News Column

DAVITA HEALTHCARE PARTNERS INC. - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations.

August 1, 2014

Forward-looking statements

This Management's Discussion and Analysis of Financial Condition and Results of Operations contains statements that are forward-looking statements within the meaning of the federal securities laws. All statements that do not concern historical facts are forward-looking statements and include, among other things, statements about our expectations, beliefs, intentions and/or strategies for the future. These forward-looking statements include statements regarding our future operations, financial condition and prospects, expectations for treatment growth rates, revenue per treatment, expense growth, levels of the provision for uncollectible accounts receivable, operating income, cash flow, operating cash flow, estimated tax rates, capital expenditures, the development of new dialysis centers and dialysis center acquisitions, government and commercial payment rates, revenue estimating risk and the impact of our level of indebtedness on our financial performance, and including earnings per share. These statements involve substantial known and unknown risks and uncertainties that could cause our actual results to differ materially from those described in the forward-looking statements, including but not limited to, risks resulting from the concentration of profits generated by higher-paying commercial payor plans for which there is continued downward pressure on average realized payment rates, and a reduction in the number of patients under such plans, which may result in the loss of revenues or patients, a reduction in government payment rates under the Medicare ESRD program or other government-based programs, the impact of the Center for Medicare and Medicaid Services (CMS) 2014 Medicare Advantage benchmark structure, risks arising from potential federal and/or state legislation that could have an adverse effect on our operations and profitability, changes in pharmaceutical or anemia management practice patterns, payment policies, or pharmaceutical pricing, legal compliance risks, including our continued compliance with complex government regulations and current or potential investigations by various government entities and related government or private-party proceedings, including risks relating to the resolution of the 2010 and 2011 U.S. Attorney Physician Relationship Investigations, such as restrictions on our business and operations required by a corporate integrity agreement and other settlement terms, and the financial impact thereof, continued increased competition from large and medium-sized dialysis providers that compete directly with us, our ability to maintain contracts with physician medical directors, changing affiliation models for physicians, and the emergence of new models of care introduced by the government or private sector that may erode our patient base and reimbursement rates such as accountable care organizations (ACOs), independent practice associations (IPAs) and integrated delivery systems, or to businesses outside of dialysis and HCP's business, our ability to complete acquisitions, mergers or dispositions that we might be considering or announce, or to integrate and successfully operate any business we may acquire or have acquired, including HCP, or to expand our operations and services to markets outside the U.S., variability of our cash flows, the risk that we might invest material amounts of capital and incur significant costs in connection with the growth and development of our international operations, yet we might not be able to operate them profitably anytime soon, if at all, risks arising from the use of accounting estimates, judgments and interpretations in our financial statements, loss of key HCP employees, potential disruption from the HCP transaction making it more difficult to maintain business and operational relationships with customers, partners, associated physicians and physician groups, hospitals and others, the risk that laws regulating the corporate practice of medicine could restrict the manner in which HCP conducts its business, the risk that the cost of providing services under HCP's agreements may exceed our compensation, the risk that reductions in reimbursement rates, including Medicare Advantage rates, and future regulations may negatively impact HCP's business, revenue and profitability, the risk that HCP may not be able to successfully establish a presence in new geographic regions or successfully address competitive threats that could reduce its profitability, the risk that a disruption in HCP's healthcare provider networks could have an adverse effect on HCP's business operations and profitability, the risk that reductions in the quality ratings of health maintenance organization plan customers of HCP could have an adverse effect on HCP's business, or the risk that health plans that acquire health maintenance organizations may not be willing to contract with HCP or may be willing to contract only on less favorable terms, and the other risk factors set forth in Part II, Item 1A. of this Quarterly Report on Form 10-Q. We base our forward-looking statements on information currently available to us, and we undertake no obligation to update or revise any forward-looking statements, whether as a result of changes in underlying factors, new information, future events or otherwise. 41



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The following should be read in conjunction with our condensed consolidated financial statements.

Consolidated results of operations

We operate two major divisions, Kidney Care and HealthCare Partners (HCP). Our Kidney Care division is comprised of our U.S. dialysis and related lab services business, our ancillary services and strategic initiatives including our international operations, and our corporate support expenses. Our HCP division is comprised of our HCP business. Our largest major line of business is our U.S. dialysis and related lab services, which is a leading provider of kidney dialysis services in the U.S. for patients suffering from chronic kidney failure, also known as ESRD. Our other major line of business is HCP, which is a patient- and physician-focused integrated health care delivery and management company.



Following is a summary of our consolidated operating results for the second quarter of 2014 compared with the prior sequential quarter and the same quarter of 2013, as well as the six months ended June 30, 2014 compared to the same period in 2013, for reference in the discussion that follows.

Three months ended Six months ended June 30, March 31, June 30, June 30, June 30, 2014 2014 2013 2014 2013 (dollar amounts rounded to nearest million) Net revenues: Patient service revenues $ 2,187$ 2,114$ 2,049$ 4,301$ 4,028 Less: Provision for uncollectible accounts (88 ) (83 ) (72 ) (171 ) (142 ) Net patient service revenues 2,099 2,031 1,977 4,130 3,886 Capitated revenues 799 788 710 1,587 1,473 Other revenues 274 224 185 498 342



Total consolidated net revenues 3,172 100 % 3,043 100 % 2,872 100 % 6,215 100 % 5,701 100 %

Operating expenses and charges: Patient care costs 2,247 71 % 2,180



71 % 2,015 70 % 4,426 71 % 3,975 70 % General and administrative

298 9 % 284



9 % 268 9 % 582 9 % 553 10 % Depreciation and amortization

146 5 % 142 5 % 131 5 % 288 5 % 256 4 % Provision for uncollectible accounts 3 - 3 - 1 - 6 - 2 - Equity investment income (6 ) - (7 ) - (8 ) - (13 ) - (17 ) - Loss contingency reserve - - - - - - - - 300 5 % Contingent earn-out obligation adjustment - - - - (57 ) (2 %) - - (57 ) (1



%)

Total operating expenses and charges 2,688 85 % 2,602 85 % 2,350 82 % 5,289 85 % 5,012 88 % Operating income $ 484 15 % $ 441 15 % $ 522 18 % $ 926 15 % $ 689 12 % 42



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The following table summarizes consolidated net revenues for our Kidney Care division and our HCP division:

Three months ended Six months ended June 30, March 31, June 30, June 30, June 30, 2014 2014 2013 2014 2013 (dollar amounts rounded to nearest million) Net revenues: Kidney Care: U.S. dialysis and related lab services patient service revenues $ 2,106$ 2,037$ 1,988$ 4,142$ 3,905 Less: Provision for uncollectible accounts (84 ) (82 ) (69 ) (166 ) (137 ) U.S. dialysis and related lab services net patient service revenues $ 2,022$ 1,955$ 1,919$ 3,976$ 3,768 Other revenues 3 3 3 7 6 Total net U.S. dialysis and related lab services revenues 2,025 1,958 1,922 3,983 3,774 Other-Ancillary services and strategic initiatives revenues 229 214 166 442 319 Other-Capitated revenues 16 16 18 32 34 Other-Ancillary services and strategic initiatives net patient service revenues (less provision for uncollectible accounts) 29 27 16 56 31 Total net other-ancillary services and strategic initiatives revenues 274 257 200 530 384 Elimination of intersegment and division revenues (14 ) (13 ) (11 ) (26 ) (22 ) Total Kidney Care net revenues 2,285 2,202 2,111 4,487 4,136 HCP: HCP capitated revenues 783 772 693 1,555 1,439 HCP net patient service revenues (less provision for uncollectible accounts) 58 56 49 114 103 Other revenues 46 13 19 59 23 Total net HCP revenues 887 841 761 1,728 1,565



Total consolidated net revenues $ 3,172$ 3,043$ 2,872$ 6,215$ 5,701

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The following table summarizes consolidated operating income and adjusted consolidated operating income:

Three months ended Six months ended June 30, March 31, June 30, June 30, June 30, 2014 2014 2013 2014 2013 (dollar amounts rounded to nearest million) Operating income: Kidney Care: U.S. dialysis and related lab services $ 408$ 387$ 402$ 795$ 486 Other-Ancillary services and strategic initiatives (losses) income (2 ) 2 (7 ) - (22 ) Contingent earn-out obligation adjustment - - 57 - 57 Corporate support costs (4 ) (2 ) (11 ) (5 ) (22 ) Total kidney care operating income 402 387 441 790 499 HCP services 82 54 81 136 190 Total consolidated operating income 484 441 522 926 689 Reconciliation of non-GAAP measures: Add: Contingent earn-out obligation adjustment - - (57 ) - (57 ) Loss contingency reserve - - - - 300 Adjusted consolidated operating income(1) $ 484$ 441$ 465$ 926$ 932



(1) For the three and six months ended June 30, 2013, we have excluded $57

million related to an adjustment to decrease HCP's contingent earn-out

obligation. In addition, for the six months ended June 30, 2013, we have

excluded $300 million of expenses related to an estimated loss contingency

reserve. These are non-GAAP measures and are not intended as substitutes for

the GAAP equivalent measures. We have presented these adjusted amounts because management believes that these presentations enhance a user's understanding of our normal consolidated operating income by excluding an unusual adjustment of $57 million for a decrease in HCP's contingent



earn-out obligation and an estimated $300 million loss contingency reserve

related to the 2010 and 2011 U.S. Attorney Physician Relationship

Investigations (see Note 9 to the condensed consolidated financial

statements). We therefore consider these adjusted consolidated operating

income amounts meaningful and comparable to our prior period results.

