding, Inc., as Syndication Agent, and The Bank of New York, as
Administrative Agent.(10)
10.21 Security Agreement dated as of July 14, 2000, by and among TRCH,
subsidiaries of TRCH, The Bank of New York, as Collateral Agent, the
lenders under the Revolving Credit Agreement and their agent, the
lenders under the Term Loan Agreement and their agent, and the
Secured Interest Rate Exchangers (as defined therein).(10)
10.22 Amended and Restated Subsidiary Guaranty, dated as of July 14, 2000,
by subsidiaries of TRCH in favor of and for the benefit of The Bank
of New York, as Collateral Agent, the lenders under the Revolving
Credit Agreement and their agent, the lenders under the Term Loan
Agreement and their agent, and the Acknowledging Interest Rate
Exchangers (as defined therein).(10)
10.23 Guaranty, entered into as of March 31, 1998, by TRCH in favor of and
for the benefit of PNC Bank.(2)
10.24 Amendment #2, dated June 22, 2000, to Agreement No. 19990110 between
Amgen Inc. and Total Renal Care, Inc., and letter agreement dated
January 17, 2001 modifying Amendment #2.X**
10.25 Amendment #3, dated January 16, 2000, to Agreement No. 19990112
between Amgen Inc. and Total Renal Care, Inc.X**
12.1 Statement re Computation of Ratios of Earnings to Fixed Charges.X
21.1 List of our subsidiaries.X
39
23.1 Consent of KPMG LLP.X
23.2 Consent of PricewaterhouseCoopers LLP.X
24.1 Powers of Attorney with respect to DaVita Inc. (included on page II-1).
- --------
X Included in this filing.
* 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 18, 1996 as an exhibit to our Transitional Report on Form
10-K for the transition period from June 1, 1995 to December 31, 1995.
(2) Filed on March 31, 1998 as an exhibit to our Form 10-K for the year ended
December 31, 1997.
(3) Filed on October 24, 1995 as an exhibit to Amendment No. 2 to our
Registration Statement on Form S-1 (Registration Statement No. 33-97618).
(4) Filed on August 29, 1995 as an exhibit to our Form 10-K for the year
ended May 31, 1995.
(5) Filed as an exhibit to RTC's Form 10-Q for the quarter ended June 30,
1996.
(6) Filed on December 18, 1998 as an exhibit to our Registration Statement on
Form S-3 (Registration Statement No. 333-69227).
(7) Filed as an exhibit to our Form 10-Q for the quarter ended September 30,
1998.
(8) Filed on November 15, 1999 as an exhibit to our Form 10-Q for the quarter
ended September 30, 1999.
(9) Filed on February 18, 2000 as an exhibit to our Registration Statement
on Form S-8 (Registration Statement No. 333-30736).
(10) Filed on August 14, 2000, as an exhibit to our Form 10-Q for the quarter
ended June 30, 2000.
(11) Filed on March 29, 2000, as an exhibit to our Form 10-K for the year
ended December 31, 1999.
(b) Reports on Form 8-K:
Form 8-K dated October 5, 2000, filed on October 6, 2000, to report under
Item 5 the filing of an amendment to the Company's certificate of
incorporation to effect the change of its name from Total Renal Care
Holdings, Inc. to DaVita Inc.
40
REPORTS OF INDEPENDENT ACCOUNTANTS
The Board of Directors and Shareholders
DaVita Inc.:
We have audited the accompanying consolidated balance sheet of DaVita Inc.
and subsidiaries as of December 31, 2000, and the related consolidated
statements of income and comprehensive income, shareholders' equity, and cash
flows for the year ended December 31, 2000. The consolidated financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on the consolidated financial
statements based on our audit.
We conducted our audit in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of DaVita Inc.
and subsidiaries as of December 31, 2000, and the results of their operations
and their cash flows for the year ended December 31, 2000, in conformity with
accounting principles generally accepted in the United States of America.
KPMG LLP
Seattle, Washington
February 20, 2001
----------------
To the Board of Directors and Shareholders of
DaVita Inc.
In our opinion, the accompanying consolidated balance sheet and the related
consolidated statements of income and comprehensive income, of shareholders'
equity and of cash flows present fairly, in all material respects, the
financial position of DaVita Inc. (formerly Total Renal Care Holdings, Inc.)
and its subsidiaries at December 31, 1999, and the results of their operations
and their cash flows for each of the two years in the period ended December 31,
1999 in conformity with accounting principles generally accepted in the United
States of America. These financial statements are the responsibility of the
Company's management; our responsibility is to express an opinion on these
financial statements based on our audits. We conducted our audits of these
statements in accordance with auditing standards generally accepted in the
United States of America which require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the accounting principles used and significant estimates made by management,
and evaluating the overall financial statement presentation. We believe that
our audits provide a reasonable basis for the opinion expressed above.
Our report dated March 22, 2000, included an explanatory paragraph indicating
the Company was out of compliance with several debt covenants which raised
substantial doubt about the Company's ability to continue as a going concern.
As discussed in Note 10, on July 14, 2000, the Company restructured its primary
borrowing arrangements resulting in the elimination of the debt covenant
violations and the associated uncertainty about the Company's ability to
continue as a going concern. Accordingly, our present opinion on the 1999
financial statements as presented herein is different from that expressed in
our previous report in that the explanatory paragraph is no longer required.
PricewaterhouseCoopers LLP
Seattle, Washington
March 22, 2000, except for the first paragraph of
Note 10 as to which the date is July 14, 2000
F-1
DAVITA INC.
CONSOLIDATED BALANCE SHEETS
(dollars in thousands)
December 31,
----------------------
2000 1999
---------- ----------
ASSETS
------
Cash and cash equivalents.............................. $ 31,207 $ 107,981
Accounts receivable, less allowance of $61,619 and
$67,315............................................... 290,412 390,329
Inventories............................................ 20,641 32,916
Other current assets................................... 10,293 32,082
Income taxes receivable................................ 2,830 45,645
Deferred income taxes.................................. 42,492 45,795
---------- ----------
Total current assets............................... 397,875 654,748
Property and equipment, net............................ 236,659 285,449
Intangible assets, net................................. 921,623 1,069,672
Investments in third-party dialysis businesses......... 34,194 35,552
Other long-term assets................................. 1,979 4,744
Deferred income taxes.................................. 4,302 6,553
---------- ----------
$1,596,632 $2,056,718
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------
Accounts payable....................................... $ 74,882 $ 121,561
Other liabilities...................................... 102,563 77,141
Accrued compensation and benefits...................... 70,406 47,647
Current portion of long-term debt...................... 1,676 26,585
Long-term debt potentially callable under covenant
provisions............................................ 1,425,610
---------- ----------
Total current liabilities.......................... 249,527 1,698,544
Long-term debt, less $1,425,610 potentially callable
classified as current in 1999......................... 974,006 5,696
Other long-term liabilities............................ 4,855 3,497
Minority interests..................................... 18,876 22,577
Commitments and contingencies
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; 82,135,634 and 81,193,011 shares issued
and outstanding).................................... 82 81
Additional paid-in capital........................... 430,676 426,025
Notes receivable from shareholders .................. (83) (192)
Accumulated other comprehensive loss................. (4,718)
Accumulated deficit.................................. (81,307) (94,792)
---------- ----------
Total shareholders' equity......................... 349,368 326,404
---------- ----------
$1,596,632 $2,056,718
========== ==========
See notes to consolidated financial statements.
F-2
DAVITA INC.
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
(dollars in thousands, except per share data)
Year ended December 31,
----------------------------------
2000 1999 1998
---------- ---------- ----------
Net operating revenues.................... $1,486,302 $1,445,351 $1,203,738
Operating expenses:
Dialysis centers and labs............... 1,032,153 993,239 779,740
General and administrative.............. 123,624 130,555 75,686
Depreciation and amortization........... 111,605 112,481 90,353
Provision for uncollectible accounts.... 39,649 133,253 44,858
Impairment and valuation losses......... 4,556 139,805
Merger related costs.................... 78,188
---------- ---------- ----------
Total operating expenses.............. 1,311,587 1,509,333 1,068,825
---------- ---------- ----------
Operating income (loss)................... 174,715 (63,982) 134,913
Other income (loss)....................... (7,201) (1,895) 4,894
Debt expense.............................. 116,637 110,797 84,003
Minority interests in income of
consolidated subsidiaries................ (5,942) (5,152) (7,163)
---------- ---------- ----------
Income (loss) before income taxes,
extraordinary item and change in
accounting principle................... 44,935 (181,826) 48,641
Income tax expense (benefit).............. 27,960 (34,570) 38,449
---------- ---------- ----------
Income (loss) before extraordinary item
and change in accounting principle..... 16,975 (147,256) 10,192
Extraordinary loss related to early
extinguishment of debt, net of tax of
$2,222 and $7,668, respectively.......... (3,490) (12,744)
Cumulative effect of change in accounting
principle, net of tax of $4,300.......... (6,896)
---------- ---------- ----------
Net income (loss)....................... $ 13,485 $ (147,256) $ (9,448)
========== ========== ==========
Earnings (loss) per common share--basic:
Income (loss) before extraordinary item
and change in accounting principle..... $ 0.21 $ (1.81) $ 0.12
Extraordinary loss, net of tax.......... (0.04) (0.16)
Cumulative effect of change in
accounting principle, net of tax....... (0.08)
---------- ---------- ----------
Net income (loss)....................... $ 0.17 $ (1.81) $ (0.12)
========== ========== ==========
Weighted average number of common shares
outstanding.............................. 81,581,000 81,152,000 80,143,000
========== ========== ==========
Earnings (loss) per common share--assuming
dilution:
Income (loss) before extraordinary item
and change in accounting principle..... $ 0.20 $ (1.81) $ 0.12
Extraordinary loss, net of tax.......... (0.04) (0.16)
Cumulative effect of change in
accounting principle, net of tax....... (0.08)
---------- ---------- ----------
Net income (loss)....................... $ 0.16 $ (1.81) $ (0.12)
========== ========== ==========
Weighted average number of common shares
and equivalents outstanding--assuming
dilution................................. 83,157,000 81,152,000 81,701,000
========== ========== ==========
STATEMENTS OF COMPREHENSIVE INCOME
Net income (loss)....................... $ 13,485 $ (147,256) $ (9,448)
Other comprehensive income:
Foreign currency translation.......... 4,718 (4,718)
---------- ---------- ----------
Comprehensive income (loss)............. $ 18,203 $ (151,974) $ (9,448)
========== ========== ==========
See notes to consolidated financial statements.
