DVA

Business Context and Reporting Period

Company: DaVita Inc. (formerly Total Renal Care Holdings, Inc.)
Filing Type: Form 10-Q (Unaudited)
Reporting Period: Quarter ended March 31, 2001
Business Overview: DaVita operates dialysis centers and laboratories, primarily within the continental United States. The company substantially completed the divestiture of its non-continental U.S. operations in 2000, leaving only two centers in Puerto Rico pending sale.

Key Financial Metrics

Operational Highlights:

• Continental U.S. dialysis treatments increased 3.7% year-over-year to 1,366,000.
• Average revenue per treatment rose to $274 (from $247 in Q1 2000), driven by Medicare rate increases and improved billing.
• Center operating expenses were 67% of revenues, an improvement from 69% in Q1 2000.

Material Changes vs. Prior Period

• Profitability Surge: Net income increased 704% year-over-year, primarily due to a $21 million reduction in debt expense and a $21 million reversal of bad debt expense (recoveries of aged receivables).
• Revenue Growth: Net operating revenues grew 3.8% year-over-year, with Continental U.S. revenues up 13%.
• Debt Reduction: Total long-term debt decreased by approximately $42 million during the quarter. Debt expense dropped from $33.2 million to $19.7 million due to lower interest rates and reduced balances.
• Bad Debt Provision: The provision for uncollectible accounts turned positive (a credit of $8.2 million) in Q1 2001 compared to a charge of $12.9 million in Q1 2000, largely due to $16 million in cash recoveries of accounts reserved in 1999.

Guidance, Outlook, and Risks

Management Guidance:

• Projected operating earnings before depreciation, amortization, debt, and taxes (EBITDA) for 2001 are expected to be in the range of $320 million to $360 million, excluding the $16 million one-time bad debt recovery.
• Assumptions include 3-4% internal growth in dialysis treatments and minimal acquisitions.

Recent Capital Actions (Subsequent Events):

• April 2001: Sold $225 million of 9 1/4% Senior Subordinated Notes; proceeds used to pay down senior credit facilities.
• May 2001: Refinanced senior credit facilities with a new Term A ($50M), Term B ($200M), and Revolver ($150M). Interest rates improved by 0.25% to 1.0%.

Material Risks and Contingencies:

• Florida Laboratory Dispute: A Medicare carrier has suspended payments and issued overpayment determinations totaling approximately $20.6 million for periods 1995-1998. Additional suspended claims of $27.7 million (1998-2000) were deemed unsupported. The company estimates potential cash exposure at no more than $15 million but faces uncertainty regarding timing and potential fines.
• Government Review: The U.S. Attorney's Office for the Eastern District of Pennsylvania is reviewing historical billing practices and physician relationships. No allegations of wrongdoing have been made, but penalties could be substantial if wrongdoing is found.
• Reimbursement Risk: Ongoing risks related to government reimbursement rates and interpretations of medical necessity.

Investor Verification Checklist

• Bad Debt Recovery Sustainability: Verify if the $16 million recovery of aged receivables is a one-time event or indicative of a trend, as it significantly inflated Q1 2001 earnings.
• Florida Lab Resolution: Monitor the status of the administrative law judge hearing (expected Q2 2001) regarding the $15 million+ exposure and payment suspension.
• Debt Refinancing Impact: Confirm the interest savings realized from the May 2001 refinancing and the impact on future cash flows.
• DOJ Inquiry Status: Track the scope and outcome of the U.S. Attorney's Office review of historical practices.
• Revenue Mix: Assess the reliance on Medicare reimbursement rates versus private payor contracts given the concentration of profits.