Consolidated net revenues

Consolidated net revenues for the second quarter of 2014 increased by approximately $129 million, or approximately 4.2%, as compared to the first quarter of 2014. The increase in consolidated net revenues was primarily due to an increase of approximately $67 million associated with the U.S. dialysis and related lab services net revenues, principally due to one and a half additional treatment days in the second quarter of 2014 as compared to the first quarter of 2014 and strong non-acquired growth, partially offset by a decrease of $1 in the average dialysis revenue per treatment mainly due to a seasonal decrease in acute services. In addition, HCP's net operating revenues increased by approximately $46 million, mainly from the recognition of additional HCP revenues related to the maintenance of existing physician networks, additional senior capitated members and the timing of revenue from its annual premium reconciliation for senior capitated members which previously occurred in the third quarter of 2013. The increase in consolidated net revenues was also due to an increase of approximately $17 million associated with our ancillary services and strategic initiatives revenues primarily from additional pharmacy revenues. Consolidated net revenues for the second quarter of 2014 increased by approximately $300 million, or approximately 10.4%, as compared to the second quarter of 2013. The increase in consolidated net revenues was mostly due to an increase of $103 million in the U.S. dialysis and related lab services net revenues, primarily as a 44



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result of strong volume growth from non-acquired treatment growth in existing and new centers and an increase of $1 in the average dialysis revenue per treatment, driven by changes in the mix of our government reimbursements and an increase in some of our commercial payment rates. The increase in consolidated net revenues was also due to an increase in HCP net revenues of $126 million due to acquired growth, an increase in senior capitated members in the second quarter of 2014 and from the recognition of additional HCP revenues related to the maintenance of existing physician networks, as well as the timing of revenue from its annual premium reconciliation for senior capitated members which previously occurred in the third quarter of 2013, partially offset by a reduction in HCP's Medicare Advantage payments. In addition, the increase in consolidated net revenues was also due to an increase of approximately $74 million in our ancillary services and strategic initiatives, mainly from growth in our pharmacy services and in our international operations. Consolidated net revenues for the six months ended June 30, 2014 increased by approximately $514 million, or approximately 9.0%, as compared to the same period in 2013. The increase in consolidated net revenues was primarily due to an increase of $209 million in the U.S. dialysis and related lab services net revenues, largely as a result of strong volume growth from non-acquired treatment growth in existing and new centers, and an increase in HCP net revenues of $163 million, primarily due to an increase in senior capitated members in the first quarter of 2014 and from the recognition of additional HCP revenues related to the maintenance of existing physician networks, as well as the timing of revenue from its annual premium reconciliation for senior capitated members which previously occurred in the third quarter of 2013, partially offset by a reduction in HCP's Medicare Advantage payments. In addition, the increase in consolidated net revenues was also due to an increase of approximately $146 million in our ancillary services and strategic initiatives, largely due to growth in our pharmacy services and in our international operations.



Consolidated operating income

Consolidated operating income for the second quarter of 2014 increased by approximately $43 million, or approximately 9.8%, as compared to the first quarter of 2014. The increase in the consolidated operating income was for the most part due to an increase in U.S. dialysis and related lab services net revenues due to strong volume growth primarily from one and a half additional treatment days in the second quarter of 2014 as compared to the first quarter of 2014, lower payroll taxes, improved productivity, as well as improved operating results in HCP mainly from the recognition of additional revenues as described above, and an increase in HCP senior capitated members. Consolidated operating income was negatively impacted by an increase in pharmaceutical costs, an increase in the intensities of physician prescribed pharmaceuticals, higher labor costs, an increase in travel costs for management meetings, higher long-term incentive compensation and an increase in HCP's medical claims expense as a result of additional senior and Medicaid members who have higher utilization. Consolidated operating income for the second quarter of 2014 decreased by approximately $38 million, or approximately 7.3%, as compared to the second quarter of 2013, including the contingent earn-out obligation adjustment of $57 million in the second quarter of 2013. Excluding this item, adjusted consolidated operating income would have increased by $19 million. The increase in adjusted consolidated operating income was primarily due to strong volume growth in the number of treatments from non-acquired growth and acquisitions, and from improved productivity. In addition, adjusted consolidated operating income was also positively impacted by improved operating performance of certain ancillary services and strategic initiatives, mainly our pharmacy services, and the recognition of additional HCP revenues as described above, partially offset by the impact of lower HCP Medicare Advantage payments, an increase in HCP's medical claims expenses as a result of additional senior capitated members, higher pharmaceutical unit costs, an increase in the intensities of physician-prescribed pharmaceuticals, an increase in the provision for uncollectible accounts, higher labor costs and related payroll taxes, and higher long-term incentive compensation. Consolidated operating income for the six months ended June 30, 2014 increased by approximately $237 million, or approximately 34.4%, as compared to the same period in 2013, which includes the accrued estimated loss contingency reserve of $300 million and the contingent earn-out obligation adjustment of $57 million. 45



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Excluding these items, adjusted consolidated operating income would have decreased by $6 million. The decrease in adjusted operating income was primarily due to the impact of lower HCP operating results, largely from lower Medicare Advantage payments, partially offset by the recognition of additional HCP revenues as described above. In addition, the decrease in adjusted consolidated operating income was also due to higher pharmaceutical unit costs, an increase in the intensities of physician-prescribed pharmaceuticals, an increase in the provision for uncollectible accounts, higher labor costs and related payroll taxes, an increase in benefit costs, higher long-term incentive compensation and an increase in HCP's medical claims expenses, as a result of additional senior capitated members. The decrease in adjusted consolidated operating income was partially offset by strong volume growth in the number of treatments from non-acquired growth, improved productivity and lower professional fees for legal and compliance matters. In addition, adjusted consolidated operating income was also positively impacted by improved operating performance of certain ancillary services and strategic initiatives, primarily from growth in our pharmacy services.



U.S. dialysis and related lab services business

Results of operations Three months ended Six months ended June 30, March 31, June 30, June 30, June 30, 2014 2014 2013 2014 2013 (dollar amounts rounded to nearest million, except per treatment data) Net revenues: Dialysis and related lab services patient service revenues $ 2,106$ 2,037$ 1,988$ 4,142$ 3,905 Less: Provision for uncollectible accounts (84 ) (82 ) (69 ) (166 ) (137 ) Dialysis and related lab services net patient service revenues $ 2,022$ 1,955$ 1,919$ 3,976$ 3,768 Other revenues 3 3 3 7 6 Total net dialysis and related lab services revenues $ 2,025$ 1,958$ 1,922$ 3,983$ 3,774 Operating expenses and charges: Patient care costs 1,358 1,323 1,265 2,680 2,482 General and administrative 164 155 169 319 338 Depreciation and amortization 99 96 89 196 174 Loss contingency reserve - - - - 300 Equity investment income (4 ) (3 ) (3 ) (7 ) (6 ) Total operating expenses and charges 1,617 1,571 1,520 3,188 3,288 Operating income $ 408$ 387$ 402$ 795$ 486 Dialysis treatments 6,196,394 5,975,627 5,867,973 12,172,021 11,496,772 Average dialysis treatments per treatment day 79,441 78,215 75,230 78,834 74,413 Average dialysis and related lab services revenue per treatment $ 340$ 341$ 339$ 340$ 340 Net revenues Dialysis and related lab services' net revenues for the second quarter of 2014 increased by approximately $67 million, or approximately 3.4%, as compared to the first quarter of 2014. The increase in dialysis and related lab services' net revenues was due to an increase in the number of treatments as a result of one and a half 46