F-3
DAVITA INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(dollars in thousands)
Year ended December 31,
-------------------------------------
2000 1999 1998
----------- ----------- -----------
Cash flows from operating activities:
Net income (loss)..................... $ 13,485 $ (147,256) $ (9,448)
Non-cash items included in net income
(loss):
Depreciation and amortization........ 111,605 112,481 90,353
Impairment and valuation losses...... 4,556 139,805
Gain on divestitures................. (2,875)
Deferred income taxes................ 8,906 (21,546) (17,577)
Non-cash debt expense................ 3,008 2,563 1,376
Stock option expense and tax
benefits............................ 2,908 2,280 33,912
Equity investment losses (income).... 931 140 (157)
Foreign currency exchange loss....... 4,718
Minority interests in income of
consolidated subsidiaries........... 5,942 5,152 7,163
Extraordinary loss................... 3,490 20,412
Cumulative effect of change in
accounting principle................ 11,196
Changes in operating assets and
liabilities, net of effect of
acquisitions and divestitures:
Accounts receivable.................. 59,564 28,486 (155,393)
Inventories.......................... 9,402 (8,742) (7,152)
Other current assets................. 15,150 14,171 (30,104)
Other long-term assets............... 2,683 5,503 8,414
Accounts payable..................... (28,716) 72,694 10,131
Accrued compensation and benefits.... 26,365 11,541 8,933
Other liabilities.................... 19,445 5,200 36,580
Income taxes......................... 45,473 (52,464) 11,004
Other long-term liabilities.......... 1,608 1,498 (7,725)
----------- ----------- -----------
Net cash provided by operating
activities........................ 307,648 171,506 11,918
----------- ----------- -----------
Cash flows from investing activities:
Additions of property and equipment,
net.................................. (41,088) (106,657) (82,820)
Acquisitions and divestitures, net.... 1,120 (154,226) (338,164)
Divestitures of non-continental U.S.
operations........................... 133,177
Investments in affiliates, net........ 488 (25,380) (16,785)
Intangible assets..................... (342) (5,184) (14,555)
----------- ----------- -----------
Net cash provided by (used in)
investing activities.............. 93,355 (291,447) (452,324)
----------- ----------- -----------
Cash flows from financing activities:
Borrowings............................ 1,913,893 2,337,790 1,570,620
Payments on long-term debt............ (2,390,929) (2,136,273) (1,443,325)
Proceeds from convertible notes....... 345,000
Deferred financing costs.............. (3,092) (8,546) (17,631)
Interest rate swap liquidation
proceeds............................. 6,257
Net proceeds from issuance of common
stock................................ 2,658 2,234 24,157
Distributions to minority interests... (6,564) (4,052) (3,628)
----------- ----------- -----------
Net cash provided by (used in)
financing activities.............. (477,777) 191,153 475,193
Foreign currency translation loss in
comprehensive income................... (4,718)
----------- ----------- -----------
Net increase (decrease) in cash ........ (76,774) 66,494 34,787
Cash and cash equivalents at beginning
of year ............................... 107,981 41,487 6,700
----------- ----------- -----------
Cash and cash equivalents at end of
year................................... $ 31,207 $ 107,981 $ 41,487
=========== =========== ===========
See notes to consolidated financial statements.
F-4
DAVITA INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(in thousands)
Notes Accumulated
Common Stock Additional receivable other Retained
------------- paid-in from comprehensive earnings
Shares Amount capital shareholders income (loss) (deficit) Total
------ ------ ---------- ------------ ------------- --------- --------
Balance at December 31,
1997................... 77,992 $78 $363,486 $(3,030) $ 61,912 $422,446
Shares issued in
acquisitions........... 99 2,796 2,796
Shares issued to
employees and others... 49 1,085 1,085
Options exercised....... 2,890 3 36,396 36,399
Repayment of notes
receivable, net of
interest accrued....... 2,674 2,674
Income tax benefit on
stock options
exercised.............. 14,199 14,199
Grant of stock options.. 128 128
Stock option expense.... 3,585 3,585
Net loss................ (9,448) (9,448)
------ --- -------- ------- ------- -------- --------
Balance at December 31,
1998................... 81,030 81 421,675 (356) 52,464 473,864
Shares issued to
employees and others... 77 1,937 1,937
Options exercised....... 86 109 109
Repayment of notes
receivable, net of
interest accrued....... 164 164
Income tax benefit on
stock options
exercised.............. 375 375
Grant of stock options.. 813 813
Stock option expense.... 1,116 1,116
Foreign currency
translation............ $(4,718) (4,718)
Net loss................ (147,256) (147,256)
------ --- -------- ------- ------- -------- --------
Balance at December 31,
1999................... 81,193 81 426,025 (192) (4,718) (94,792) 326,404
Shares issued to
employees and others... 126 720 720
Options exercised....... 817 1 2,080 2,081
Repayment of notes
receivable, net of
interest accrued....... 109 109
Income tax benefit on
stock options
exercised.............. 1,977 1,977
Stock option expense
(benefit) ............. (126) (126)
Foreign currency
translation............ 4,718 4,718
Net income.............. 13,485 13,485
------ --- -------- ------- ------- -------- --------
Balance at December 31,
2000................... 82,136 $82 $430,676 $ (83) $ 0 $(81,307) $349,368
====== === ======== ======= ======= ======== ========
See notes to consolidated financial statements.
F-5
DAVITA INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands)
1. Organization and summary of significant accounting policies
Organization
DaVita Inc. (formerly Total Renal Care Holdings, Inc.) operates kidney
dialysis centers and provides related medical services in dialysis centers in
the United States. These operations represent a single business segment. See
Note 2 regarding the Company's divestiture of its operations outside the
continental United States during 2000.
Basis of presentation
These consolidated financial statements include the Company's wholly-owned
and majority-owned subsidiaries and partnerships, as well as other entities in
which the Company maintains a controlling financial interest. Non-consolidated
equity investments are recorded under the equity method of accounting, unless
DaVita's equity interest is less than 20% and it does not exercise significant
influence over the operations of the investee. For all periods presented, the
annual results of our operations outside the U.S. are based on the twelve-month
period ended November 30 to accommodate our consolidated reporting time
schedules.
Net operating revenues
Revenues are recognized as services are provided to patients. Operating
revenues consist primarily of reimbursement for dialysis and ancillary services
to patients. A usual and customary fee schedule is maintained for our dialysis
treatment and other patient services; however, actual collectible revenue is
normally at a discount to the fee schedule. Medicare and Medicaid programs are
billed at pre-determined net realizable rates per treatment that are
established by statute or regulation. Most non-governmental payors, including
contracted managed care payors, are billed at our usual and customary rates,
but a contractual allowance is recorded to reflect the expected net realizable
revenue for services provided. Contractual and bad debt allowances are
established based upon credit risk of specific third-party payors, contractual
terms and collection experience. Net revenue recognition and allowances for
uncollectible billings require the use of estimates, and any changes in these
estimates are reflected as they become known.
Management services are provided to dialysis centers not owned by the
Company. The management fees are typically determined as a percentage of the
centers' patient revenues and are included in net operating revenues as earned.
Any costs incurred in performing these management services are recognized in
facility operating and general and administrative expenses.
Other income
Other income includes interest income on cash investments, earnings and
losses from non-consolidated equity investments and other non-operating gains
and losses.
Cash and cash equivalents
Cash equivalents are highly liquid investments with maturities at purchase of
three months or less.
Inventories
Inventories are stated at the lower of cost (first-in, first-out) or market
and consist principally of drugs and dialysis related supplies.
F-6
DAVITA INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(dollars in thousands)
Property and equipment
Property and equipment are stated at cost. Maintenance and repairs are
charged to expense as incurred. Depreciation and amortization expense are
computed using the straight-line method over the useful lives of the assets
estimated as follows: buildings, 20 to 40 years; leasehold improvements, over
the shorter of their estimated useful life or the lease term; and equipment, 3
to 15 years. Disposition gains and losses are included in current earnings.
Capitalized interest
Applicable interest charges incurred during significant facility expansion
and construction are capitalized as one of the elements of cost and are
amortized over the assets' estimated useful lives. Interest capitalized was
$1,125, $709 and $804 for 2000, 1999 and 1998, respectively.
Intangible assets
The excess of aggregate purchase price over the fair value of the net assets
of businesses acquired in purchase transactions is recorded as goodwill.
Goodwill is amortized over 15 to 40 years using the straight-line method. As of
December 31, 2000, the blended average life of goodwill is 35 years. Business
acquisition costs allocated to patient lists are amortized generally over five
to eight years using the straight-line method. Business acquisition costs
allocated to covenants not to compete are amortized over the terms of the
agreements, typically three to ten years, using the straight-line method.
Deferred debt issuance costs are amortized over the term of the related debt
using the effective interest method.
Impairment of long-lived assets
Long-lived assets including goodwill, other intangible assets, property and
equipment, and investment balances are reviewed for possible impairment
whenever significant events or changes in circumstances, including changes in
our business strategy and plans, indicate a potential impairment may have
occurred, and when the sum of the expected future undiscounted net cash flows
identifiable to that asset or group of assets is less than book value. For
potential impairment of goodwill balances, cash flows are reviewed for the
specific facility operations compared to the goodwill balance that resulted
from the acquisition of that specific group of centers. Impairment losses are
determined based on net realizable values or projections of net cash flows.
Interest is not accrued on impaired loans unless the estimated recovery amounts
justify such accruals. Cash flows of facility operations are routinely reviewed
for indications of potential impairment.
Income taxes
Federal, state and foreign income taxes are computed at current tax rates,
less tax credits. Taxes are adjusted both for items that do not have tax
consequences and for the cumulative effect of any changes in tax rates from
those previously used to determine deferred tax assets or liabilities. Tax
provisions include amounts that are currently payable, plus changes in deferred
tax assets and liabilities that arise because of temporary differences between
the timing of when items of income and expense are recognized for financial
reporting and income tax purposes.
Minority interests
Minority interests represent the proportionate equity interest of other
partners and shareholders in consolidated entities which are not wholly-owned.
As of December 31, 2000, these included 16 active partnerships and
corporations.
F-7
DAVITA INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(dollars in thousands)
Stock-based compensation
Stock-based compensation for employees is determined in accordance with APB
No. 25 as allowed under FAS 123. Stock option grants to employees do not result
in an expense if the exercise price is at least equal to the market price at
the date of grant. Stock option expense is also measured and recorded for
certain modifications to stock options as required under FIN 44.
Stock options issued to non-employees are valued using the Black-Scholes
model and attributed to the respective vesting periods using the FIN 28 expense
attribution method, except that for options granted prior to the second quarter
of 1997 (effective date of EITF 96-18) such expense was a fixed amortization of
the grant date fair value.
Earnings per share
Basic earnings per share is calculated by dividing net income before
extraordinary items and the cumulative effect of changes in accounting
principle by the weighted average number of shares of common stock outstanding.
Earnings per common share assuming dilution includes the dilutive effects of
stock options and warrants, using the treasury stock method, in determining the
weighted average number of shares of common stock outstanding. The convertible
debt was antidilutive in all periods presented and therefore not included in
the diluted earnings per share calculation.
Interest rate swap agreements
The Company has from time to time entered into interest rate swap agreements
(see Note 10) as a means of managing interest rate exposure. These agreements
have not been for trading or speculative purposes, and had the effect of
converting a portion of our variable rate debt to a fixed rate. Net amounts
paid or received have been reflected as adjustments to interest expense. The
Company had no interest rate swap agreements as of December 31, 2000.
Foreign currency translation
Until sold in June 2000 the Company's principal operations outside of the
United States were in Argentina and were relatively self-contained and
integrated within Argentina. The currency in Argentina, which was considered
the functional currency, is tied to the U.S. dollar. Other operations outside
the U.S. were translated into U.S. dollars at period-end exchange rates and any
unrealized gains and losses were accounted for as a component of other
comprehensive income. Unrealized gains or losses on debt denominated in foreign
currency, which was considered a hedge of the net investment in foreign
operations, were accounted for as a component of other comprehensive income
until June 2000 when we divested our non-continental operations.
Derivative instruments and hedging activities
Statement of Financial Accounting Standards No. 133, Accounting for
Derivative Instruments and Hedging Activities. SFAS 133, as amended by SFAS 137
and 138, will be adopted effective January 1, 2001. SFAS 133 requires that all
derivative instruments be recorded on the balance sheet at their fair values.
Changes in the fair value of derivatives are recorded each period in current
earnings or other comprehensive income, depending on whether a derivative is
designated as part of a hedge transaction and, if it is, the type of hedge
transaction. As of December 31, 2000, the Company is not party to any
derivative instruments that will have a significant impact on the Company's
reported financial condition or results of operation upon adoption of this
statement.
F-8
DAVITA INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(dollars in thousands)
Use of estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosure of contingent assets
and liabilities at the dates of the financial statements and the reported
amounts of revenues and expenses during the reporting periods. Actual results
could differ from those estimates.
