DVA

Business Context and Reporting Period

Company: DaVita Inc. (formerly Total Renal Care Holdings, Inc.)
Filing Type: Form 10-Q (Unaudited)
Reporting Period: Quarter and six months ended June 30, 2001
Business Overview: DaVita operates dialysis centers and laboratories, primarily within the continental United States. The company has substantially divested non-continental U.S. operations, retaining only two centers in Puerto Rico pending sale.

Key Financial Metrics

Operating Margins (Q2 2001): Operating margin improved to approximately 17.6% ($70.4M / $400.6M) compared to 8.7% in Q2 2000.

Material Changes vs. Prior Period

• Revenue Growth: Net operating revenues increased 5.7% year-over-year in Q2 2001. Continental U.S. revenue grew 15%, driven by a 10% increase in average revenue per treatment (to $276) and a 5% increase in treatment volume.
• Profitability Turnaround: The company returned to profitability, reporting net income of $29.5M in Q2 2001 compared to a loss of $15.4M in Q2 2000. This was aided by a significant reduction in the provision for uncollectible accounts due to cash recoveries of aged receivables.
• Debt Restructuring: In April 2001, the company issued $225M in 9 1/4% Senior Subordinated Notes. In May 2001, senior credit facilities were refinanced, reducing interest rates (LIBOR + 2.75%) and lowering debt expense by approximately $16M compared to the prior year quarter.
• Bad Debt Provision: The provision for uncollectible accounts was a credit of $(378) thousand in Q2 2001 (due to recoveries) versus an expense of $12.6M in Q2 2000.

Guidance, Outlook, and Risks

Management Guidance

Management projects normal operating earnings before depreciation, amortization, debt expense, and taxes (EBITDA) for the full year 2001 to be in the range of $340 million to $360 million. This projection excludes the one-time cash recoveries of previously reserved accounts receivable.

Key Risks and Contingencies

• Medicare Laboratory Review: A Florida-based laboratory subsidiary is under review by a third-party carrier and the Department of Justice (DOJ). Payments have been suspended since May 1998. The company estimates potential cash exposure of no more than $10M but notes that adverse resolution could result in substantial fines and penalties.
• DOJ Inquiry: The Civil Division of the U.S. Attorney's Office for the Eastern District of Pennsylvania is reviewing historical practices, including billing and physician relationships. No allegations of wrongdoing have been made at this time, but the inquiry is ongoing.
• Reimbursement Rates: Approximately 53% of revenue comes from Medicare. Future declines or lack of increases in reimbursement rates, or changes to the composite rate structure (e.g., inclusion of EPO or lab services), could materially reduce income.
• Medical Director Agreements: Agreements at 48 centers are at risk of expiring by December 31, 2002. Termination of these relationships could impact patient referrals and revenue.
• Accounting Changes: New FASB standards (SFAS 141 and 142) effective in 2001 and 2002 will discontinue goodwill amortization but require impairment testing, which could lead to future non-cash charges.

Investor Verification Checklist

• Receivable Quality: Verify the sustainability of the "provision for uncollectible accounts" credit, which was driven by $8.9M in recoveries of 1999 write-offs.
• Debt Service: Confirm the impact of the new debt structure on future interest expense and the ability to meet quarterly amortization requirements ($3M).
• Regulatory Exposure: Monitor the status of the DOJ inquiry and the Florida laboratory carrier review for potential cash outflows or revenue suspensions.
• Revenue Drivers: Assess the durability of the $276 average revenue per treatment, specifically the portion attributable to Medicare rate increases versus billing improvements.
• Contract Renewals: Track the renewal status of medical director agreements expiring in 2002 to gauge future patient volume stability.