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additional treatment days in the second quarter of 2014 as compared to the first quarter of 2014 and strong non-acquired treatment growth in existing and new centers, partially offset by a decrease in the average dialysis revenue per treatment of approximately $1. The decrease in the average dialysis revenue per treatment was primarily due to a seasonal decrease in our acute services, partially offset by an increase in our commercial mix and an increase in some of our commercial payment rates. Dialysis and related lab services' net revenues for the second quarter of 2014 increased by approximately $103 million, or approximately 5.4%, as compared to the second quarter of 2013. The increase in net revenues in the second quarter of 2014 was principally due to strong volume growth from additional treatments. The increase in the number of treatments was primarily attributable to strong non-acquired treatment growth at existing and new centers. The average dialysis revenue per treatment also increased by approximately $1 in the second quarter of 2014 as compared to the second quarter of 2013. The increase in our average dialysis revenue per treatment was primarily due to an increase as a result of changes in the mix of our government reimbursements and an increase in some of our average commercial payment rates, partially offset by a decrease in our commercial mix and an increase in the provision for uncollectible accounts. Dialysis and related lab services' net revenues for the six months ended June 30, 2014 increased by approximately $209 million, or approximately 5.5%, as compared to the same period in 2013. The increase in net revenues in the first six months of 2014 was principally due to strong volume growth from additional treatments. The increase in the number of treatments was primarily attributable to strong non-acquired treatment growth at existing and new centers. The average dialysis revenue per treatment was flat in the first six months of 2014 as compared to the first six months of 2013, but was impacted by an increase in our acute services and an increase in some of our average commercial payment rates, offset by a decrease in our Medicare reimbursements as a result of sequestration that went into effect on April 1, 2013, and a slight decrease in our commercial mix. Dialysis and related lab services' net revenues were also negatively impacted by an increase in the provision for uncollectible accounts. Provision for uncollectible accounts. The provision for uncollectible accounts receivable for dialysis and related lab services was 4.0% for the second quarter of 2014, 4.0% for the first quarter of 2014, and 3.5% for the second quarter of 2013. We continue to experience higher amounts of non-covered Medicare write-offs. We assess our level of the provision for uncollectible accounts based upon our historical cash collection experience and trends, and have and will continue to adjust the provision as necessary as a result of changes in our cash collections. Medicare update CMS issued the 2014 final rule for the ESRD Prospective Payment System (PPS), which phases in over three to four years the 12% cut mandated by the American Taxpayer Relief Act of 2012 (ATRA). Although no reimbursement reduction is expected in 2015 under the final ESRD PPS rule, it is anticipated that future reductions will occur no later than 2017. However, the recent "Protecting Access to Medicare Act" that was passed on March 31, 2014 further modified the reduction to only 1.25% in 2016 and 2017, and 1% in 2018. While this modification eases reimbursement pressure, future legislative actions could have the opposite effect. CMS recently issued the 2015 proposed rule for ESRD PPS, which was published in the Federal Register on July 11, 2014. The proposed rule would increase payments to dialysis facilities modestly by 0.3% to 0.5%, although rural facilities would receive a decrease of 0.5%. The "Protecting Access to Medicare Act" was passed by Congress on March 31, 2014 which delayed the implementation of oral-only medications that will be included in the bundled ESRD payment rate to dialysis centers until June 1, 2024. As previously disclosed, sequestration spending cuts took effect on April 1, 2013, which reduced our Medicare payments by 2%. These spending cuts were extended through 2014 and 2015 by a two-year funding bill signed into law on December 31, 2013, which will continue to negatively impact our condensed consolidated financial results. 47



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Operating expenses and charges

Patient care costs. Dialysis and related lab services' patient care costs of approximately $219 per treatment for the second quarter of 2014 decreased by $2 as compared to the first quarter of 2014. The decrease in patient care costs per treatment was primarily due to a decrease in benefit costs and related payroll taxes, improved productivity and a decrease in seasonal occupancy costs, partially offset by an increase in travel expenses related to management meetings, higher pharmaceutical unit costs and an increase in professional fees. Dialysis and related lab services' patient care costs on a per treatment basis for the second quarter of 2014 increased by approximately $3 as compared to the second quarter of 2013. The increase was primarily attributable to higher labor costs, higher pharmaceutical unit costs, higher occupancy costs, an increase in our other direct operating expenses associated with our dialysis centers and an increase in intensities of physician-prescribed pharmaceuticals, partially offset by improved productivity and lower benefit costs. Dialysis and related lab services' patient care costs on a per treatment basis for the six months ended June 30, 2014 increased by approximately $4 as compared to the same period in 2013. The increase was primarily attributable to higher labor costs, an increase in benefit costs, higher pharmaceutical unit costs, higher occupancy costs, an increase in our other direct operating expenses associated with our dialysis centers and an increase in intensities of physician-prescribed pharmaceuticals, partially offset by improved productivity. General and administrative expenses. Dialysis and related lab services' general and administrative expenses of approximately $164 million in the second quarter of 2014 increased by approximately $9 million as compared to the first quarter of 2014. The increase in general and administrative expenses was primarily due to higher labor and benefit costs, an increase in travel expenses related to management meetings and higher long-term incentive compensation, partially offset by lower payroll taxes and lower professional fees. Dialysis and related lab services' general and administrative expenses for the second quarter of 2014 decreased by approximately $5 million as compared to the second quarter of 2013. The decrease was primarily due to lower labor costs, lower travel expenses and a decrease in professional fees for legal matters, partially offset by higher long-term incentive compensation. Dialysis and related lab services' general and administrative expenses for the six months ended June 30, 2014 decreased by approximately $19 million as compared to the same period in 2013. The decrease was primarily due to lower labor costs, lower travel expenses, a decrease in professional fees for compliance matters and information technology initiatives, partially offset by higher long-term incentive compensation. Depreciation and amortization. Depreciation and amortization for dialysis and related lab services was approximately $99 million for the second quarter of 2014, $96 million for the first quarter of 2014 and $89 million for the second quarter of 2013. The increases in depreciation and amortization in the second quarter of 2014, as compared to the first quarter of 2014 and the second quarter of 2013, were primarily due to growth in newly developed centers and from acquired centers. Depreciation and amortization for dialysis and related lab services was approximately $196 million for the six months ended June 30, 2014 as compared to $174 million for the same period in 2013. The increase was primarily due to the same factors as described above. Loss contingency reserve. We have previously agreed to a framework for a global resolution with the United States Attorney's Office for the District of Colorado, the Civil Division of the United States Department of Justice and the Office of the Inspector General for both the 2010 and the 2011 U.S. Attorney Physician Relationship Investigations. The final settlement remains subject to negotiation for both the 2010 and 2011 U.S. Attorney Physician Relationship Investigations described above. The settlement will include payment of approximately $389 million. The final settlement remains subject to negotiation of specific terms. During 2013, 48



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in connection with offers to settle these matters, we accrued a total of $397 million as an estimated loss contingency reserve, $300 million in the first quarter of 2013 and $97 million in the third quarter of 2013.

Equity investment income. Equity investment income for dialysis and related lab services was approximately $4.1 million for the second quarter of 2014, as compared to $2.7 million for the first quarter of 2014 and $2.8 million for the second quarter of 2013. The increase in equity investment income in the second quarter of 2014 as compared to the first quarter of 2014, and the first quarter of 2013, was primarily due to an increase in the profitability of certain joint ventures in the second quarter of 2014.



Accounts receivable

Our dialysis and related lab services accounts receivable balances at June 30, 2014 and March 31, 2014 were $1,148 million and $1,168 million, respectively, which represented approximately 53 days and 55 days, respectively, which is net of the provision for uncollectible accounts. Our DSO calculation is based on the current quarter's average revenues per day. There were no significant changes during the second quarter of 2014 from the first quarter of 2014 in the amount of unreserved accounts receivable over one year old or the amounts pending approval from third-party payors.