Reclassifications
Certain prior year amounts have been reclassified to conform to the current
year presentation. These reclassifications had no effect on reported earnings.
2. Impairments and valuation losses
Impairment and valuation losses for the year ended December 31, 2000 and 1999
consisted of the following:
Year ended
December 31,
--------------------
2000 1999
------ --------
Non-continental U.S. operations......................... $ (616) $ 82,812
Continental U.S. operations............................. 5,172 56,993
------ --------
$4,556 $139,805
====== ========
During the fourth quarter of 1999, the Company announced its intention to
sell its dialysis operations outside the continental United States resulting in
an impairment charge of $82,812 representing the estimated losses on the sales
of these operations, including the costs of buying out minority interests and
the direct transaction costs of completing the sale. The divestitures were
substantially completed in the second quarter of 2000.
The impairment and valuation losses of $56,993 recorded in 1999 associated
with dialysis centers within the continental U.S. similarly relate to actions
taken and decisions made during 1999. The Company established a plan to curtail
new facility acquisitions and developments and to close centers not supporting
the Company's new strategic direction. The losses principally related to
centers identified for closure or sale during the first half of 2000, new
facility plans terminated and projects abandoned, and impairments of loans to
and investments in third-party dialysis-related businesses. Additional charges
on continental U.S. operations were taken in 2000. The closure and abandonment
losses averaged less than $1,000 per facility, and were principally associated
with the impairment of leasehold improvements and intangible assets
specifically identified with these centers. The Company's new strategic
direction and curtailed new center acquisition had also affected the valuation
of several partnership investments in third-party dialysis-related businesses.
We do not expect recovery of the impairment losses even through potential
bankruptcy processes.
Other than in connection with the impairment losses discussed above, we
determined that there were no goodwill impairments as of year-end 2000.
3. Accounts receivable
The total provisions for uncollectible accounts were $39,649, $133,253 and
$44,858 for 2000, 1999 and 1998, respectively. The Company's rapid growth
through acquisitions through 1998 and the merger with RTC
F-9
DAVITA INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(dollars in thousands)
in 1998 had a significant impact on the Company's administrative functions,
including billing and cash collection processes, which at times operated below
optimal levels of efficiency and effectiveness. The backlog of aged accounts
receivable continued to increase during the first half of 1999 due to high
turnover of billing and collection personnel and process inefficiencies. The
subsequent collection rates for the older billings did not match our earlier
projections and estimates. Those earlier estimates had been based on prior
collection experience, but the build-up of the backlog of aged accounts
receivable not processed on a timely basis created collection difficulties at a
level not previously experienced or anticipated.
During 2000, 1999 and 1998, the Company received approximately 58%, 59% and
57%, respectively, of dialysis revenues in the continental U.S. from Medicare
and Medicaid programs. Accounts receivable from Medicare and Medicaid were
approximately $120,000 and $150,000, including the Florida lab receivables as
of December 31, 2000 and 1999, respectively. Medicare historically pays
approximately 80% of government established rates for services provided. The
remaining 20% typically is paid by state Medicaid programs, private insurance
companies or directly by the patients receiving the services. (See Note 15
regarding the Florida lab receivables.)
4. Other current assets
Other current assets were comprised of the following:
December 31,
---------------
2000 1999
------- -------
Supplier rebates and other non-trade receivables............ $ 4,289 $19,043
Operating advances to managed centers....................... 3,394 8,310
Prepaid expenses............................................ 2,248 4,391
Deposits.................................................... 362 338
------- -------
$10,293 $32,082
======= =======
Operating advances to managed centers are generally unsecured and interest
bearing under the terms of the applicable management agreements.
5. Property and equipment
Property and equipment were comprised of the following:
December 31,
--------------------
2000 1999
--------- ---------
Land................................................... $ 1,033 $ 1,193
Buildings.............................................. 6,940 9,846
Leasehold improvements................................. 152,978 150,067
Equipment.............................................. 229,408 248,428
Construction in progress............................... 15,142 17,575
--------- ---------
405,501 427,109
Less accumulated depreciation and amortization......... (168,842) (141,660)
--------- ---------
Property and equipment, net............................ $ 236,659 $ 285,449
========= =========
Depreciation and amortization expense on property and equipment was $56,330,
$51,045 and $40,032 for 2000, 1999 and 1998, respectively.
F-10
DAVITA INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(dollars in thousands)
6. Intangible assets
Intangible assets were comprised of the following:
December 31,
----------------------
2000 1999
---------- ----------
Goodwill........................................... $ 896,769 $ 971,344
Patient lists...................................... 121,208 137,469
Noncompetition agreements.......................... 103,532 112,378
Deferred debt issuance costs, net of deferred gains
on swap terminations.............................. 14,182 24,524
---------- ----------
1,135,691 1,245,715
Less accumulated amortization...................... (214,068) (176,043)
---------- ----------
$ 921,623 $1,069,672
========== ==========
Amortization expense applicable to intangible assets was $55,275, $61,436 and
$50,321 for 2000, 1999 and 1998, respectively.
In April 1998, Statement of Position No. 98-5, Reporting on the Costs of
Start-up Activities, or SOP 98-5, was issued. We adopted SOP 98-5 effective
January 1, 1998. SOP 98-5 requires that start-up and organization costs
incurred in conjunction with facility pre-opening activities, which had
previously been treated as deferred costs and amortized over five years, should
be expensed as incurred. As a result of the adoption of SOP 98-5, all remaining
unamortized pre-opening, development and organizational costs existing prior to
January 1, 1998 of $11,196 ($6,896 net of tax) were recognized as the
cumulative effect of a change in accounting principle in 1998.
7. Investments in third-party dialysis businesses
During 1997 and 1998, the Company entered into various agreements to provide
funding for expansion to companies that provide dialysis-related services.
Investments in third-party dialysis businesses and related advances were as
follows:
December 31,
---------------
2000 1999
------- -------
Investments in non-consolidated businesses.................. $ 8,975 $ 3,782
Acquisition advances and loans generally convertible to
equity investments, less allowance of $16,326 in 2000 and
$14,000 in 1999............................................ 25,219 31,770
------- -------
$34,194 $35,552
======= =======
The loans to third-party dialysis businesses are in the form of notes
receivable that are secured by the assets and operations of these companies and
are convertible to equity investments. The notes receivable as of December 31,
2000 bear interest at the prime rate plus 1.5%. The valuation assessments
assume that the conversion options will be exercised in most instances.
Additional loan losses of $2,326 were recognized during 2000.
F-11
DAVITA INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(dollars in thousands)
8. Other liabilities
Other accrued liabilities were comprised of the following:
December 31,
----------------
2000 1999
-------- -------
Payor deferrals............................................. $ 60,964 $40,505
Accrued interest............................................ 10,703 14,664
Disposition accruals........................................ 8,019
Other....................................................... 22,877 21,972
-------- -------
$102,563 $77,141
======== =======
9. Income taxes
Income tax expense (benefit) consisted of the following:
Year ended December 31,
-------------------------
2000 1999 1998
------- -------- -------
Current
Federal......................................... $12,307 $(11,497) $46,061
State........................................... 4,288 (2,527) 8,913
Foreign......................................... 2,459 1,000 1,052
Deferred
Federal......................................... 6,730 (18,199) (15,557)
State........................................... 2,176 (3,347) (2,020)
------- -------- -------
$27,960 $(34,570) $38,449
======= ======== =======
Temporary differences which gave rise to deferred tax assets and liabilities
were as follows:
December 31,
------------------
2000 1999
-------- --------
Asset impairment losses... $ 45,532 $ 46,291
Receivables, primarily
allowance for doubtful
accounts................. 28,768 34,991
Accrued expenses.......... 15,938 10,890
Other..................... 14,269 6,941
-------- --------
Gross deferred tax
assets................. 104,507 99,113
-------- --------
Property and equipment.... (1,354) (4,134)
Intangible assets......... (18,332) (10,842)
Other..................... (3,691) (1,197)
-------- --------
Gross deferred tax
liabilities............ (23,377) (16,173)
-------- --------
Valuation allowance..... (34,336) (30,592)
-------- --------
Net deferred tax
assets................. $ 46,794 $ 52,348
======== ========
At December 31, 2000, the Company had state net operating loss carryforwards
of approximately $15,000 that expire through 2015. At December 31, 2000, the
Company also had federal capital loss carryforwards of
F-12
DAVITA INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(dollars in thousands)
approximately $50,000 that expire in 2005, and foreign tax credit carryforwards
of approximately $200 that expire in 2002. The utilization of state net
operating loss carryforwards may be limited in future years based on the
profitability of certain subsidiary corporations. The utilization of capital
loss carryforwards and foreign tax credits may be limited in future years based
on the amount of capital gain and foreign source income generated in those
years. The Company has also recorded certain impairment losses that, when
recognized for tax purposes, will generate additional capital losses. The
Company has recorded a valuation allowance of $34,300, principally associated
with these deferred tax assets. The valuation allowance was increased by $3,700
in 2000.
The reconciliation between our effective tax rate and the U.S. federal income
tax rate is as follows:
Year ended
December 31,
------------------
2000 1999 1998
---- ----- ----
Federal income tax rate................................ 35.0% 35.0 % 35.0%
State taxes, net of federal benefit.................... 5.9 3.7 3.1
Foreign income taxes................................... 3.6 (0.7)
Write off of deferred tax asset associated with
cancellation of medical director stock options........ 6.3
Nondeductible amortization of intangible assets........ 5.6 (2.1) 2.0
Valuation allowance.................................... 2.4 (15.6)
Other.................................................. 3.4 (1.3)
---- ----- ----
Effective tax rate before merger costs................. 62.2 19.0 40.1
Merger charges......................................... 38.9
---- ----- ----
Effective tax rate..................................... 62.2% 19.0 % 79.0%
==== ===== ====
The effective tax rate for 1999 represents the tax benefit associated with
the pre-tax loss for the year ended December 31, 1999. The 15.6% reduction in
the effective income tax rate for the valuation allowance in 1999 represents an
increase to the valuation allowance.
10. Long-term debt
As of December 31, 1999, the Company was not in compliance with several
formula-based covenants in its credit facilities. As a result of this non-
compliance, all debt outstanding under the credit facilities and the
convertible subordinated notes as of December 31, 1999 was potentially callable
and due within one year, and therefore had been reclassified from long-term
debt to a current classification. On July 14, 2000, a restructuring of the
credit facilities was completed, and the Company became in compliance with all
of the credit facilities covenants.
F-13
DAVITA INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(dollars in thousands)
Long-term debt was comprised of the following:
December 31,
---------------------
2000 1999
-------- -----------
Credit facilities................................... $498,800 $ 959,610
Convertible subordinated notes, 7%, due 2009........ 345,000 345,000
Convertible subordinated notes, 5 5/8%, due 2006.... 125,000 125,000
Acquisition obligations and other notes payable..... 829 21,482
Capital lease obligations (see Note 11)............. 6,053 6,799
-------- -----------
975,682 1,457,891
Less current portion and long-term debt potentially
callable under covenant provisions in 1999......... (1,676) (1,452,195)
-------- -----------
$974,006 $ 5,696
======== ===========
Scheduled maturities of long-term debt were as follows:
2001................................................................. 1,676
2002................................................................. 15,097
2003................................................................. 232,519
2004................................................................. 70,212
2005................................................................. 70,198
Thereafter........................................................... 585,980
Included in debt expense was interest expense, net of capitalized interest,
of $112,180, $106,633 and $72,804 for 2000, 1999, and 1998, respectively. Also
included in debt expense were amortization and write-off of deferred financing
costs of $4,457, $4,164 and $1,376 for 2000, 1999, and 1998, respectively, and
interest rate swap early termination costs of $9,823 in 1998.
