DVA

DaVita Inc. 10-Q Summary: Quarter Ended March 31, 2002

Business Context and Reporting Period

This Form 10-Q covers the three-month period ended March 31, 2002, for DaVita Inc., a provider of dialysis services. The company operates primarily in the continental United States, having divested most non-continental operations by the end of 2000. As of May 1, 2002, there were 84,058,786 shares of common stock outstanding.

Key Financial Metrics

Margins: Operating margin for the quarter was approximately 18.5%. Debt expense decreased to $15.1 million from $19.7 million in the prior year due to lower effective interest rates and reduced debt balances.

Material Changes vs. Prior Period

• Revenue Growth: Net operating revenues increased 11% year-over-year, driven by a 6% increase in average revenue per treatment and a 5% increase in the number of treatments. Average revenue per treatment rose to $290 from $274.
• Expense Trends: Center operating expenses remained at 68% of revenues. General and administrative expenses increased 6% in absolute dollars due to labor costs and infrastructure investments.
• Accounting Changes: The company adopted SFAS No. 142, eliminating goodwill amortization effective January 1, 2002. This reduced amortization expense significantly compared to the prior year.
• Debt Reduction: Long-term debt decreased by approximately $12.5 million compared to the prior year-end, and debt expense was $4.6 million lower than Q1 2001.

Guidance, Outlook, and Risks

Recapitalization Plan: In March 2002, DaVita initiated a plan to repurchase up to 20 million shares of common stock (potential cost up to $520 million) and all outstanding $225 million of 9 1/4% Senior Subordinated Notes (cost approx. $265 million). The company secured a new $1.115 billion senior credit facility to finance these transactions. As of the filing, $380 million of the new Term Loan B had been drawn.

Projections: Management projects 2002 EBITDA in the range of $350 million to $380 million, unchanged from prior guidance. 2003 EBITDA is projected in the same range. Assumptions include 3-4% internal growth in treatments and no increase in the Medicare composite rate.

Risks and Contingencies:

• Legal Proceedings: The company is subject to a third-party carrier review of its Florida laboratory subsidiary regarding Medicare reimbursement claims. Potential cash exposure is estimated at no more than $10 million, though penalties could be substantial. A federal administrative law judge is reviewing the matter.
• Government Investigations: The company is cooperating with the U.S. Attorney's Office and the HHS Office of Inspector General in Philadelphia regarding historical billing practices and financial relationships with physicians. A subpoena was received in May 2002.
• Reimbursement Risk: Approximately 51-53% of revenues are from Medicare. There is no increase in the Medicare composite rate for 2002, while operating costs (labor, drugs) continue to rise.

Investor Verification Checklist

• Verify the status and potential financial impact of the Florida laboratory Medicare carrier review and the ongoing DOJ/OIG investigation in Philadelphia.
• Confirm the final terms and execution of the modified Dutch auction tender offer for common stock repurchases.
• Monitor the utilization of the new $1.115 billion credit facility and the company's leverage ratio.
• Track the renewal rates of medical director agreements, as 52 centers required renewal by March 31, 2003.
• Assess the impact of potential changes in EPO (Erythropoietin) reimbursement policies and pricing from the sole supplier, Amgen.