Segment operating income

Dialysis and related lab services' operating income for the second quarter of 2014 increased by approximately $21 million, or approximately 5.4%, as compared to the first quarter of 2014. Operating income increased primarily due to strong volume growth in the number of treatments due to one and a half additional treatment days in the second quarter of 2014 as compared to the first quarter of 2014 and strong non-acquired growth in existing and new centers. Dialysis and related lab services operating income also increased as a result of lower payroll taxes, a decrease in occupancy costs and improved productivity, partially offset by higher pharmaceutical unit costs, an increase in the intensities of physician-prescribed pharmaceuticals, an increase in direct medical supply expense, an increase in long-term incentive compensation and an increase in travel expenses for management meetings. Dialysis and related lab services' operating income for the second quarter of 2014 increased by approximately $6 million, or approximately 1.5%, as compared to the second quarter of 2013. The increase is primarily attributable to strong volume growth in revenues from additional treatments as a result of non-acquired treatment growth in existing and new centers, lower travel expenses for management meetings, a decrease in professional fees and improved productivity. Dialysis and related lab services operating income was negatively impacted by higher labor costs, higher pharmaceutical unit costs, an increase in the intensities of physician-prescribed pharmaceuticals, an increase in the provision for uncollectible accounts and an increase in long-term incentive compensation. Dialysis and related lab services' operating income for the six months ended June 30, 2014 increased by approximately $309 million, or approximately 63.6%, as compared to the same period in 2013, including the accrued estimated legal contingency reserve of $300 million in the first quarter of 2013. Excluding this item from the first six months of 2013, adjusted operating income would have increased by $9 million, primarily attributable to strong volume growth in revenues from additional treatments as a result of non-acquired treatment growth in existing and new centers, and improved productivity. Adjusted dialysis and related lab services operating income was negatively impacted by higher labor costs and related payroll taxes, higher benefit costs, higher pharmaceutical unit costs, an increase in the intensities of physician-prescribed pharmaceuticals, an increase in occupancy costs and an increase in the provision for uncollectible accounts. 49



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Table of Contents HCP business Results of operations Three months ended Six months ended June 30, March 31, June 30, June 30, June 30, 2014 2014 2013 2014 2013 (dollar amounts rounded to nearest millions) Net revenues: HCP capitated revenue $ 783 88 % $ 772 92 % $ 693 91 % $ 1,555 90 % $ 1,439 92 % Patient service revenue 62 58 52 119 109 Less: Provision for uncollectible accounts (4 ) (2 ) (3 ) (5 ) (6 ) Net patient service revenue 58 7 % 56 7 % 49 7 % 114 7 % 103 7 % Other revenues 46 5 % 13 1 % 19 2 % 59 3 % 23 1 % Total net revenues $ 887 100 % $ 841 100 % $ 761 100 % $ 1,728 100 % $ 1,565 100 % Operating expense: Patient care costs $ 688 77 % $ 672 80



% $ 590 78 % $ 1,360 78 % $ 1,185 76 % General and administrative expense 77 9 % 78 9 % 56 7 % 155 9 % 125 8 % Depreciation and amortization

42 5 % 42 5 % 39 5 % 84 5 % 76 5 % Equity investment income (2 ) - (5 ) (1 )% (5 ) (1 )% (7 ) - (11 ) (1 )% Total expenses 805 91 % 787 93 % 680 89 % 1,592 92 % 1,375 88 % Operating income $ 82 9 % $ 54 7 % $ 81 11 % $ 136 8 % $ 190 12 %



Capitated membership information

The following table provides (i) the total number of capitated members to whom HCP provided healthcare services as of June 30, 2014, March 31, 2014 and June 30, 2013, and (ii) the aggregate member months for the six months ended June 30, 2014, March 31, 2014 and June 30, 2013. Member months represent the aggregate number of months of healthcare services HCP has provided to capitated members during a period of time: Members at Members months for Three months ended June 30, March 31, June 30, June 30, March 31, June 30, 2014 2014 2013 2014 2014 2013



HCP total capitated membership 828,500 795,300 733,300

2,455,700 2,373,000 2,209,000

In addition to the members above, HCP provided healthcare services to members of Magan Medical Group, an unconsolidated joint venture that is accounted for as an equity investment. The Magan Medical Group joint venture provided health care services for approximately 44,800 members as of June 30, 2014 and for approximately 133,600 member months for the quarter ended June 30, 2014.



The increase in members and member months was primarily attributable to an increase in senior members resulting from new acquisitions and non-acquired growth, partially offset by a decline in commercial members resulting from the state of California discontinuing the Healthy Families program.

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Revenues

The following table provides HCP's revenue by source:

Three months ended Six months ended June 30, March 31, June 30, June 30, June 30, 2014 2014 2013 2014 2013 (dollars rounded to nearest millions) HCP revenues: Commercial revenues $ 177 20 % $ 187 22 % $ 176 23 % $ 363 21 % $ 357 23 % Senior revenues 576 65 % 565 67 % 496 65 % 1,141 66 % 1,048 67 % Medicaid revenues 30 3 % 20 3 % 21 3 % 51 3 % 34 2 % Total capitated revenues $ 783 88 % $ 772 92 % $ 693 91 % $ 1,555 90 % $ 1,439 92 % Patient service revenue, net of provision for uncollectible accounts 58 7 % 56 7 % 49 7 % 114 7 % 103 7 % Other revenues 46 5 % 13 1 % 19 2 % 59 3 % 23 1 % Total net revenues $ 887 100 % $ 841 100 % $ 761 100 % $ 1,728 100 % $ 1,565 100 % Net revenues HCP's net revenue for the second quarter of 2014 increased by $46 million, or approximately 5.5%, as compared to the first quarter of 2014. The increase in revenue was primarily attributable to an increase in senior capitated members, an increase in Medicaid membership, the timing of revenue associated with HCP's annual premium reconciliation of senior capitated members, which previously occurred in the third quarter of 2013, and from the recognition of additional HCP revenues related to the maintenance of existing physician networks. HCP's net revenue for the second quarter of 2014 increased by $126 million, or approximately 16.6%, as compared to the second quarter of 2013. The increase in revenue was primarily attributable to an increase in the number of senior capitated members from acquired and organic growth, an increase in Medicaid membership, the timing of revenue associated with HCP's annual premium reconciliation of senior capitated members which previously occurred in the third quarter of 2013 and from the recognition of additional HCP revenues related to the maintenance of existing physician networks, partially offset by a decrease in Medicare Advantage rates, and a decline in the number of commercial members to whom HCP provides health care services. HCP's net revenue for the six months ended June 30, 2014 increased by $163 million, or approximately 10.4%, as compared to the same period in 2013. The increase in revenue was primarily attributable to an increase in the number of senior capitated members from acquired and organic growth, an increase in Medicaid membership, the timing of revenue associated with HCP's annual premium reconciliation of senior capitated members which previously occurred in the third quarter of 2013 and from the recognition of additional HCP revenues related to the maintenance of existing physician networks, partially offset by a decrease in Medicare Advantage rates, a reduction in Medicare rates due to sequestration and a decline in the number of commercial members to whom HCP provides health care services. On April 7, 2014 CMS issued final guidance for 2015 Medicare Advantage rates, which incorporated a re-blending of the risk adjustment models which CMS utilizes to determine risk acuity scores of Medicare Advantage patients. We estimate that the final cumulative impact of the 2015 rate structure represents an increase of up to approximately 0.4% of HCP's average revenues it manages on behalf of its senior capitated population as compared to 2014, instead of a decrease of 1.9% that was originally proposed by CMS in February 2014.



Operating expenses

HCP's patient care costs of approximately $688 million for the second quarter of 2014, increased by approximately $16 million, or approximately 2.4%, as compared to the first quarter of 2014. The increase is primarily attributable to the increase in medical claim expenses due to acquisitions and higher utilization, including an increase in higher dollar claims. 51



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HCP's patient care costs of approximately $688 million for the second quarter of 2014, increased by approximately $98 million, or approximately 16.6%, as compared to the second quarter of 2013. The increase was primarily attributable to the same factors as described for the increase in the second quarter of 2014 as compared to the first quarter of 2014. HCP's patient care costs of approximately $1,360 million for the six months ended June 30, 2014, increased by approximately $175 million, or approximately 14.8%, as compared to the same period in 2013. The increase was primarily attributable to the same factors as described for the increase in the second quarter of 2014 as compared to the first quarter of 2014.



HCP's general and administrative costs of approximately $77 million for the second quarter of 2014, was relatively flat as compared to the first quarter of 2014.

HCP's general and administrative costs of approximately $77 million for the second quarter of 2014, increased by approximately $21 million, or approximately 37.5%, as compared to the second quarter of 2013. The increase in general and administrative expenses was primarily attributable to increases in corporate support departments to accommodate additional acquisitions and changes in our estimated accruals related to acquired entities in the second quarter of 2013. HCP's general and administrative costs of approximately $155 million for the six months ended June 30, 2014, increased by approximately $30 million, or approximately 24.0%, as compared to the same period in 2013. The increase in general and administrative expenses was primarily attributable to increases in corporate support departments to accommodate additional acquisitions and changes in our estimated accruals related to acquired entities in the second quarter of 2013. HCP's depreciation and amortization of approximately $42 million for the second quarter of 2014 was relatively flat as compared to the first quarter of 2014. Depreciation and amortization is primarily based upon the fair value of equipment, leasehold improvements and intangible assets we recognized in the HCP acquisition and subsequent acquisitions. HCP's depreciation and amortization of approximately $42 million for the second quarter of 2014 increased by approximately $3 million, as compared to the second quarter of 2013, primarily attributable to depreciation and amortization of acquired assets associated with acquisitions. HCP's depreciation and amortization of approximately $84 million for the six months ended June 30, 2014 increased by approximately $8 million, as compared to the same period in 2013, primarily attributable to depreciation and amortization of acquired assets associated with acquisitions.