Credit facilities
In July 2000, the major terms of the credit facilities were restructured
which included the collateralization of the debt with substantially all of the
Company's assets, a reduction in the revolving credit availability to $150,000
together with conversion of $299,000 of the revolving facility into a term
loan, a new quarterly amortization schedule beginning September 30, 2000, and
the immediate permanent pay-down of $50,000. Total outstanding debt under the
credit facilities consisted of the following:
December 31,
-----------------
2000 1999
-------- --------
Term loan................................................. $301,460 $392,000
Revolving credit facility................................. 567,610
Revolving credit facility--term tranche................... 197,340
-------- --------
$498,800 $959,610
======== ========
In conjunction with the restructuring, the associated interest rates returned
to the lower LIBOR-based rate formulas in effect prior to the non-compliance.
The new financial covenants reflected the Company's financial position and
projected operating results and plans at the time of the restructuring. As a
result of the
F-14
DAVITA INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(dollars in thousands)
restructuring, related financing costs were written off. These write-offs were
recorded in 2000 as an extraordinary loss of $3,490, net of tax, and pre-tax
debt expenses of $1,192.
In 1998, the then existing credit facilities were replaced with an aggregate
of $1,350,000 in two senior bank facilities. As a result of this refinancing,
remaining net deferred financing costs of $16,018 net of tax were recognized as
an extraordinary loss in 1998.
Several of the Company's subsidiaries, including subsidiaries owning
substantially all of the Company's dialysis center assets, have guaranteed the
obligations under the credit facilities.
At the time of the merger, RTC also had a credit agreement which provided for
a $350,000 revolving credit/term facility available to fund acquisitions and
general working capital requirements. The RTC credit agreement was terminated
and repaid with borrowings under the credit facilities on February 27, 1998 in
connection with the completion of our merger with RTC. The remaining net
unamortized deferred financing costs in the amount of $4,393 related to the RTC
credit agreement were recognized as an extraordinary loss in 1998.
7% convertible subordinated notes
In November 1998, $345,000 of 7% convertible subordinated notes due 2009 were
issued in a private placement offering subject to subsequent registration for
resale. The notes are convertible, at the option of the holder, at any time
into common stock at a conversion price of $32.81 principal amount per share,
and the notes may be redeemed on or after November 15, 2001. The notes are
general, unsecured obligations junior to all existing and future senior debt
and effectively all existing and future liabilities of the Company and its
subsidiaries. Commencing May 18, 1999, the Company incurred monetary penalties
on a weekly basis until the registration of the notes under the Securities Act
of 1933 was declared effective. Penalties of $976 were included in debt expense
for the year ended December 31, 1999. The Company's registration statement
covering the resale of the notes was declared effective on February 1, 2000.
5 5/8% convertible subordinated notes
In June 1996, RTC (a wholly-owned subsidiary following the merger with the
Company in 1998) issued $125,000 of 5 5/8% convertible subordinated notes due
2006. These notes are convertible, at the option of the holder, at any time
after August 12, 1996 through maturity, unless previously redeemed or
repurchased, into our common stock at a conversion price of $25.62 principal
amount per share. After July 17, 1999, all or any part of these notes are
redeemable at the Company's option on at least 15 and not more than 60 days'
notice as a whole or, from time to time, in part at redemption prices ranging
from 103.94% to 100% of the principal amount thereof, depending on the year of
redemption, together with accrued interest to, but excluding, the date fixed
for redemption. These notes are guaranteed by DaVita Inc.
Condensed consolidating financial statements for the Company, including
summarized financial information of RTC (a wholly-owned subsidiary) are
disclosed in Note 20.
Interest rate swap agreements
In April 1998, in conjunction with the refinancing of senior credit
facilities, the existing two interest rate swap agreements were cancelled. The
loss associated with the early cancellation of those swaps was $9,823 and was
included in debt expense for 1998.
In May 1998, the Company entered into cancelable interest rate swap
agreements with a combined notional amount of $800,000. During 1999 two of the
swap agreement counterparties exercised their right to
F-15
DAVITA INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(dollars in thousands)
cancel agreements in the aggregate notional amount of $100,000. During 2000 two
more of the swap counterparties exercised their right to cancel agreements with
notional amounts totaling $100,000.
During 2000, the Company liquidated or cancelled all of the remaining
interest rate swap agreements which had notional amounts of $600,000. The
Company received approximately $7,454 in the settlement of these swap
agreements and recorded an associated gain of $6,297, which is being amortized
over the remaining contractual life of the credit facilities.
11. Leases
The majority of the Company's facilities are leased under noncancelable
operating leases expiring in various years through 2021. Most lease agreements
cover periods from five to ten years and contain renewal options of five to ten
years at the fair rental value at the time of renewal or at rates subject to
periodic consumer price index increases. In the normal course of business,
operating leases are generally renewed or replaced by similar leases at
replacement centers. Some equipment is leased under capital lease agreements.
Future minimum lease payments under noncancelable operating leases and under
capital leases are as follows:
Operating Capital
leases leases
--------- -------
2001.................................................... $ 45,109 $ 1,411
2002.................................................... 40,783 1,192
2003.................................................... 38,047 1,049
2004.................................................... 35,610 579
2005.................................................... 31,637 545
Thereafter.............................................. 100,304 4,676
-------- -------
$291,490 9,452
========
Less portion representing interest...................... (3,399)
-------
Total capital lease obligation, including current
portion................................................ $ 6,053
=======
Rental expense under all operating leases for 2000, 1999 and 1998 was
$51,421, $52,504 and $38,975, respectively. The net book value of property and
equipment under capital lease was $6,192 and $7,719 at December 31, 2000 and
1999, respectively. Capital lease obligations are included in long-term debt
(see Note 10).
F-16
DAVITA INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(dollars in thousands)
12. Shareholders' equity
Earnings per share
The reconciliation of the numerators and denominators used to calculate
earnings per share, or EPS, is as follows:
Year ended December 31,
---------------------------
2000 1999 1998
------- --------- -------
(in thousands, except per
share)
Income (loss) before extraordinary item and
cumulative effect of change in accounting
principle--basic:
As reported..................................... $16,975 $(147,256) $10,192
======= ========= =======
Income (loss) before extraordinary item and
cumulative effect of change in accounting
principle--assuming dilution:
As reported..................................... $16,975 $(147,256) $10,192
======= ========= =======
Applicable common shares:
Weighted average outstanding during the year.... 81,593 81,168 80,156
Reduction in shares in connection with notes
receivable from Employees...................... (12) (16) (13)
------- --------- -------
Weighted average number of shares outstanding for
use in computing basic earnings per share........ 81,581 81,152 80,143
Outstanding stock options (based on the treasury
stock method).................................. 1,576 1,558
------- --------- -------
Adjusted weighted average number of common and
common share equivalent shares outstanding--
assuming dilution.............................. 83,157 81,152 81,701
======= ========= =======
Earnings (loss) per common share--basic........... $ 0.17 $ (1.81) $ (0.12)
Earnings (loss) per common share--assuming
dilution......................................... $ 0.16 $ (1.81) $ (0.12)
Options to purchase 7,887,079 and 4,726,975 shares of common stock at
$6.70 to $33.50 per share and $28.43 to $36.13 per share, were outstanding
during 2000 and 1998, respectively, but were not included in the computation of
diluted EPS because the options' exercise price was greater than the average
market price of the common shares or the effect was anti-dilutive. All options
to purchase common stock were excluded from the 1999 EPS calculation because
they were anti-dilutive. The shares of common stock from the assumed conversion
of the 7% convertible subordinated notes and the 5 5/8% convertible
subordinated notes (see Note 10) were not included in the computation of
diluted EPS for any period because the effect was anti-dilutive.
Stock-based compensation plans
The Company's stock-based compensation plans are described below.
1994 plan. The 1994 Equity Compensation Plan provides for grants of
nonqualified stock options to purchase common stock and other rights to
purchase shares of common stock to certain employees, directors, consultants
and facility medical directors. In December 1999, the plan was amended so that
no further grants may be made under this plan.
There are 1,447,426 unexercised options outstanding under the 1994 plan.
Original options granted generally vest on the ninth anniversary of the date of
grant, subject to accelerated vesting in the event that
F-17
DAVITA INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(dollars in thousands)
certain performance criteria are met. In April 1996, the vesting schedule was
changed for new options granted so that options vest over four years from the
date of grant. The exercise price of each option equals the market price of our
stock on the date of grant, and an option's maximum term is ten years.
Purchase rights to acquire 1,314,450 common shares for $0.90-$3.60 per share
were granted to certain employees under the 1994 plan. All of these rights were
exercised and the Company received notes for the uncollected portion of the
purchase proceeds. These notes bear interest at the lesser of The Bank of New
York's prime rate or 8%, are full recourse to the employees, and are secured by
the employees' stock. The notes are repayable four years from the date of
issuance, subject to certain prepayment requirements. At December 31, 2000 and
1999 the outstanding notes plus accrued interest totaled $83 and $192,
respectively.
1995 plan. The 1995 Equity Compensation Plan provides for grants of stock
options and the issuance of restricted stock to certain employees, directors
and other individuals providing services. In December 1999, the plan was
amended so that no further grants may be made under this plan. There are
712,640 unexercised options outstanding under the 1995 plan. Options granted
generally vest over four years from the date of grant and an option's maximum
term is ten years, subject to certain restrictions. Awards were generally
issued with the exercise prices equal to the market price of the stock on the
date of grant.
1997 plan. The 1997 Equity Compensation Plan provides for grants of stock
options and the issuance of restricted stock to certain employees, directors
and other individuals providing services. In February 1998, the shares reserved
for issuance under the 1997 plan were increased to 7,166,667 common shares.
Options granted generally vest over four years from the date of grant and an
option's maximum term is ten years. Grants are generally issued with the
exercise prices equal to the market price of the stock on the date of grant.
1999 plans. The 1999 Equity Compensation Plan provides for grants of stock
options to employees, directors and other individuals providing services. There
are 3,000,000 common shares reserved for issuance under this plan. Options
granted under this plan generally vest over four years from the date of grant
and an option's maximum term is seven years, subject to certain restrictions.
Grants under this plan are generally issued with the exercise prices equal to
the market price of the stock on the date of grant.
The 1999 Non-Executive Officer and Non-Director Equity Compensation Plan
provides for grants of stock options to employees other than executive officers
and to other individuals providing services. There are 4,000,000 common shares
reserved for issuance under this plan. Options granted under this plan
generally vest over four years from the date of grant, subject to certain
restrictions. Grants under this plan are generally issued with the exercise
prices equal to the market price of the stock on the date of grant.
Special Purpose Option Plan (RTC Plans). Upon consummation of the merger with
RTC, all outstanding options under RTC plans were converted to Total Renal Care
Holdings Inc. Special Purpose Option Plan options. This plan provides for
grants of incentive and nonqualified stock options in exchange for outstanding
RTC stock plan options. Options under this plan have the same provisions and
terms provided for in the RTC stock plans, including acceleration provisions
upon certain sales of assets, mergers and consolidations. On the merger date,
there was a conversion of 2,156,426 options. Further, options for 1,305,738
shares became fully vested due to change in control vesting acceleration
provisions that were contained in the original grants. Options for
1,780,193 shares were exercised subsequent to the merger date. In December
1999, the plan was amended so that no further grants may be made under this
plan.
The fair value of each option grant was estimated on the date of grant using
the Black-Scholes option-pricing model with the following assumptions for
grants for 2000, 1999, and 1998, respectively: dividend yield of 0% for all
periods; weighted average expected volatility of 72.05%, 50.01%, and 33.98%;
risk-free interest rates of 6.13%, 5.63%, and 5.51% and weighted average
expected lives of 3.5, 6.0 and 6.0 years.
F-18
DAVITA INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(dollars in thousands)
Stock options issued under these plans to non-employees and modifications to
previous grants to employees resulted in stock option expense of $126, $1,116,
and $3,585 for the years ended December 31, 2000, 1999, and 1998, respectively.
A combined summary of the status of the plans is presented below:
Year ended December 31,
--------------------------------------------------------------
2000 1999 1998
-------------------- -------------------- --------------------
Weighted Weighted Weighted
average average average
exercise exercise exercise
Options price Options price Options price
---------- -------- ---------- -------- ---------- --------
Outstanding at beginning
of year................ 10,421,845 $15.79 10,415,417 $23.85 8,325,030 $14.90
Granted................. 9,619,400 4.70 4,575,000 9.35 5,570,567 31.10
Exercised............... (817,546) 2.55 (84,723) 1.23 (3,155,438) 12.61
Forfeited............... (4,555,120) 16.74 (4,483,849) 28.22 (324,742) 27.61
---------- ------ ---------- ------ ---------- ------
Outstanding at end of
year................... 14,668,579 $ 8.96 10,421,845 $15.79 10,415,417 $23.85
========== ====== ========== ====== ========== ======
Options exercisable at
year end............... 5,006,908 4,004,675 2,208,871
========== ========== ==========
Weighted-average fair
value of options
granted during the
year................... $ 2.61 $12.74 $13.67
====== ====== ======
Effective September 20, 1999, 1,750,000 options with exercise prices greater
than $30 per share were forfeited for the right to participate in a retention
bonus program. Retention compensation expense of $2.6 million was recognized in
1999, and no replacement options were awarded within six months. Effective
December 31, 2000, 910,000 options with exercise prices over $15.00 were
voluntarily relinquished and no replacement options have been issued.
The following table summarizes information about fixed stock options
outstanding at December 31, 2000:
Weighted
Options average Weighted Weighted
outstanding remaining average Exercisable average
as of contractual exercise as of exercise
Range of Exercise Prices 12/31/00 life price 12/31/00 price
- ------------------------ ----------- ----------- -------- ----------- --------
$ 0.01-$ 5.00............ 4,676,844 4.1 $ 2.66 1,181,539 $ 2.51
$ 5.01-$10.00............ 6,433,119 6.2 7.24 1,291,244 7.42
$10.01-$15.00............ 465,237 6.1 11.36 47,237 11.94
$15.01-$20.00............ 2,146,347 4.8 18.52 1,912,213 18.52
$20.01-$25.00............ 236,612 6.5 23.11 145,957 22.70
$25.01-$30.00............ 167,113 7.3 26.67 100,096 26.81
$30.01-$35.00............ 543,307 6.8 32.11 328,622 32.08
---------- --- ------ --------- ------
14,668,579 5.4 $ 8.96 5,006,908 $12.99
========== === ====== ========= ======
Stock purchase plan. The Employee Stock Purchase Plan entitles qualifying
employees to purchase up to $25 of common stock during each calendar year. The
amounts used to purchase stock are accumulated through payroll withholdings or
through an optional lump sum payment made in advance of the first day of the
plan. The plan allows employees to purchase stock for the lesser of 100% of the
fair market value on the first day of the purchase right period or 85% of the
fair market value on the last day of the purchase right period. Each
F-19
DAVITA INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(dollars in thousands)
purchase right period begins on January 1 or July 1, as elected by the employee
and ends on December 31. Payroll withholdings related to the plan, included in
accrued employee compensation and benefits, were $631 and $1,937 at December
31, 2000 and 1999, respectively. Subsequent to December 31, 2000, and December
31, 1999, 99,648 and 77,106 shares, respectively, were issued to satisfy
obligations under the plan.
The fair value of the employees' purchase rights was estimated on the
beginning dates of the purchase right periods using the Black-Scholes model
with the following assumptions for grants on July 1, 2000, January 1, 2000,
July 1, 1999, January 1, 1999, July 1, 1998, and January 1, 1998, respectively:
dividend yield of 0% for all periods; expected volatility of 75% in 2000, 54%
in 1999 and 42% in 1998; risk-free interest rate of 6.0%, 6.4%, 5.5%, 4.6%,
5.5%, and 5.7%; and expected lives of 0.5 and 1.0 years. Using these
assumptions, the weighted-average fair value of purchase rights granted were
$1.33, $2.11, $2.50, $6.84, $6.24 and $7.84, respectively.
Pro forma net income and earnings per share. The Company applies APB Opinion
No. 25 and related interpretations in accounting for all of our employee stock
compensation plans. Had compensation cost for our stock-based compensation
plans been determined under the provisions of SFAS 123, net income and earnings
per share would have been reduced to the pro forma amounts indicated below:
Year ended December 31,
----------------------------
2000 1999 1998
------- --------- --------
(in thousands, except per
share)
Income (loss) before extraordinary item and
cumulative effect of change in accounting
principle...................................... $(3,492) $(162,472) $ 4,004
Extraordinary loss............................ (3,490) (12,744)
Cumulative effect of change in accounting
principle.................................... (6,896)
------- --------- --------
Net income (loss)............................. $(6,982) $(162,472) $(15,636)
======= ========= ========
Earnings (loss) per common share--basic:
Income (loss) before extraordinary item....... $ (0.05) $ (2.00) $ 0.04
Extraordinary loss............................ (0.04) (0.16)
Cumulative effect of change in accounting
principle.................................... (0.08)
------- --------- --------
Net income (loss)............................. $ (0.09) $ (2.00) $ (0.20)
======= ========= ========
Weighted average number of common shares and
equivalents
outstanding.................................... 81,581 81,152 80,143
======= ========= ========
Earnings (loss) per common share--assuming
dilution:
Income (loss) before extraordinary item....... $ (0.05) $ (2.00) $ 0.05
Extraordinary loss............................ (0.04) (0.16)
Cumulative effect of change in accounting
principle.................................... (0.08)
------- --------- --------
Net income (loss)............................. $ (0.09) $ (2.00) $ (0.19)
======= ========= ========
Weighted average number of common shares and
equivalents outstanding--Assuming dilution..... 81,581 81,152 81,076
======= ========= ========
13. Transactions with related parties
Richard K. Whitney, our Chief Financial Officer, received a loan from the
Company in the principal amount of $65,000 in July 1997. In February 2001 Mr.
Whitney prepaid this loan in full, with a $65,000 payment for the
F-20
DAVITA INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(dollars in thousands)
outstanding principal. Under the terms of the loan, Mr. Whitney was required to
pay interest only on the note on a monthly basis from August 1997 at the rate
of 7% per year through July 2002, at which time the unpaid principal balance
was due in full. The loan was secured by all of Mr. Whitney's options to
purchase our common stock. Mr. Whitney used the proceeds of this loan in the
purchase of his principal residence.
Joseph C. Mello, our Chief Operating Officer, received a loan from the
Company in the principal amount of $275,000 in December 2000. Mr. Mello is
required to pay quarterly interest only on the note from March 2001 through
September 2002 at a rate of 7% per year. Thereafter, Mr. Mello is required to
make quarterly interest and principal payments of approximately $15,800 through
September 2007, at which time the unpaid principal balance will be repaid in
full. The loan is secured by all of Mr. Mello's options to purchase our common
stock. Mr. Mello used the proceeds of this loan in the purchase of his
principal residence.
Tenet
Tenet Healthcare Corporation, or Tenet, owns less than 5% of our common
stock. The Company provides dialysis services to Tenet hospital patients under
agreements with terms of one to three years. The contract terms are comparable
to contracts with unrelated third parties. Included in accounts receivable are
amounts related to these services of $459 and $1,211 at December 31, 2000 and
1999, respectively. Net operating revenues received from Tenet for these
services were $4,903, $7,037, and $2,424, for 2000, 1999, and 1998,
respectively.
DLJ
A managing director of Donaldson, Lufkin & Jenrette, or DLJ, has served on
the Company's board of directors since August 1994 and, prior to August 1997,
an affiliate of DLJ held an ownership interest in the Company. Effective with
the August 1997 public offering of common stock, DLJ and its affiliates no
longer own an interest in the Company. During 1998, DLJ advised the Company on
the acquisition of RTC and assisted us in the issuance of the 7% notes.
Prior to November 2000 the Company maintained a business arrangement with DLJ
under which the Company managed third-party dialysis centers with options to
acquire the centers at future dates and guaranteed third-party debt of
approximately $11 million as of December 31, 1999. The Company purchased these
dialysis centers from DLJ and accordingly cancelled these guarantees in
November 2000.
14. Employee benefit plans
The Company has a savings plan for substantially all employees, which has
been established pursuant to the provisions of Section 401(k) of the Internal
Revenue Code, or IRC. The plan provides for employees to contribute from 1% to
15% of their base annual salaries on a tax-deferred basis not to exceed IRC
limitations. The Company may make a contribution under the plan each fiscal
year as determined by our board of directors. Company matched contributions
were $91, $76, and $58 for the years ended December 31, 2000, 1999, and 1998,
respectively, in accordance with specific state requirements.
RTC had a defined contribution savings plan covering substantially all of its
employees. RTC's contributions under the plan were approximately $641 for the
year ended December 31, 1998. Effective July 1, 1998, the plan was terminated
and merged into the Company's savings plan.
During 2000, the Company established the DaVita Inc. Profit Sharing Plan and
is in the process of applying to have it qualified under Section 401(a) of the
IRC. Contributions to this plan are made solely by the
F-21
DAVITA INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(dollars in thousands)
Company. All contributions by the Company to the plan require the approval of
the Board of Directors and are deposited into an irrevocable trust. The profit
sharing award for each eligible participant is calculated as a percentage of
base salary and is based upon the achievement of certain employee specific and
corporate financial and operating goals. During 2000, the Company recognized
expense of $15,806 and made contributions of $7,088 to the trust.
15. Contingencies
Health care providers' 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 implications
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 $5.6 million for the
review period from January 1995 to April 1996, and $15 million for the review
period from May 1996 to March 1998. The carrier has suspended all payments of
Medicare claims from this laboratory since May 1998. The carrier has also
determined that $16.1 million of the suspended claims for the review period
from April 1998 to August 1999 were not properly supported by the prescribing
physicians' medical justification. The carrier has alleged that 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, and 70% of the tests performed in the period from April 1998 to August
1999 were not properly supported by the prescribing physicians' medical
justification. In August 2000, the carrier requested additional records with
respect to the time period August 1999 to May 2000.
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 Company received minimal responses from the carrier to its
repeated requests for clarification and information regarding the continuing
payment suspension. 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 $5.6
million. 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 $14.2 million, or substantially all of the overpayment determination.
The Company has filed appeals of both decisions to a federal administrative law
judge, and has moved to consolidate the two appeals. At this time, we have not
received a scheduled date for a hearing with an administrative law judge,
although HHS has informed us that we can expect a hearing by the second quarter
of 2001.
In February 1999, our Florida-based laboratory subsidiary filed a complaint
against the carrier and HHS seeking a court order to lift the payment
suspension. In July 1999, the court dismissed our complaint because we had not
exhausted all administrative remedies, that is, the carrier review and
administrative law judge processes described above.
In addition to the formal appeal process with a federal administrative law
judge, beginning in the third quarter of 1999 we 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 HHS of this
matter, and we 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 will be provided.
F-22
DAVITA INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(dollars in thousands)
Timing of the final resolution of this matter is highly uncertain, and beyond
the Company's control or influence. Beginning in the third quarter of 2000, the
Company stopped accruing additional Medicare revenue from this laboratory until
the uncertainties regarding both the timing of resolution and the ultimate
revenue valuations are at least substantially eliminated. The amount of
potential Medicare revenue not accrued beginning in the third quarter of 2000
was approximately $4 million per quarter. As of June 30, 2000, the cumulative
recognized gross revenue associated with the withheld billings was
approximately $38 million. We estimate that the potential cash exposure as of
December 31, 2000 was not more than $15 million based on the carrier's
overpayment findings noted above. In addition, the government could impose
additional fines and penalties, which could be substantial.