Segment operating income

HCP's operating income for second quarter of 2014 increased by approximately $28 million, or approximately 51.9%, as compared to the first quarter of 2014. The increase was primarily attributable to an increase in our senior capitated members, an increase in Medicaid membership, an increase in revenue associated with HCP's annual premium reconciliation of senior capitated members and from the recognition of additional HCP revenues related to the maintenance of existing physician networks, partially offset by a reduction in the number of commercial members and higher medical claims expenses.



For the three months ended June 30, 2014, HCP's operating income included approximately $12 million of operating income related to the physician owned entities (physician groups).

HCP's operating income for second quarter of 2014 was relatively flat as compared to the second quarter of 2013.

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HCP's operating income for six months ended June 30, 2014 decreased by approximately $54 million, or approximately 28.4%, as compared to the same period in 2013. The decrease was primarily attributable to a decrease in Medicare Advantage payments, a decrease in commercial memberships and higher medical claims expense, partially offset by an increase in our senior capitated members, an increase in Medicaid membership, an increase in revenue associated with HCP's annual premium reconciliation of senior capitated members and from the recognition of additional HCP revenues related to the maintenance of existing physician networks.



For the six months ended June 30, 2014, HCP's operating income included approximately $20 million of operating income associated with the physician groups.

Other-Ancillary services and strategic initiatives business

Our other operations include ancillary services and strategic initiatives which are primarily aligned with our core business of providing dialysis services to our network of patients. As of June 30, 2014 these consisted primarily of pharmacy services, disease management services, vascular access services, ESRD clinical research programs, physician services, direct primary care and our international dialysis operations. The ancillary services and strategic initiatives generated approximately $274 million of net revenues in the second quarter of 2014, representing approximately 8.5% of our consolidated net revenues. We currently expect to continue to invest in our ancillary services and strategic initiatives, including our continued expansion into certain international markets as we work to develop successful new business operations in the U.S. as well as outside the U.S. However, any significant change in market conditions, business performance or the regulatory environment may impact the economic viability of any of these strategic initiatives. Any unfavorable changes in these strategic initiatives could result in a write-off or an impairment of some or all of our investments, including goodwill and could also result in significant termination costs if we were to exit a particular line of business. As of June 30, 2014, we provided dialysis and administrative services to a total of 84 outpatient dialysis centers located in ten countries outside of the U.S. The total net revenues generated from our international operations are provided below.



The following table reflects the results of operations for the ancillary services and strategic initiatives:

Three months ended Six months ended June 30, March 31, June 30, June 30, June 30, 2014 2014 2013 2014 2013 (dollar amounts rounded to nearest millions) U.S. revenues Net patient service revenues $ 5 $ 4 $ 3$ 9 $ 6 Other revenues 227 212 164 439 317 Capitated revenues 16 16 18 32 34 Total 248 232 185 480 357 International revenues Net patient service revenues 24 23 13 47 24 Other revenues 2 2 2 3 3 Total 26 25 15 50 27 Total net revenues $ 274$ 257$ 200$ 530$ 384 Total operating (loss) income $ (2 ) $ 2 $ (7 ) $ - $ (22 ) Net revenues The ancillary services and strategic initiatives net revenues for the second quarter of 2014 increased by approximately $17 million or 6.6% as compared to the first quarter of 2014. The increase was primarily from growth in prescriptions dispensed as part of our pharmacy services. 53



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The ancillary services and strategic initiatives net revenues for the second quarter of 2014 increased by approximately $74 million, or 37.0%, as compared to the second quarter of 2013. The increase was primarily from growth in prescriptions dispensed as part of our pharmacy services and growth in our international operations. The ancillary services and strategic initiatives net revenues for the six months ended June 30, 2014 increased by approximately $146 million, or 38.0%, as compared to the same period in 2013. The increase was primarily from growth in prescriptions dispensed as part of our pharmacy services and growth in our international operations.



Operating expenses

Ancillary services and strategic initiatives operating expenses for the second quarter of 2014 increased by approximately $21 million as compared to the first quarter of 2014. The increase in operating expenses was primarily due to an increase in volume in our pharmacy business, increased expenses related to our disease management services and an increase in expenses associated with our international dialysis expansion. Ancillary services and strategic initiatives operating expenses for the second quarter of 2014 increased by approximately $69 million as compared to the second quarter of 2013. The increase in operating expenses was primarily due to an increase in volume in our pharmacy business, an increase in expenses associated with our international dialysis expansion into Europe, South America and Asia Pacific, an increase in labor costs and related payroll taxes and an increase in benefit costs. Ancillary services and strategic initiatives operating expenses for the six months ended June 30, 2014 increased by approximately $124 million as compared to the same period in 2013. The increase in operating expenses was primarily due to an increase in volume in our pharmacy business, an increase in expenses associated with our international dialysis expansion into Europe, South America and Asia Pacific, an increase in professional fees, higher labor costs and related payroll taxes and an increase in benefit costs.



Ancillary services and strategic initiatives operating income (loss)

Ancillary services and strategic initiatives operating income for the second quarter of 2014 decreased by approximately $4 million from the first quarter of 2014. The decrease in operating income was primarily due to an increase in costs associated with international dialysis expansion and an increase in claims expenses related to our disease management services, partially offset by improved operating performance in our pharmacy business. Ancillary services and strategic initiatives operating losses for the second quarter of 2014 decreased by approximately $5 million from the second quarter of 2013. The decrease in operating losses was primarily due to improved operating performance of our pharmacy business related to increased prescriptions dispensed, partially offset by an increase in costs associated with international dialysis expansion, an increase in claims expenses related to our disease management services, an increase in labor costs and related payroll taxes, and an increase in benefit costs. Ancillary services and strategic initiatives operating losses for the six months ended June 30, 2014 decreased by approximately $22 million from the same period in 2013. The decrease in operating losses was primarily due to improved operating performance of our pharmacy business related to increased prescriptions dispensed, partially offset by an increase in labor costs and related payroll taxes, and an increase in benefit costs.



Corporate-level charges

Debt expense. Debt expense of $106.1 million was relatively flat in the second quarter of 2014 as compared to the first quarter of 2014.

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Debt expense in the second quarter of 2014 decreased by approximately $2 million primarily due to lower average outstanding principal balances, as compared to the second quarter of 2013. Our overall weighted average effective interest rate for the second quarter of 2014 was 4.85% compared to 4.89% for the first quarter of 2014 and 4.86% for the second quarter of 2013.



For the six months ended June 30, 2014, debt expense of $212.5 million decreased by approximately $1.5 million, primarily due to lower average outstanding principal balances, as compared to the same period in 2013.

Corporate support costs. Corporate support costs consist primarily of labor, benefits and long-term incentive compensation costs for departments which provide support to all of our different operating lines of business. Corporate support costs were approximately $3.8 million in the second quarter of 2014, $1.1 million in the first quarter of 2014 and $11.0 million in second quarter of 2013. These expenses are included in our consolidated general and administrative expenses. The increase in corporate support costs in the second quarter of 2014 as compared to the first quarter of 2014 was primarily due to higher long-term incentive compensation. The decrease in corporate support costs in the second quarter of 2014 as compared to the second quarter of 2013 was primarily from internal management fees paid by our ancillary lines of businesses related to the licensing and the right to use newly developed intellectual property and other corporate level services. Corporate support costs were approximately $4.9 million in the six months ended June 30, 2014, as compared to $22.4 million for the same period in 2013. These expenses are included in our consolidated general and administrative expenses. The decrease in corporate support costs were primarily due to the same reasons as noted above for the change in the second quarter of 2014 as compared to the second quarter of 2013. Other income. Other income for the second quarter of 2014 was $1.7 million as compared to $1.7 million for the first quarter of 2014 and a loss of ($1.4) million for the second quarter of 2013. The increase in other income in the second quarter of 2014 as compared to the second quarter of 2013 was primarily related to the sale of certain investments at a loss during the second quarter of 2013. Noncontrolling interests Net income attributable to noncontrolling interests was $33.7 million for the second quarter of 2014 as compared to $28.4 million for the first quarter of 2014, and $29.0 million for the second quarter of 2013. The increases in net income attributable to noncontrolling interests in the second quarter of 2014, as compared to both the first quarter of 2014 and the second quarter of 2013, was primarily due to the overall number of joint ventures and an increase in the overall profitability of certain of our dialysis joint ventures.



Accounts receivable

Our consolidated total accounts receivable balances at June 30, 2014 and March 31, 2014 were $1,550 million and $1,540 million, respectively, which represented approximately 46 and 47 days of revenue, respectively, which is net of the provision for uncollectible accounts.

Outlook

We are updating our consolidated operating income guidance for 2014 to now be in the range of $1.755 billion to $1.840 billion. Our previous consolidated operating income guidance for 2014 was in the range of $1.725 billion to $1.840 billion. We are also updating our operating income guidance for our Kidney Care division for 2014 to now be in the range of $1.550 billion to $1.600 billion. Our previous operating income guidance for Kidney Care for 2014 was in the range of $1.520 billion to $1.580 billion. 55



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We are lowering the high end of our operating income guidance for HCP for 2014 to now be in the range of $205 million to $240 million. Our previous operating income guidance for HCP for 2014 was in the range of $205 million to $260 million.



We still expect our consolidated operating cash flow for 2014 to be in the range of $1.450 billion to $1.550 billion.

The consolidated cash flow amounts for 2014 exclude any potential payment relating to the 2010 and 2011 U.S. Attorney Physician Relationship Investigations.

These projections and the underlying assumptions involve significant risks and uncertainties, and actual results may differ materially from these current projections. See page 41 for further details regarding our forward looking statements.

Liquidity and capital resources

Liquidity and capital resources. Cash flow from operations during the second quarter of 2014 was $262 million, compared to $307 million during the second quarter of 2013. Cash flow from operations in the second quarter of 2014 decreased as a result of a decline in cash collections and the timing of certain other working capital items, partially offset by lower income tax payments. Non-operating cash outflows for the second quarter of 2014 included capital asset expenditures of $152 million, including $88 million for new center developments and relocations and $64 million for maintenance and information technology. In addition, we spent $31 million for acquisitions and we paid distributions to noncontrolling interests of $33 million in that period. Non-operating cash outflows for the second quarter of 2013 included capital asset expenditures of $142 million, including $84 million for new center developments and relocations and $58 million for maintenance and information technology. In addition, we spent $61 million for acquisitions and we paid distributions to noncontrolling interests of $30 million in that period. Cash flow from operations for the six months ended June 30, 2014 was $681 million, compared to $686 million during the same period in 2013. Cash flow from operations in 2014 decreased as a result of a decline in cash collections and the timing of certain working capital items. Non-operating cash outflows during the six months ended June 30, 2014, included capital asset expenditures of $279 million, including $165 million for new center developments and relocations and $114 million for maintenance and information technology. In addition, we spent $98 million for acquisitions and we paid distributions to noncontrolling interests of $66 million in that period. Non-operating cash outflows during the six months ended June 30, 2013, included capital asset expenditures of $258 million, including $154 million for new center developments and relocations and $104 million for maintenance and information technology. In addition, we spent $152 million for acquisitions and we paid distributions to noncontrolling interests of $65 million in that period. During the second quarter of 2014, our U.S. dialysis and related lab services business opened 22 dialysis centers and provided management and administrative services to one less dialysis center. In addition, our international dialysis operations acquired three dialysis centers, opened six dialysis centers, closed one dialysis center and provided management and administrative services to one additional center. During the second quarter of 2013, we acquired a total of three dialysis centers, opened 18 dialysis centers, merged one center into one other existing center, sold two centers and provided management and administrative services to one additional center located in the U.S. In addition, we also acquired a total of eight centers and closed one center outside of the U.S. During the six months ended June 30, 2014, our U.S. dialysis and related lab services business acquired a total of one dialysis center, opened 46 dialysis centers and merged two dialysis centers into other existing dialysis centers. In addition, our international dialysis operations acquired three dialysis centers, opened seven dialysis centers, closed two dialysis centers and provided management and administrative services to three additional 56



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centers. During the six months ended June 30, 2013, we acquired a total of 11 dialysis centers, opened 45 dialysis centers, merged two centers into other existing centers, sold two centers and provided management and administrative services to four additional centers located in the U.S. In addition, we also acquired and opened a total of 12 centers and provided management and administrative service to one additional center outside of the U.S., four of which we provide management and administrative services to, which we consolidate under applicable accounting standards. During the second quarter of 2014, our HCP business acquired one primary care physician practice and two private medical practices. During the six months ended June 30, 2014, our HCP business acquired one management services organization, six private medical practices, one family practice and two primary care physician practices. During the second quarter of 2013, our HCP business acquired two primary care physician practices and one oncology services center. During the six months ended June 30, 2014, our HCP business acquired two primary care physician practices, one oncology services center and one hospice care services business. During the first six months of 2014, we made mandatory principal payments under our then existing Senior Secured Credit Facilities (before entering into a new senior secured credit agreement and repaying all outstanding amounts under the then existing Senior Secured Credit Facilities) totaling $37.5 million on the Term Loan A, $16.9 million on the Term Loan A-3, $4.4 million on the Term Loan B and $4.1 million on the Term Loan B-2. In June 2014, we entered into a $5,500 million senior secured credit agreement (the New Credit Agreement). The New Credit Agreement consists of a five year Revolving Credit Facility in the aggregate principal amount of $1,000 million (the New Revolver), a five year Term Loan A facility in the aggregate principal amount of $1,000 million (the New Term Loan A) and a seven year Term Loan B facility in the aggregate principal amount of $3,500 million (the New Term Loan B and collectively with the New Revolver and the New Term Loan A, the New Loans). In addition, we can increase the existing revolving commitments and enter into one or more incremental term loan facilities in an amount not to exceed the sum of $1,500 million (less the amount of other permitted indebtedness incurred or issued in reliance on such amount), plus an amount of indebtedness such that the senior secured leverage ratio is not in excess of 3.50 to 1.00 after giving effect to such borrowings. The New Revolver and the New Term Loan A initially bears interest at LIBOR plus an interest rate margin of 1.75% which is subject to adjustment depending upon our leverage ratio and can range from 1.50% to 2.00%. The New Term Loan A requires annual principal payments beginning on September 30, 2014 of $25 million in 2014, $50 million in 2015, $62.5 million in 2016, $87.5 million in 2017, and $100 million in 2018 with the balance of $675 million due in 2019. The New Term Loan B bears interest at LIBOR (Floor of 0.75%) plus an interest rate margin of 2.75%. The New Term Loan B requires annual principal payments of $17.5 million in 2014, and $35 million for each year from 2015 through 2020, with the balance of $3,272.5 million due in 2021. These New Loans under the New Credit Agreement are guaranteed by certain of our direct and indirect wholly-owned domestic subsidiaries holding most of our domestic assets and are secured by substantially all of DaVita HealthCare Partners Inc.'s and the guarantors' assets. The New Credit Agreement contains certain customary affirmative and negative covenants such as various restrictions or limitations on the amount of investments, acquisitions, the payment of dividends and redemptions and the incurrence of other indebtedness. Many of these restrictions and limitations will not apply as long as our leverage ratio is below 3.50 to 1.00. In addition, the New Credit Agreement places limitations on the amount of tangible net assets of the non-guarantor subsidiaries and also requires compliance with a maximum leverage ratio covenant. In addition, in June 2014, we issued $1,750 million 5 1/8% Senior Notes due 2024 (the 5 1/8% Senior Notes). The 5 1/8% Senior Notes pay interest on January 15 and July 15 of each year beginning January 15, 2015. The 5 1/8% Senior Notes are unsecured obligations and will rank equally in right of payment with our existing and future unsecured senior indebtedness. The 5 1/8% Senior Notes are guaranteed by each of our domestic subsidiaries that guarantees our New Credit Agreement. We may redeem up to 35% of the 5 1/8% Senior Notes at any time prior to July 15, 2017 at a certain specified price from the proceeds of one or more equity offerings. In 57