In February 2001, the Civil Division of the United States Attorney's Office
for the Eastern District of Pennsylvania contacted us and requested that the
Company cooperate in a review of some of our historical practices, including
billing and other operating procedures and our financial relationships with
physicians.
The Civil Division has requested that we provide a wide range of information
responding to the areas of review. The Civil Division has not initiated any
legal process or served any subpoena on the Company. The Civil Division has
indicated that it is not making any allegation of wrongdoing at this time and
that no criminal action against the Company or any individual is contemplated.
The Company is cooperating in this review.
The inquiry appears to be at an early stage. As it proceeds, the Civil
Division could expand its areas of concern. If a court determines there has
been wrongdoing, the penalties under applicable statutes could be substantial.
Following the announcement on February 18, 1999 of the Company's preliminary
results for the fourth quarter of 1998 and the full year then ended, class
action lawsuits were filed alleging violations of the federal securities laws
arising from allegedly false and misleading statements during a class period of
March 11, 1997 to July 18, 1999. During 2000 the consolidated lawsuit was
settled. Under a stipulation of settlement the Company contributed $10.8
million and our insurance carriers contributed $14.2 million for a $25 million
settlement fund. The Company agreed to implement corporate governance
principles and procedures to ensure the accountability of the Company's board
and management to its shareholders. The Company admitted to no wrongdoing or
liability in the stipulation of settlement.
In addition, DaVita is subject to claims and suits in the ordinary course of
business for which the Company is believed to be covered by insurance.
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.
16. Mergers, acquisitions and divestitures
Merger
On February 27, 1998 the Company merged with Renal Treatment Centers, Inc.,
or RTC. In connection with the merger, the Company issued 34,565,729 shares of
its common stock in exchange for all of the outstanding shares of RTC common
stock. In addition, the Company guaranteed $125,000 of RTC's 5 5/8% convertible
subordinated notes. In conjunction with this transaction, an additional 140,000
shares of common stock were authorized by the shareholders.
F-23
DAVITA INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(dollars in thousands)
The RTC merger transaction was accounted for as a pooling of interests and
these consolidated financial statements have been restated to include the
results of operations and account balances of RTC for all periods presented.
There were no transactions between RTC and the Company prior to the
combination.
As a result of the merger, RTC's revolving credit agreement was terminated
and the outstanding balance of approximately $297,228 was paid off through
additional borrowings under our credit facilities. The remaining net
unamortized deferred financing costs in the amount of $4,393, less tax of
$1,580, related to RTC's revolving credit agreement were recognized as an
extraordinary loss in 1998.
Merger and related costs recorded during 1998 included transaction costs,
integration costs, employee severance and other directly associated
compensation expense.
A summary of merger and related costs and accrual activity through December
31, 2000 is as follows:
Severance
Direct and Costs to
transaction employment integrate
costs costs operations Total
----------- ---------- ---------- --------
Initial expense................. $ 21,580 $ 41,960 $ 15,895 $ 79,435
Amounts utilized during 1998.... (22,885) (37,401) (13,137) (73,423)
Adjustment of estimates......... 1,305 (959) (1,593) (1,247)
-------- -------- -------- --------
Accrual, December 31, 1998...... 3,600 1,165 4,765
Amounts utilized during 1999.... (600) (377) (977)
-------- -------- -------- --------
Accrual, December 31, 1999...... 3,000 788 3,788
Amounts utilized during 2000.... (788) (788)
-------- -------- -------- --------
Accrual, December 31, 2000...... $ -- $ 3,000 $ -- $ 3,000
======== ======== ======== ========
Direct transaction costs consisted primarily of investment banking fees,
legal and accounting costs and filing costs. Severance and other compensation
costs directly resulting from the merger included termination of employment
contracts; severance payments; the exercise of RTC stock options with tendered
shares (less than six months from exercise date); and special merger bonuses.
Integration costs of the combined operations were principally associated with
the elimination of the following RTC departments: human resources, managed
care, laboratory, and all finance functions with the exception of patient
accounting. In addition, RTC's laboratory, located in Las Vegas, Nevada, was
closed prior to its commencement of operation. Integration costs included
termination of a long-term laboratory management service agreement, write-off
of leasehold improvements and other capitalized costs, and incremental costs of
integrating operations.
The remaining accrual balance is included in other liabilities.
F-24
DAVITA INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(dollars in thousands)
Acquisitions
The following is a summary of acquisitions that were accounted for as
purchases:
Year ended December 31,
-------------------------
2000 1999 1998
------- -------- --------
Number of centers acquired ...................... 8 45 76
Number of common shares issued .................. 98,549
Estimated fair value of common shares issued .... $ 2,796
Deferred purchase payments and acquisition
obligations .................................... $ 12,737 15,233
Cash paid, net of cash acquired ................. $12,895 154,226 338,164
------- -------- --------
Aggregate purchase price ........................ $12,895 $166,963 $356,193
======= ======== ========
The assets and liabilities of the acquired entities in the preceding table
were recorded at their estimated fair market values at the dates of
acquisition. The results of operations of these centers have been included in
the financial statements from their effective acquisition dates. The nearest
month-end has been used as the effective date for recording acquisitions that
close during the month because there were no partial month accounting cutoffs
and partial month results associated with these acquisitions would not have a
material impact on consolidated operating results. The Company acquired all of
its foreign operations and several domestic operations through purchases of
capital stock. Any settlement with tax authorities relating to pre-acquisition
income tax liabilities may result in an adjustment to goodwill attributable to
that acquisition.
The initial allocations of fair value are based upon available information
for the acquired businesses and are finalized when the contingent acquisition
amounts are determined. The final allocations did not differ materially from
the initial allocations. Allocations were as follows:
Year ended December 31,
---------------------------
2000 1999 1998
------- -------- --------
Identified intangible assets ................... $ 18,061 $ 39,992
Goodwill........................................ 140,111 315,655
Tangible assets................................. $13,006 20,359 30,650
Liabilities assumed............................. (111) (11,568) (30,104)
------- -------- --------
Total purchase price.......................... $12,895 $166,963 $356,193
======= ======== ========
F-25
DAVITA INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(dollars in thousands)
The following summary, prepared on a pro forma basis, combines the results of
operations as if the acquisitions had been consummated as of the beginning of
each of the periods presented, after including the impact of certain
adjustments such as amortization of intangibles, interest expense on
acquisition financing and income tax effects.
Year ended December 31,
----------------------------------
2000 1999 1998
(unaudited) (unaudited) (unaudited)
----------- ---------- ----------
Net revenues ............................. $1,497,979 $1,476,727 $1,285,546
Net income (loss) before extraordinary
item and cumulative effect of change in
accounting principle .................... $ 19,035 $ (145,246) $ 15,587
Net income (loss)......................... 15,545 (145,246) (4,053)
Pro forma net income (loss) per share
before extraordinary item and cumulative
effect of change in accounting principle
......................................... $ 0 .23 $ (1.79) $ 0.19
Pro forma net income (loss) per share
before extraordinary item and cumulative
effect of change in accounting
principle--assuming dilution ............ $ 0.23 $ (1.79) $ 0.19
Pro forma net income (loss) per share..... 0.19 (1.79) (0.05)
Pro forma net income (loss) per share--
assuming dilution ....................... 0.19 (1.79) (0.05)
The unaudited pro forma results are not necessarily indicative of what
actually would have occurred if the acquisitions had been completed prior to
the beginning of the periods presented. In addition, they are not intended to
be a projection of future results and do not reflect the synergies, additional
revenue-generating services or direct facility operating expense reduction that
might be achieved from combined operations.
Divestitures
During the fourth quarter of 1999, the Company announced its intention to
sell its dialysis operations outside the continental U.S. and recorded an
impairment loss of $82,812 associated with the non-continental U.S. operations.
Assets and liabilities of the non-continental U.S. operations as of December
31, 1999 were $259,596 and $34,294 respectively.
On June 19, 2000, the Company completed the sales of its operations outside
the continental U.S. with the exception of operations in Puerto Rico and Guam.
The definitive sale agreement for the Puerto Rico operations was signed in the
first quarter of 2000 and amended in the second quarter of 2000, and the sale
will be completed upon the receipt of required regulatory approvals and third-
party consents. The sales completed in June 2000 represented approximately 90%
of the total value of the non-continental operations being divested. An
additional impairment loss of $3,000 was recognized as of June 30, 2000
attributable to the completion of these sales. The Company recognized a foreign
currency translation loss of $4,700 associated with non-continental U.S.
operations divested during the second quarter. The foreign currency translation
loss had previously been recognized in other comprehensive income.
On November 1, 2000 the Company completed the sales of its interests in
operations on the island of Guam for a gain of approximately $1,600. Also in
the fourth quarter, the Company recognized accounts receivable recoveries on
the non-continental U.S. accounts receivable not sold of $1,100 and reversal of
$900 in transaction costs accrued for the sale of the non-continental U.S.
operations. Accruals for transaction costs and associated obligations amounted
to $7,843 as of December 31, 2000. Future charges or credits resulting from the
ultimate resolution of divestitures, indemnities and other estimated costs are
not expected to be material.
F-26
DAVITA INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(dollars in thousands)
Net cash proceeds from the sales of non-continental U.S. operations in 2000
were $133,177. Of these proceeds, $125,000 was immediately applied to our
credit facilities debt in accordance with the conditions under which we
received consent from the lenders to consummate the sales.
Operating results for the non-continental U.S. operations excluding
impairment charges were as follows (in thousands):
Year ended December 31,
-------------------------
2000 1999 1998
------- -------- -------
Net operating revenue............................. $74,453 $124,410 $88,978
Operating expenses
Dialysis centers and labs....................... 59,264 100,204 70,873
General and administrative...................... 3,640 7,396 3,940
Depreciation and amortization................... 8,181 12,629 7,531
Provision for uncollectible accounts............ 1,728 5,717 2,734
------- -------- -------
72,813 125,946 85,078
------- -------- -------
Operating income (loss)........................... $ 1,640 $ (1,536) $ 3,900
======= ======== =======
17. Fair value of financial instruments
Financial instruments consist primarily of cash, accounts receivable, notes
receivable, accounts payable, accrued compensation and benefits, and other
accrued liabilities. The balances of these financial instruments as presented
in the financial statements at December 31, 2000 approximate their fair values.
Borrowings under credit facilities, of which $498,800 was outstanding as of
December 31, 2000, reflect fair value as they are subject to fees and
adjustable rates competitively determined in the marketplace. The fair value of
the 7% convertible subordinated notes and the RTC 5 5/8% convertible
subordinated notes were approximately $293,000 and $110,000 at December 31,
2000 based on quoted market prices.