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addition, we may redeem the 5 1/8% Senior Notes at any time prior to July 15, 2019 at make whole redemption prices and after such date at certain specified redemption prices. We received total proceeds from these borrowings of $6,250 million, $4,500 million from the issuance of the New Term Loans and $1,750 million from the issuance of the 5 1/8% Senior Notes. We used a portion of the proceeds to pay off the total outstanding principal balances under our then existing Senior Secured Credit Facilities plus accrued interest totaling $5,362.4 million and in addition, to purchase pursuant to a cash tender offer $483.1 million of the outstanding principal balances of our $775 million 6 3/8% Senior Notes plus accrued interest and cash tender premium totaling $512.4 million. The total amount paid for the 6 3/8% Senior Notes from the cash tender offer was $1,051.25 per 1,000 of principal amount of the 6 3/8% Senior Notes, which resulted in our paying a cash tender premium of $24.8 million for the redemption of this portion of the 6 3/8% Senior Notes. We also incurred an additional $81.6 million in fees, discounts and other professional expenses associated with these transactions. In July 2014, we also purchased an additional $0.188 million principal amount of the 6 3/8% Senior Notes plus accrued interest totaling $0.194 million pursuant to the cash tender offer at a price of $1,021.25 per 1,000 of principal amount of the 6 3/8% Senior Notes, which resulted in our paying an additional cash tender premium of $0.004 million. In addition, in July 2014, we redeemed the remaining outstanding principal balance of the 6 3/8% Senior Notes of $291.7 million at a redemption price of $1,047.81 per 1,000 of principal amount of the 6 3/8% Senior Notes plus accrued interest and a redemption premium which totaled $310.0 million. This resulted in an additional redemption premium of $14.0 million being recorded as debt refinancing charges. As a result of these transactions, we recorded debt refinancing charges of $97.5 million that consist of the cash tender premiums, the redemption premium, the write-off of existing deferred financing costs, the write-off of certain new refinancing costs, other professional fees and the losses associated with the termination of several of our interest rate swap agreements. In addition, as a result of these transactions, we terminated $1,137.5 million notional amounts of amortizing swaps and also terminated $600.0 million of forward swaps during June 2014, that resulted in our recognizing a loss of $3.1 million, of which $3.0 million was previously recorded in other comprehensive income due to our previously outstanding principal debt being paid-off as described above, and as a result of future forecasted transactions that are no longer probable. The loss is included as a component of our debt refinancing charges. During the six months ended June 30, 2014, we recognized debt expense of $6.1 million from these swaps. As of June 30, 2014, we maintain several interest rate swap agreements that were entered into in March 2013 with amortizing notional amounts of these swap agreements totaling $878.7 million. These agreements have the economic effect of modifying the LIBOR variable component of our interest rate on an equivalent amount of our New Term Loan A to fixed rates ranging from 0.49% to 0.52%, resulting in an overall weighted average effective interest rate of 2.26%, including the New Term Loan A margin of 1.75%. The overall weighted average effective interest rate also includes the effects of $121.3 million of unhedged New Term Loan A debt that bears interest at LIBOR plus an interest rate margin of 1.75%. The swap agreements expire on September 30, 2016 and require monthly interest payments. During the six months ended June 30, 2014, we recognized debt expense of $1.6 million from these swaps. As of June 30, 2014, the total fair value of these swap agreements was a net asset of approximately $0.8 million. We estimate that approximately $2.7 million of existing unrealized pre-tax losses in other comprehensive income at June 30, 2014 will be reclassified into income over the next twelve months. As of June 30, 2014, we maintain several interest rate cap agreements that were entered into in March 2013 with notional amounts totaling $2,735 million on our New Term Loan B debt. These agreements have the economic effect of capping the LIBOR variable component of our interest rate at a maximum of 2.50% on an 58



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equivalent amount of our New Term Loan B. During the six months ended June 30, 2014, we recognized debt expense of $1.2 million from these caps. The cap agreements expire on September 30, 2016. As of June 30, 2014, the total fair value of these cap agreements was an asset of approximately $2.7 million. During the six months ended June 30, 2014, we recorded a loss of $4.9 million in other comprehensive income due to a decrease in the unrealized fair value of these cap agreements. As of June 30, 2014, we also maintain five other interest rate cap agreements with notional amounts totaling $1,250 million. These agreements have the economic effect of capping the LIBOR variable component of our interest rate at a maximum of 4.00% on an equivalent amount of our New Term Loan B debt. However, as a result of the interest rate cap agreements that were entered into in March 2013, as described above, these interest rate cap agreements became ineffective cash flow hedges and as a result any changes in the fair value associated with these interest rate cap agreements will be charged to income. During the six months ended June 30, 2014, we recognized debt expense of $1.8 million from these caps. The cap agreements expire on September 30, 2014. As a result of an embedded LIBOR floor on the New Term Loan B debt agreement and the swap and cap agreements, our overall weighted average effective interest rate on the Senior Secured Credit Facilities was 3.51%, based upon the current margins in effect of 1.75% for the New Term Loan A and 2.75% for the New Term Loan B, as of June 30, 2014. As of June 30, 2014, the interest rate on our New Term Loan B debt is effectively fixed because of an embedded LIBOR floor which is higher than actual LIBOR as of such date. Furthermore, the interest rate on $2,735 million of our New Term Loan B is subject to an interest rate cap if LIBOR should rise above 2.50%. Interest rates on our senior notes are fixed by their terms. The LIBOR variable component of our interest rates on the majority of our New Term Loan A is economically fixed as a result of interest rate swaps.



Our overall weighted average effective interest rate during the second quarter of 2014 was 4.85% and as of June 30, 2014 was 4.56%.

As of June 30, 2014, we had undrawn revolving credit facilities totaling $1,000 million of which approximately $83 million was committed for outstanding letters of credit. In addition, HCP has an outstanding letter of credit of approximately $1 million that is secured by a certificate of deposit. We believe that we will have sufficient liquidity and will generate significant operating cash flows to fund our scheduled debt service and other obligations for the foreseeable future, including the next 12 months, under the terms of our debt agreements. Our primary sources of liquidity are cash from operations and cash from borrowings. Goodwill HCP's current and expected future operating results have eroded recently, primarily as a result of reductions in its Medicare Advantage reimbursement rates. As a result, we have determined that two of HCP's reporting units, HCP California and HCP Nevada, are at risk of goodwill impairment. HCP California and HCP Nevada have goodwill of $2,511 million and $518 million respectively. We obtained preliminary third-party valuations of these two businesses as of June 30, 2014, noting that the estimated fair values of HCP California and HCP Nevada exceed their total carrying values by approximately 6.0% and 10.9%, respectively. Further reductions in HCP's reimbursement rates or other significant adverse changes in its expected future cash flows or valuation assumptions could result in a goodwill impairment charge in the future. For example, a sustained, long-term reduction of 3% in operating income for HCP California and HCP Nevada could reduce their estimated fair values by up to 3.1% and 2.9%, respectively. Separately, an increase in their respective discount rates of 100 basis points could reduce the estimated fair values of HCP California and HCP Nevada by up to 7.7% and 6.1%, respectively. 59



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During the first six months of 2014, we did not record any goodwill impairment charges. Except as described above, none of the goodwill associated with our various other reporting units was considered at risk of impairment as of June 30, 2014. Since the dates of our last annual goodwill impairment tests, there have been certain developments, events, changes in operating performance and other changes in circumstances that have affected our businesses. However, these did not cause management to believe it is more likely than not that the fair value of any of its reporting units would be less than its carrying amount.



Stock-based compensation awards

Stock-based compensation awards are measured at their estimated fair values on the date of grant if settled in shares, or at their estimated fair values at the end of each reporting period if settled in cash. The value of stock-based awards so measured is recognized as compensation expense on a cumulative straight-line basis over the vesting terms of the awards, adjusted for expected forfeitures. During the six months ended June 30, 2014, we granted 1,247,927 stock-settled stock appreciation rights with an aggregate grant-date fair value of $20.0 million and a weighted-average expected life of approximately 4.2 years and 315,799 stock units with an aggregate grant-date fair value of $22.8 million and a weighted-average expected life of approximately 3.4 years, 105,360 of which are performance-based.



Long-term incentive compensation

Long-term incentive program (LTIP) compensation includes both stock-based awards (principally stock-settled stock appreciation rights, restricted stock units and performance stock units) as well as long-term performance-based cash awards. Long-term incentive compensation expense, which was primarily general and administrative in nature, was attributed to our dialysis and related lab services business, our HCP business, corporate support costs, and the ancillary services and strategic initiatives. Long-term incentive compensation costs of $29.9 million in the second quarter of 2014 increased by approximately $6.8 million as compared to the first quarter of 2014 and increased by approximately $9.8 million as compared to the second quarter of 2013. The increase in long-term incentive compensation in the second quarter of 2014 as compared to the first quarter of 2014 was primarily due to an increase in the fair value of LTIP awards during the quarter that contributed additional expense as well as the additional expense from LTIP awards granted during the second quarter. The increase in long-term incentive compensation in the second quarter of 2014 as compared to the second quarter of 2013 was primarily due to an increase in the fair value of LTIP awards that contributed expense to this period and additional expense from the LTIP grants awarded during the quarter. As of June 30, 2014, there was $162.4 million of total estimated unrecognized compensation cost for outstanding LTIP awards, including $99.3 million related to stock-based compensation arrangements under our equity compensation and stock purchase plans. We expect to recognize the performance-based cash component of these LTIP costs over a weighted average remaining period of 1.1 years and the stock-based component of these LTIP costs over a weighted average remaining period of 1.4 years.