18. Supplemental cash flow information
The table below provides supplemental cash flow information:
Year ended December 31,
--------------------------
2000 1999 1998
-------- -------- -------
Cash paid (received) for:
Income taxes ................................. $(28,585) $ 32,324 $13,676
Interest...................................... 117,856 102,125 66,409
Non-cash investing and financing activities:
Estimated value of stock and options issued in
acquisitions ................................ 2,796
Fixed assets acquired under capital lease
obligations ................................. 3,405 583
Contribution to consolidated partnerships .... 25 2,195 2,592
Deferred financing cost write-off............. 1,192 1,601
F-27
DAVITA INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(dollars in thousands)
19. Selected quarterly financial data (unaudited)
Summary unaudited quarterly financial data for 2000 and 1999 is as follows:
2000 1999
------------------------------------------- -------------------------------------------
December 31 September 30 June 30 March 31 December 31 September 30 June 30 March 31
----------- ------------ -------- -------- ----------- ------------ -------- --------
Net operating revenues
....................... $372,746 $362,535 $378,908 $372,113 $ 373,120 $367,168 $352,819 $352,244
Operating income (loss)
....................... 51,649 49,906 32,843 40,317 (154,864) 35,107 (6,353) 62,128
Income (loss) before
extraordinary item..... 15,333 13,150 (15,355) 3,847 (150,664) 2,259 (22,059) 23,207
Net income (loss) ...... 15,333 9,660 (15,355) 3,847 (150,664) 2,259 (22,059) 23,207
Income (loss) per common
share--basic:
Income (loss) before
extraordinary item.... $ 0.19 $ 0.16 $ (0.19) $ 0.05 $ (1.86) $ 0.03 $ (0.27) $ 0.29
Extraordinary loss .... (0.04)
-------- -------- -------- -------- --------- -------- -------- --------
Net income (loss) per
share ................ $ 0.19 $ 0.12 $ (0.19) $ 0.05 $ (1.86) $ 0.03 $ (0.27) $ 0.29
======== ======== ======== ======== ========= ======== ======== ========
Income (loss) per common
share--assuming
dilution:
Income (loss) before
extraordinary item.... $ 0.18 $ 0.16 $ (0.19) $ 0.05 $ (1.86) $ 0.03 $ (0.27) $ 0.28
Extraordinary loss..... (0.04)
-------- -------- -------- -------- --------- -------- -------- --------
Net income (loss) per
share................. $ 0.18 $ 0.12 $ (0.19) $ 0.05 $ (1.86) $ 0.03 $ (0.27) $ 0.28
======== ======== ======== ======== ========= ======== ======== ========
F-28
DAVITA INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(dollars in thousands)
20. Condensed consolidating financial statements
The following information is presented as required under the Securities and
Exchange Commission Financial Reporting Release No. 55 due to the publicly
traded debt of the RTC subsidiary. This information is not routinely prepared
for use by management.
Condensed consolidating balance sheet
DaVita RTC, Inc. Non-
Inc. issuer guarantor Consolidating Consolidated
guarantor subsidiary subsidiaries adjustments total
---------- ---------- ------------ ------------- ------------
As of December 31, 2000
Cash and cash
equivalents............ $ 16,553 $ 1,871 $ 12,783 $ 31,207
Accounts receivable,
net.................... 83,313 207,099 290,412
Other current assets.... 2,014 15,967 58,275 76,256
---------- -------- ---------- ----------- ----------
Total current assets.. 18,567 101,151 278,157 397,875
Property and equipment,
net.................... 5,377 61,686 169,596 236,659
Investment in
subsidiaries........... 45,384 (45,384)
Receivable from
subsidiaries........... 1,159,278 (1,159,278)
Intangible assets, net.. 9,548 299,813 612,262 921,623
Other assets............ 37,692 2,146 637 40,475
---------- -------- ---------- ----------- ----------
Total assets.......... $1,275,846 $464,796 $1,060,652 $(1,204,662) $1,596,632
========== ======== ========== =========== ==========
Current liabilities..... 15,278 23,996 210,253 249,527
Payables to subsidiary /
parent................. 160,209 999,069 (1,159,278)
Long-term debt and other
long-term liabilities.. 843,800 125,000 10,061 978,861
Minority interests...... 18,876 18,876
Shareholders' equity.... 416,768 155,591 (177,607) (45,384) 349,368
---------- -------- ---------- ----------- ----------
Total liabilities and
shareholders'
equity............... $1,275,846 $464.796 $1,060,652 $(1,204,662) $1,596,632
========== ======== ========== =========== ==========
As of December 31, 1999
Cash and cash
equivalents............ $ 90,544 $ 4,118 $ 13,319 $ 107,981
Accounts receivable,
net.................... 115,442 274,887 390,329
Other current assets.... 9,599 11,946 134,893 156,438
---------- -------- ---------- ----------- ----------
Total current assets.. 100,143 131,506 423,099 654,748
Property and equipment,
net.................... 5,850 86,572 193,027 285,449
Investment in
subsidiaries........... 143,023 (143,023)
Receivable from
subsidiaries........... 1,339,734 (1,339,734)
Intangible assets, net.. 28,862 346,756 694,054 1,069,672
Other assets............ 40,038 167 6,644 46,849
---------- -------- ---------- ----------- ----------
Total assets.......... $1,657,650 $565,001 $1,316,824 $(1,482,757) $2,056,718
========== ======== ========== =========== ==========
Current liabilities..... 1,328,180 237,424 132,940 1,698,544
Payables to subsidiary /
parent................. 161,720 1,178,014 (1,339,734)
Long-term debt and other
long-term liabilities.. 3,066 1,504 4,623 9,193
Minority interests...... 22,577 22,577
Shareholders' equity.... 326,404 164,353 (21,330) (143,023) 326,404
---------- -------- ---------- ----------- ----------
Total liabilities and
shareholders'
equity............... $1,657,650 $565,001 $1,316,824 $(1,482,757) $2,056,718
========== ======== ========== =========== ==========
F-29
DAVITA INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(dollars in thousands)
Condensed consolidating statements of income
RTC, Inc. Non-
DaVita Inc. issuer guarantor Consolidating Consolidated
guarantor subsidiary subsidiaries adjustments total
----------- ---------- ------------ ------------- ------------
For the year ended
December 31, 2000
Net operating revenues.. $ 117,111 $505,006 $ 973,372 $(109,187) $1,486,302
Operating expenses...... 155,950 433,132 831,692 (109,187) 1,311,587
--------- -------- --------- --------- ----------
Operating income
(loss)................. (38,839) 71,874 141,680 174,715
Other income (loss)..... (12,030) (607) 5,436 (7,201)
Debt expense............ 108,644 7,040 953 116,637
Minority interest
expense................ (5,942) (5,942)
Income taxes............ (65,400) 27,563 65,797 27,960
DaVita Inc.'s equity
earnings in
consolidated
subsidiary............. 111,088 (111,088)
Extraordinary loss...... (3,490) (3,490)
--------- -------- --------- --------- ----------
Net income (loss)...... $ 13,485 $ 36,664 $ 74,424 $(111,088) $ 13,485
========= ======== ========= ========= ==========
For the year ended
December 31, 1999
Net operating revenues.. $ 100,344 $496,380 $ 941,538 $ (92,911) $1,445,351
Operating expenses...... 51,668 499,560 1,051,016 (92,911) 1,509,333
--------- -------- --------- --------- ----------
Operating loss......... 48,676 (3,180) (109,478) (63,982)
Other income (loss)..... (514) (3,639) 2,258 (1,895)
Debt expense............ 100,798 7,988 2,011 110,797
Minority interest
expense................ (5,152) (5,152)
Income taxes............ (10,132) 9,296 (33,734) (34,570)
DaVita Inc.'s equity
earnings in
consolidated
subsidiary............. (104,752) 104,752
--------- -------- --------- --------- ----------
Net income (loss)...... $(147,256) $(24,103) $ (80,649) $ 104,752 $ (147,256)
========= ======== ========= ========= ==========
For the year ended
December 31, 1998
Net operating revenues.. $ 78,212 $472,355 $ 707,162 $ (53,991) $1,203,738
Operating expenses...... 48,015 446,367 628,434 (53,991) 1,068,825
--------- -------- --------- --------- ----------
Operating income ...... 30,197 25,988 78,728 134,913
Other income ........... 595 4,299 4,894
Debt expense............ 73,306 8,993 1,704 84,003
Minority interest
expense................ (7,163) (7,163)
Income taxes............ 4,597 19,959 13,893 38,449
DaVita Inc.'s equity
earnings in
consolidated
subsidiary............. 47,595 (47,595)
Extraordinary loss...... (9,932) (2,812) (12,744)
Cumulative effect of
accounting change...... (3,993) (2,903) (6,896)
--------- -------- --------- --------- ----------
Net income (loss)...... $ (9,448) $ (9,769) $ 57,364 $ (47,595) $ (9,448)
========= ======== ========= ========= ==========
F-30
DAVITA INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(dollars in thousands)
Condensed consolidating statements of cash flows
RTC, Inc.
DaVita Inc. issuer Non-guarantor Consolidating Consolidated
guarantor subsidiary subsidiaries adjustments total
----------- ---------- ------------- ------------- ------------
Year ended December 31,
2000
Cash flows from
operating activities
Net income............. $ 13,485 $ 36,664 $ 74,424 $(111,088) $ 13,485
Changes in operating
and intercompany
assets and liabilities
and non cash items
included in net
income................ 384,801 (132,011) (69,715) 111,088 294,163
--------- --------- --------- --------- ---------
Net cash provided by
(used) in operating
activities......... 398,286 (95,347) 4,709 307,648
--------- --------- --------- --------- ---------
Cash flows from
investing activities
Purchases of property
and equipment, net.... (722) (12,242) (28,124) (41,088)
Acquisitions and
divestitures, net..... 105,342 28,955 134,297
Other items............ (342) 488 146
--------- --------- --------- --------- ---------
Net cash provided by
(used in) investing
activities......... (1,064) 93,100 1,319 93,355
--------- --------- --------- --------- ---------
Cash flows from
financing activities
Long-term debt......... (477,036) (477,036)
Other items............ 5,823 (6,564) (741)
--------- --------- --------- --------- ---------
Net cash used in
financing
activities......... (471,213) -- (6,564) (477,777)
--------- --------- --------- --------- ---------
Net decrease in cash... (73,991) (2,247) (536) (76,774)
Cash at the beginning
of the year........... 90,544 4,118 13,319 107,981
--------- --------- --------- --------- ---------
Cash at the end of the
year.................. $ 16,553 $ 1,871 $ 12,783 $ $ 31,207
========= ========= ========= ========= =========
(0) 0 0
Year ended December 31,
1999
Cash flows from
operating activities
Net loss............... $(147,256) $ (24,103) $ (80,649) $ 104,752 $(147,256)
Changes in operating
and intercompany
assets and liabilities
and non cash items
included in net loss.. 41,825 50,485 331,204 (104,752) 318,762
--------- --------- --------- --------- ---------
Net cash provided by
(used in) operating
activities......... (105,431) 26,382 250,555 -- 171,506
--------- --------- --------- --------- ---------
Cash flows from
investing activities
Purchases of property
and equipment, net.... (5,133) (27,660) (73,864) (106,657)
Acquisitions........... (154,226) (154,226)
Other items............ (30,564) (30,564)
--------- --------- --------- --------- ---------
Net cash used in
investing
activities......... (5,133) (27,660) (258,654) -- (291,447)
--------- --------- --------- --------- ---------
Cash flows from
financing activities
Long-term debt......... 201,517 201,517
Other items............ (6,312) (4,052) (10,364)
--------- --------- --------- --------- ---------
Net cash provided by
(used in) financing
activities......... 195,205 -- (4,052) -- 191,153
Foreign currency
translation loss...... (4,718)
Net increase (decrease)
in cash............... 84,641 (1,278) (16,869) -- 66,494
Cash at the beginning
of the year........... 5,903 5,396 30,188 41,487
--------- --------- --------- --------- ---------
Cash at the end of the
year.................. $ 90,544 $ 4,118 $ 13,319 $ -- $ 107,981
========= ========= ========= ========= =========
-- -- --
F-31
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, we have duly caused this Report on Form 10-K to be signed
on our behalf by the undersigned, thereunto duly authorized, in the City of
Torrance, State of California, on March 16, 2001.
DAVITA INC.
/s/ Kent J. Thiry
By: _________________________________
Kent J. Thiry
Chairman and Chief Executive
Officer
KNOW ALL MEN BY THESE PRESENT, that each person whose signature appears below
constitutes and appoints Kent J. Thiry, Richard K. Whitney, and Steven J.
Udicious, and each of them his true and lawful attorneys-in-fact and agents
with full power of substitution and resubstitution, for him and in his name,
place and stead, in any and all capacities, to sign any and all amendments to
this Report on Form 10-K, and to file the same, with all exhibits thereto, and
other documents in connection therewith, with the Securities and Exchange
Commission, granting unto said attorneys-in-fact and agents, and each of them,
full power and authority to do and perform each and every act and thing
requisite or necessary to be done in and about the premises, as fully to all
intents and purposes as he might or could do in person, hereby ratifying and
confirming all that said attorneys-in-fact and agents or any of them, or their
or his substitute or substitutes, may lawfully do or cause to be done by virtue
hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this
Report on Form 10-K has been signed by the following persons in the capacities
and on the dates indicated.
Signature Title Date
--------- ----- ----
/s/ Kent J. Thiry Chairman and Chief March 16, 2001
______________________________________ Executive Officer
Kent J. Thiry (Principal Executive
Officer)
/s/ Richard K. Whitney Chief Financial Officer March 16, 2001
______________________________________ (Principal Financial
Richard K. Whitney Officer)
/s/ Gary W. Beil Vice President and March 16, 2001
______________________________________ Controller (Principal
Gary W. Beil Accounting Officer)
/s/ Maris Andersons Director March 16, 2001
______________________________________
Maris Andersons
/s/ Richard B. Fontaine Director March 16, 2001
______________________________________
Richard B. Fontaine
/s/ Peter T. Grauer Director March 16, 2001
______________________________________
Peter T. Grauer
/s/ C. Raymond Larkin, Jr. Director March 16, 2001
______________________________________
C. Raymond Larkin, Jr.
/s/ Shaul G. Massry Director March 16, 2001
______________________________________
Shaul G. Massry
II-1
Signature Title Date
--------- ----- ----
/s/ John M. Nehra Director March 16, 2001
______________________________________
John M. Nehra
/s/ Thomas A. Scully Director March 16, 2001
______________________________________
Thomas A. Scully
II-2
REPORTS OF INDEPENDENT ACCOUNTANTS ON
FINANCIAL STATEMENT SCHEDULE
The Board of Directors and Shareholders
DaVita Inc.
Under date of February 20, 2001, we reported on the consolidated balance
sheet of DaVita Inc. and subsidiaries as of December 31, 2000, and the related
consolidated statements of income and comprehensive income, shareholders'
equity, and cash flows for the year ended December 31, 2000, which are included
in the Form 10-K. In connection with our audit of the aforementioned
consolidated financial statements, we also audited the related consolidated
financial statement schedule for the year ended December 31, 2000 in the
Form 10-K. The financial statement schedule is the responsibility of the
Company's management. Our responsibility is to express an opinion on the
financial statement schedule based on our audit.
In our opinion, such financial statement schedule, when considered in
relation to the basic consolidated financial statements taken as a whole,
presents fairly, in all material respects, the information set forth therein.
KPMG LLP
Seattle, Washington
February 20, 2001
----------------
To the Board of Directors
of DaVita Inc.
Our audits of the consolidated financial statements referred to in our report
dated March 22, 2000, except for the first paragraph of Note 10 as to which the
date is July 14, 2000, appearing on page F-1 of this Annual Report on Form 10-K
also included audits of the Financial Statement Schedule listed in Item
14(a)(2) of this Form 10-K for the years ended December 31, 1999 and 1998. In
our opinion, the Financial Statement Schedule presents fairly, in all material
respects, the information set forth therein when read in conjunction with the
related consolidated financial statements.
Our report dated March 22, 2000, included an explanatory paragraph indicating
the Company was out of compliance with several debt covenants which raised
substantial doubt about the Company's ability to continue as a going concern.
As discussed in Note 10, on July 14, 2000, the Company restructured its primary
borrowing arrangements resulting in the elimination of the debt covenant
violations and the associated uncertainty about the Company's ability to
continue as a going concern. Accordingly, our present opinion on the 1999
financial statements as presented herein is different from that expressed in
our previous report in that the explanatory paragraph is no longer required.
PricewaterhouseCoopers LLP
Seattle, Washington
March 22, 2000, except for the first
paragraph of Note 10 as to which the
date is July 14, 2000
S-1
DAVITA INC.
SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS
Balance at Amounts Balance
beginning charged to Amounts at end of
Description of year income written off year
----------- ---------- ---------- ----------- ---------
(in thousands)
Allowance for uncollectible
accounts:
Year ended December 31, 1998.... $30,695 $ 45,537 $ 14,384 $61,848
Year ended December 31, 1999.... 61,848 133,253 127,786 67,315
Year ended December 31, 2000.... 67,315 39,649 45,345 61,619
S-2
EXHIBIT INDEX
Exhibit Page
Number Description Number
------- ----------- ------
3.1 Amended and Restated Certificate of Incorporation of Total
Renal Care Holdings, Inc., or TRCH, dated December 4,
1995.(1)
3.2 Certificate of Amendment of Certificate of Incorporation of
TRCH, dated February 26, 1998.(2)
3.3 Certificate of Amendment of Certificate of Incorporation of
DaVita Inc. (formerly Total Renal Care Holdings, Inc.),
dated October 5, 2000.(2)X
3.4 Bylaws of TRCH, dated October 6, 1995.(3)
4.1 Indenture, dated June 12, 1996 by Renal Treatment Centers,
Inc., or RTC, to PNC Bank including form of RTC Note.(5)
4.2 First Supplemental Indenture, dated as of February 27, 1998,
among RTC, TRCH and PNC Bank under the 1996 Indenture.(2)
4.3 Second Supplemental Indenture, dated as of March 31, 1998,
among RTC, TRCH and PNC Bank under the 1996 Indenture.(2)
4.4 Indenture, dated as of November 18, 1998, between TRCH and
United States Trust Company of New York, as trustee, and
form of Note.(6)
4.5 Registration Rights Agreement, dated as of November 18, 1998,
between TRCH and DLJ, BNY Capital Markets, Inc., Credit
Suisse First Boston Corporation and Warburg Dillon Read LLC,
as the initial purchasers.(6)
4.6 Purchase Agreement, dated as of November 12, 1998, between
TRCH and the initial purchasers.(6)
10.1 Employment Agreement, dated as of March 2, 1998, by and
between TRCH and Barry C. Cosgrove.(7)*
10.2 Employment Agreement, dated as of October 18, 1999, by and
between TRCH and Kent J. Thiry.(8)*
10.3 Amendment to Mr. Thiry's Employment Agreement, dated May 20,
2000.(10)*
10.4 Second Amendment to Mr. Thiry's Employment Agreement, dated
November 28, 2000.X*
10.5 Employment Agreement, dated as of March 1, 1998, by and
between TRCH and John J. McDonough.(11)*
10.6 Employment Agreement, dated as of November 29, 1999, by and
between TRCH and Gary W. Beil.X*
10.7 Employment Agreement, dated as of July 19, 2000, by and
between TRCH and Charles J. McAllister.X*
10.8 Consulting Agreement, dated as of October 1, 1998, by and
between Total Renal Care, Inc. and Shaul G. Massry, M.D.(8)*
10.9 Second Amended and Restated 1994 Equity Compensation
Plan.(11)*
10.10 Form of Stock Subscription Agreement relating to the 1994
Equity Compensation Plan.(4)*
10.11 Form of Promissory Note and Pledge Agreement relating to the
1994 Equity Compensation Plan.(4)*
10.12 Form of Purchased Shares Award Agreement relating to the 1994
Equity Compensation Plan.(4)*
10.13 Form of Nonqualified Stock Option relating to the 1994 Equity
Compensation Plan.(4)*
EXHIBIT INDEX--(Continued)
Exhibit Page
Number Description Number
------- ----------- ------
10.14 First Amended and Restated 1995 Equity Compensation
Plan.(11)*
10.15 Employee Stock Purchase Plan, 1999 Amendment and
Restatement.(11)*
10.16 First Amended and Restated 1997 Equity Compensation
Plan.(11)*
10.17 First Amended and Restated Special Purpose Option Plan.(11)*
10.18 1999 Equity Compensation Plan.(9)
10.19 Second Amended and Restated Revolving Credit Agreement, dated
as of July 14, 2000, by and among TRCH, the lenders party
thereto, DLJ Capital Funding, Inc., as Syndication Agent,
First Union National Bank, as Documentation Agent, and The
Bank of New York, as Administrative Agent.(10)
10.20 Second Amended and Restated Term Loan Agreement, dated as of
July 14, 2000, by and among TRCH, the lenders party thereto,
DLJ Capital Funding, Inc., as Syndication Agent, and The
Bank of New York, as Administrative Agent.(10)
10.21 Security Agreement dated as of July 14, 2000, by and among
TRCH, subsidiaries of TRCH, The Bank of New York, as
Collateral Agent, the lenders under the Revolving Credit
Agreement and their agent, the lenders under the Term Loan
Agreement and their agent, and the Secured Interest Rate
Exchangers (as defined therein).(10)
10.22 Subsidiary Guaranty dated as of October 24, 1997 by Total
Renal Care, Inc., TRC West, Inc. and Total Renal Care
Acquisition Corp. in favor of and for the benefit of The
Bank of New York, as Collateral Agent, the lenders to the
Revolving Credit Agreement, the lenders to the Term Loan
Agreement, the Term Agent (as defined therein), the
Acknowledging Interest Rate Exchangers (as defined therein)
and the Acknowledging Currency Exchangers (as defined
therein).(10)
10.23 Guaranty, entered into as of March 31, 1998, by TRCH in favor
of and for the benefit of PNC Bank.(2)
10.24 Amendment #2 dated June 22, 2000, to Agreement No. 19990110
between Amgen Inc. and Total Renal Care, Inc., and letter
agreement dated January 17, 2001, modifying Amendment #2.X**
10.25 Amendment #3 dated January 16, 2000, to Agreement No.
19990112 between Amgen Inc. and Total Renal Care, Inc.X**
12.1 Statement re Computation of Ratios of Earnings to Fixed
Charges.X
21.1 List of our subsidiaries.X
23.1 Consent of KPMG LLP.X
23.2 Consent of PricewaterhouseCoopers LLP.X
24.1 Powers of Attorney with respect to DaVita (included on page
II-1).
- --------
X Included in this filing.
* 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 18, 1996 as an exhibit to our Transitional Report on Form
10-K for the transition period from June 1, 1995 to December 31, 1995.
(2) Filed on March 31, 1998 as an exhibit to our Form 10-K for the year ended
December 31, 1997.
(3) Filed on October 24, 1995 as an exhibit to Amendment No. 2 to our
Registration Statement on Form S-1 (Registration Statement No. 33-97618).
(4) Filed on August 29, 1995 as an exhibit to our Form 10-K for the year ended
May 31, 1995.
(5) Filed as an exhibit to RTC's Form 10-Q for the quarter ended June 30,
1996.
(6) Filed on December 18, 1998 as an exhibit to our Registration Statement on
Form S-3 (Registration Statement No. 333-69227).
(7) Filed as an exhibit to our Form 10-Q for the quarter ended September 30,
1998.
(8) Filed on November 15, 1999 as an exhibit to our Form 10-Q for the quarter
ended September 30, 1999.
(9) Filed on February 18, 2000 as an exhibit to our Registration Statement on
Form S-8 (Registration Statement No. 333-30736).
(10) Filed on August 14, 2000, as an exhibit to our Form 10-Q for the quarter
ended June 30, 2000.
(11) Filed on March 29, 2000 as an exhibit to our Form 10-K for the year ended
December 31, 1999.