Off-balance sheet arrangements and aggregate contractual obligations

In addition to the debt obligations reflected on our balance sheet, we have commitments associated with operating leases and letters of credit, as well as potential obligations associated with our equity investments in nonconsolidated businesses and to dialysis centers that are wholly-owned by third parties. Substantially all of our U.S. dialysis facilities are leased. We have potential obligations to purchase the noncontrolling interests held by third parties in several of our majority-owned joint ventures, non-owned and minority-owned entities. These obligations are in the form of put provisions and are exercisable at the third-party owners' discretion within specified periods as outlined in each specific put provision. If these put provisions were exercised, we would be required to purchase the third-party owners' noncontrolling interests at either the appraised fair market value or a predetermined multiple of earnings or cash flow attributable to the noncontrolling interests put to us, which is 60



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intended to approximate fair value. The methodology we use to estimate the fair values of noncontrolling interests subject to put provisions assumes either the higher of a liquidation value of net assets or an average multiple of earnings, based on historical earnings, patient mix and other performance indicators that can affect future results, as well as other factors. The estimated fair values of the noncontrolling interests subject to put provisions is a critical accounting estimate that involves significant judgments and assumptions and may not be indicative of the actual values at which the noncontrolling interests may ultimately be settled, which could vary significantly from our current estimates. The estimated fair values of noncontrolling interests subject to put provisions can fluctuate and the implicit multiple of earnings at which these noncontrolling interests obligations may be settled will vary significantly depending upon market conditions including potential purchasers' access to the capital markets, which can impact the level of competition for dialysis and non-dialysis related businesses, the economic performance of these businesses and the restricted marketability of the third-party owners' noncontrolling interests. The amount of noncontrolling interests subject to put provisions that contractually employ a predetermined multiple of earnings rather than fair value are immaterial. For additional information see Note 10 to the condensed consolidated financial statements. We also have certain other potential commitments to provide operating capital to several dialysis centers that are wholly-owned by third parties or centers in which we own a minority equity investment as well as to physician-owned vascular access clinics that we operate under management and administrative services agreements.



The following is a summary of these contractual obligations and commitments as of June 30, 2014 (in millions):

Remainder of 1-3 4-5 After 2014 years years 5 years Total Scheduled payments under contractual obligations: Long-term debt $ 344 $ 343$ 858$ 7,089$ 8,634 Interest payments on the senior notes 63 541 426 822 1,852 Interest payments on the New Term Loan B(1) 65 305 239 234 843 Interest payments on the New Term Loan A(2) 10 44 28 - 82 Capital lease obligations 4 26 23 130 183 Operating leases 167 1,007

493 714 2,381 $ 653 $ 2,266$ 2,067$ 8,989$ 13,975 Potential cash requirements under existing commitments: Letters of credit $ 84 $ - $ - $ - $ 84 Noncontrolling interests subject to put provisions 424 131 79 126 760 Non-owned and minority owned put provisions 31 - - - 31 Pay-fixed swaps potential obligations 3 - - - 3 Operating capital advances 2 - - - 2 $ 544 $ 131$ 79$ 126$ 880



(1) Assuming no changes to LIBOR-based interest rates as the New Term Loan B

currently bears interest at LIBOR (floor of 0.75%) plus an interest rate

margin of 2.75%.

(2) Based upon current LIBOR-based interest rates in effect at June 30, 2014

plus an interest rate margin of 1.75% for the New Term Loan A.

The pay-fixed swap obligations represent the estimated fair market values of our interest rate swap agreements that are based upon valuation models utilizing the income approach and commonly accepted valuation techniques that use inputs from closing prices for similar assets and liabilities in active markets as well as other relevant observable market inputs and other current market conditions that existed as of June 30, 2014. This amount represents the estimated potential obligation that we would be required to pay based upon the 61



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estimated future settlement of each specific tranche over the term of the swap agreements, assuming no future changes in the forward yield curve. The actual amount of our obligation associated with these swaps in the future will depend upon changes in the LIBOR-based interest rates that can fluctuate significantly depending upon market conditions, and other relevant factors that can affect the fair market value of these swap agreements. In addition to the above commitments, we are obligated to purchase a certain amount of our hemodialysis products and supplies at fixed prices through 2015 from Gambro Renal Products, Inc. (Gambro) in connection with a product supply agreement with Gambro. Our total expenditures for the six months ended June 30, 2014 on such products were approximately 2% of our total U.S. dialysis operating costs. In January 2010, we entered into an agreement with Fresenius which originally committed us to purchase a certain amount of dialysis equipment, parts and supplies from them through 2013. However, this agreement has been extended through 2015. Our total expenditures for the six months ended June 30, 2014 on such dialysis products were approximately 2% of our total U.S. dialysis operating costs. The actual amount of purchases in future years from Gambro Renal Products and Fresenius will depend upon a number of factors, including the operating requirements of our centers, the number of centers we acquire, growth of our existing centers, and in the case of the Product Supply Agreement, Gambro Renal Products' ability to meet our needs. In November 2011, we entered into a seven year sourcing and supply agreement with Amgen USA Inc. that expires on December 31, 2018. Under the terms of the agreement, we will purchase EPO in amounts necessary to meet no less than 90% of our requirements for erythropoiesis stimulating agents (ESAs). The actual amount of EPO that we will purchase from Amgen will depend upon the amount of EPO administered during dialysis as prescribed by physicians and the overall number of patients that we serve. Settlements of approximately $74 million of existing income tax liabilities for unrecognized tax benefits including interest, penalties and other long-term tax liabilities are excluded from the above table as reasonably reliable estimates of their timing cannot be made.



Supplemental information concerning certain Physician Groups and unrestricted subsidiaries

The following information is presented as supplemental data as required by the indentures governing our senior notes.

We provide services to certain physician groups that, while consolidated in our financial statements for financial reporting purposes, are not subsidiaries of or owned by us, do not constitute "Subsidiaries", as defined in the indentures governing our outstanding senior notes, and do not guarantee those senior notes. In addition, we have entered into management agreements with these physician groups pursuant to which we receive management fees from the physician groups. As of June 30, 2014, if these physician groups were not consolidated in our financial statements, our consolidated indebtedness would have been approximately $8,800 million, our consolidated other liabilities (excluding indebtedness) would have been approximately $3,151 million and our consolidated assets would have been approximately $17,451 million. If these physician groups were not consolidated in our financial statements (i) for the three months ended June 30, 2014, our consolidated total net revenues (including approximately $145 million of management fees payable to us), consolidated operating income and consolidated net income would be reduced by approximately $253 million, $12 million, and $6 million, respectively, and (ii) for the six months ended June 30, 2014, our consolidated total net revenues (including approximately $302 million of management fees payable to us), consolidated operating income and consolidated net income would be reduced by approximately $494 million, $20 million, and $9 million, respectively.



In addition, we own a 67% equity interest in California Medical Group Insurance (CMGI). CMGI is an Unrestricted Subsidiary, as defined in the indentures governing our outstanding senior notes, and does not guarantee those senior notes. Our equity interest in CMGI is accounted for under the equity method of

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accounting, meaning that, although CMGI is not consolidated in our financial statements for financial reporting purposes, our consolidated income statement reflects our pro rata share of CMGI's net loss as equity investment loss. For the three months ended June 30, 2014, our equity investment income attributable to CMGI was income of approximately $0.016 million, and for the three months ended June 30, 2014, excluding our equity investment income attributable to CMGI, our consolidated operating income and consolidated net income would be decreased by approximately $0.016 million and $0.009 million, respectively. For the six months ended June 30, 2014, our equity investment loss attributable to CMGI was a loss of approximately $0.2 million, and for the six months ended June 30, 2014, excluding our equity investment loss attributable to CMGI, our consolidated operating income and consolidated net income would be increased by approximately $0.2 million and $0.1 million, respectively. See Note 20 to the condensed consolidated financial statements for further details.


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Source: Edgar Glimpses


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